Financing a business transaction, whether it’s an asset purchase or a share acquisition, can be complex, involving multiple parties, financial arrangements and legal considerations. At Grigoras Law, we frequently get questions from clients about the financing process. Here, we address three of the most common questions to help demystify the essentials of deal financing.
1. What Is the Purpose of a Commitment Letter in Deal Financing?
A commitment letter is a key element in financing a business acquisition. It is a formal promise from the lender, often a bank or financial institution, to provide a specified amount of financing to the purchaser. This letter outlines the terms and conditions under which the lender agrees to lend money. Sometimes clients come to us with a commitment letter that’s already been issued, while others seek legal advice before signing so that they understand all the obligations.
The terms of a commitment letter matter. Here are some key points to consider:
- Interest Rates and Fees: The cost of financing can significantly impact the success of a deal. Important factors include the interest rate, amortization period, and fees like commitment or standby fees. Legal counsel can often assist in negotiating these terms to secure better rates or reduce fees.
- Security Requirements: Most commitment letters outline the security the borrower must provide, such as general security agreements, guarantees, or mortgages on assets. It’s important to understand the overlap in these security requirements, as some may be redundant and negotiable.
- Covenants and Conditions: Borrowers also need to comply with specific covenants, such as maintaining financial ratios or providing regular reports. Legal advice can help keep these covenants achievable and realistic.
Commitment letters set the foundation for loan agreements and establish the terms that will govern the financing. Having legal oversight during this stage can help prevent unfavourable obligations that could complicate the transaction later.
2. How Do Security Agreements and Guarantees Work?
Security agreements and guarantees are necessary components of securing financing for business transactions. Security agreements give lenders an interest in specific assets, while guarantees provide extra assurance that the lender will be repaid.
Security Agreements: These agreements define the collateral used to secure the loan, which can include anything from inventory and intellectual property to real estate or company shares. Often, lenders use a general security agreement to create a security interest in all of the borrower’s current and future assets. In some cases, additional agreements are required for specific collateral types, like intellectual property or stocks.
One necessary part of a security agreement is the description of collateral. The Personal Property Security Act (PPSA) requires that collateral be clearly described to be identifiable. Accurate descriptions help with compliance and prevent disputes down the line.
Blanket filings, which cover all assets under one registration, are sometimes used to save costs. However, careful drafting is required to meet statutory requirements and protect the lender’s interest.
Guarantees: Guarantees are used when lenders need additional assurance that the borrower will fulfill their obligations. A guarantee can be provided by an individual or a corporation, and it may be limited or unlimited in scope.
Corporate guarantees can be complicated, especially where statutory restrictions apply, such as solvency tests. Guarantees also often include an assignment and postponement of debts clause, giving the lender priority over other creditors in the event of default.
When a spouse or elderly family member provides a guarantee, lenders often require independent legal advice so that they fully understand their obligations. This helps prevent future disputes related to undue influence or misunderstandings.
3. What Corporate Records and Legal Opinions Are Needed for Deal Financing?
Corporate records and legal opinions are critical for securing financing and completing the transaction. These documents reassure lenders that the borrower is in good standing and that the security provided is valid.
Corporate Records: For a financing transaction, the borrower needs to provide several corporate documents, such as:
- Certificates of Standing: These confirm the corporate borrower is in good standing in all jurisdictions where it operates.
- Certified Charter Documents: Lenders often require copies of the corporate charter and by-laws to verify the authority to enter into the transaction.
- Resolutions Authorizing the Financing: The corporate borrower must pass resolutions authorizing the loan and related security documents. This is particularly important when borrowing involves pledging assets or goes beyond regular business activities.
Legal Opinions: Lenders often ask for a legal opinion from the borrower’s lawyer, confirming that the borrower has the authority to enter into the financing and that all necessary corporate steps have been taken. These opinions may also verify the validity and enforceability of the security being provided.
Post-closing, lenders may request further legal opinions, confirming that all transaction documents have been executed correctly, security interests have been perfected, and all conditions have been met.
Proper preparation and coordination of corporate records are needed for a smooth closing. When multiple parties are involved, early approvals and certifications can prevent costly delays.
Conclusion
Financing a business acquisition involves numerous steps that require careful attention and legal advice. From the commitment letter to the security agreements and guarantees and the corporate records, each stage matters to the transaction’s success. Legal counsel can help minimize risks, keep the transaction in compliance and bring it to a clean closing.
If you need assistance with financing your next business transaction, Grigoras Law is here to help. We act from the initial negotiation to the final execution, and the intake form is the way to reach the firm.
This article is part of the firm’s work in corporate law and business purchases and sales.