GLOSSARY: Common Financing Terms

Below is a list of common terms used by investors and commercial lenders when a business is seeking to raise capital. 

 A

Acceleration —  Acceleration is the process, where the lender demands a full and final payment of the debt or loan, before the allotted time period for repayment. A clause in the document of the debt usually empowers the lender to accelerate the time period.

Acceleration Clause —  A clause in the debt document that empowers the lender to accelerate the payment, (i.e. or that is) the lender can demand the full amount of loan before the date of maturity

Accounts Payable —  Accounts payable is a list of liabilities of an organization or an individual that are due but not paid to creditors. Account payable, many a times, also appears as a current liability in the balance sheet. One must note that loans and liabilities to the bank which have not maturated, are not a part of account payable.

Accrued Interest — Interest owed on a loan or other obligation but not yet paid.

Amortization — Amortization of loans refers to the process of liquidating a loan by way of periodic payments which reduce the principal owed. The principal amount of the loan is amortized periodically by the method of payments in installments. The techniques that are used for the amortization of a loan differ from case to case (see Term Loan, Straight Line Amortization and Bullet Amortization, or check out our link to Bankrate’s Amortization Calculator).

Amortization Period — The Amortization period is the time period contemplated at the inception of the loan, ending upon the maturity of the loan. The amortization period is considered when the lender determines the rate of interest, time line of installments and also the appropriate amount of the installments. Typically, shorter amortization periods will come with a lower rate of interest, as the lender has the ability to adjust the loan terms upon maturity. 

Angel Investors —  Angels are private investors who may work as an individual or as a part of an angel network.  Either way, an Angel is a person who invests in a business venture, providing capital for start-up or expansion. These individuals are looking for a higher rate of return than would be given by more traditional investments (typically an annual return of 25 percent or more).  Angels typically will invest $50,000 to $500,000 and therefore they fill a void between the small check one might receive from family and friends and the multi-million dollar check a business might seek from a venture capital firm.  Typically, an angel investor is someone who has started and run a company in the past, and is looking for a personal opportunity as well as an investment.   Because angels want to be able to add value for the company, it’s important for any business person thinking of working with angel investors to be very clear about what role the investors might play in the business (for example, do they want to be a silent partner, a board member, or an executive?).  For more info on Angels, check out http://findcapital.org/2010/04/22/angel-investors-is-an-%e2%80%9cangel%e2%80%9d-the-right-solution/

Annual Percentage Rate (APR) — The APR is calculated by dividing the total financing costs associated with a loan by the principal amount of the loan.  

Annual Percentage Yield (APY) — The APY is a more accurate and calculated measure of yield that is paid on a standard bank deposit account, taking into consideration the impact of compounding interest.

Appraisal — An estimate of the value of property to be used as collateral for a loan.  Common when borrowing money secured by real estate, machinery and equipment, or inventory.

Availability (or Available Funds) — The amount of cash that may be withdrawn or used immediately or on demand.  If a business line of credit is tied to 75% of eligible receiveables and the business has $2 million in net eligible accounts receiveable, then availability would be $1.5 million less any amount previously withdrawn.

B

Balloon Payment or Bullet Payment  — A single payment for an entire loan amount that is paid at maturity.

“Bankable”  — A borrower is said to be “bankable” when the capital needs of the business are supported by sufficient collateral and earnings.  An established, profitable business with $10 million of collateral that is seeking a $5 million loan would typically be considered “bankable”.  A start-up business with high expenses, no revenue and no collateral other than intellectual property would not be considered “bankable”.

Bank Debt —  A bank debt is basically any debt that is owed to a bank, by any kind of consumer, organization or corporation. The debt may be anything from a bank loan to a credit card debt or an overdraft that has been used. 

Bank Holding Company — Any corporation that controls one or more banks. Examples include Goldman Sachs and Bank of America.  The corporation is subject to the Bank Holding Company Act, administered by the Federal Reserve Board.

Basis Point — One one-hundredth of a percentage point. A unit commonly used to express differences in or changes in interest rates.  100 basis points = 1 percent.

Bridge Loan — A short term loan, typically at a high interest rate – to support business operations while longer-term financing (such as a venture capital investment or an IPO) is pending.  In the context of mergers and acquisitions, a bridge loan may be provided to a company in distress in order to provide working capital (which often leads to the rhetorical question “is this a bridge or a plank?”)

Bullet Amortization —  Any loan that requires a balloon payment at the end of the term and anticipates that the loan will be refinanced in order to meet the balloon payment obligation.

C

Call loan — Money loaned by banks, usually to securities dealers or brokers, for which demand may be made at any time. Also called demand loans.

Call option — Contract that provides the owner with the right to purchase a specified financial instrument at a specified price within a specified period of time.

Cash items — Checks or coupons that accepted for tentative credit to a depositor’s account, subject to reversal if the items are not paid.

Classified Loans — Those loans criticized by an examiner as having a greater than normal degree of risk, The ratings used include “substandard”, “doubtful”, and “loss”.

Collateral — Specific property that a borrower pledges as security for a loan, agreeing that the lender shall have the right to sell the collateral if the borrower fails to respay the loan at maturity.

Commercial Paper — Short-term securities issued by large corporations with AAA credit ratings.  Commercial paper is not a financing option for small and middle-market businesses.

Covenants (also “Loan Covenants”) — Every loan agreement will contain certain covenants, or stipulations on the part of the borrower.  For example, there may be covenants where the borrower agrees not to defraud the lender, agrees to submit the books to an annual audit, agrees to file all tax returns on time, and agrees to pay all principal and interest on a pre-determined schedule.  If the borrower fails to comply with one or more of the loan covenants, the borrower would be in covenant default.

Correspondent Banking — Procedure by which banks perform services for another. Small banks rely extensively on larger correspondent banks for such services as check collection and participation in loans, and as a source of liquidity.

Credit — An advance of cash or merchandise in exchange for a promise to pay a definite sum in the future. Long-term credit generally involves bonds or mortgages. Short-term credit granted to an individual for personal use is called consumer credit.

D

Default  — A default is a scenario where the borrower has failed to comply with one or more of the loan covenants enumerated in the loan agreement.  There are many types of default, but the two most commonly referred to are “technical default” and “payment default”. 

• A Technical Default is when the borrower has remained current on all principal and interest payments, but is no longer in compliance with one or more loan covenants – such as a fixed charge covenant. A fixed charge covenant is a stipulation that the borrower’s EBITDA during a period of time (a quarter or a fiscal year) must exceed the total fixed charges (principal, interest and bank fees) for that period, typically by a margin of 25% to 50%.  If the fixed charge covenant is 1.3x, then the EBITDA must be greater than 1.3x the fixed charges.  If not, the borrower would be in technical default.
• A Payment Default is when the has missed one or more fixed charge payments.  A payment default is the most serious type of default, and could lead to the lender calling the loan immediately.

Default Rate  — A default rate is a higher interest rate that lenders may charge to a borrower in the event of a default. Typically, the default rate is 2% to 3% above the contracted rate, but it depends on the loan agreement, the state in which the agreement was written, and other factors.

Depository Institution — A financial institution that accepts deposit accounts; a commercial bank, savings bank, savings and loan association, or credit union.  By contrast, a non-depository credit institution would include commercial finance companies (like GE Capital), hedge funds, and other investment entities which have the capacity to lend money, but which do not accept deposits.

Dilution — Dilution has two primary meanings in the business context:  (1) The change in earnings per share or book value per share that would result if all warrants and stock options were exercised and all convertible securities were converted to equity; and (2) The amount to which existing shareholders’ ownership, on a percentage basis, will be reduced as a consequence of new stock being issued.  For more information about this sort of dilution, check out this article from the Motley Fool (http://www.fool.com/investing/general/2007/09/05/foolish-fundamentals-stock-dilution.aspx.)

Discount rate — The rate charged by the Federal Reserve banks for loans to other banks.  The discount rate doesn’t apply to commercial borrowers, nor does it directly correlate to the prime rate or other commercial interest rates.

E

Early Repayment (or refinancing) Penalty — An early repayment penalty is a penalty that is levied by a bank because of an early payoff of a loan by a borrower.  Most small business loans will have some penalty for early repayment, akin to a penalty for early withdrawal from a certificate of deposit.  Typically, the size of the penalty will decrease over time, and for most loans there would be no penalty for repayment or refinancing the loan after 2-3 years.

Eligible Receivables – Eligible receivables are a concept defined in a loan document, typically when the loan is in the form of an asset-based line of credit.  The purpose of classifying certain receivables as eligible or ineligible is to limit the lender’s exposure to losses due to the borrower’s bad debt.  When XYZ corporation extends credit to its customers (thereby creating an account receivable), the officers of XYZ have complete discretion over how much credit to extend and for what period of time.  After all, the relationship with XYZ’s customer might be dependent on XYZ’s ability and willingness to extend such credit.  However, XYZ’s lender isn’t in the business of making such case-by-case decisions, so the lender will set limits that cap the amount of each receivable as well as its age.  A typical small business line of credit will consider eligible receivables to include third-party receivables for which the customer has signed a purchase order or contract, and which are aged not more than 90 days, subject to a dollar cap on each individual receivable.

Eligible Inventory – The definition of eligible inventory, like eligible receivables, will be spelled out in a loan document, typically when the loan is in the form of an asset-based line of credit.  The purpose of classifying inventories is to limit the lender’s exposure to losses on obsolete inventory.  Eligibility varies widely from one industry to another, and is generally tied to the liquidation value of inventories in the event that the business were to cease operations.    A typical small business line of credit will consider eligible inventories to include a percentage of raw material inventory (25% to 50%) and a percentage on finished goods (20% to 50%).  Work-in-process inventory is rarely included in the calculation of eligible inventory because a half-completed product is very difficult to sell in the event of a liquidation.

Equity – The concept of equity has two primary connotations in business.  (1) If a business is financed by the owner(s), without debt or obligation to any third party, the business is said to be “financed with equity”, and the value of the equity is equal to the value of the tangible and intangible assets of the enterprise.  If a business borrows money or relies on credit (including vendor credit), then the value of the shareholders’ equity (also “book value” or “net worth”) is calculated as Equity = Assets – Liabilities. (2) If a business is seeking to raise equity capital, such as venture capital, the intention is for the business to issue new stock in exchange for new capital (cash), which increases the equity capital of the business.  (Also see “Private Equity”)

Escrow — A written agreement entered into by three parties and deposited for safekeeping with the third party as custodian, to be delivered by the latter only upon the performance or fulfillment of an obligation.  For example, when purchasing real estate, a buyer puts an earnest money deposit into escrow when the purchase and sale agreement is signed.  The obligation in this case is for the buyer to show up at the closing with financing.  If the buyer can’t get financing, the buyer loses the deposit, which is paid over to the seller as compensation for taking the property off the market.

ESOP - An Employee Stock Ownership Plan (ESOP) is an employee benefit plan in which the employees of a company become owners of stock in that company. The most common reason for a business to establish an ESOP is to provide liquidity to the founder or shareholders for retirement.  ESOPs generally require that the business will borrow money to fund the shareholder buy-out in stages over time.  ESOPs are typically not the most lucrative means by which to exit a business, but they have tax advantages which can make this option more attractive for certain types of businesses.  ESOPs can be established for any size company and include: UPS, AVIS, Charles Schwab, Morgan Stanley, and Southwest Airlines.

F

Factoring  (also referred to as “Invoice Factoring” or “Receivables Financing”)  — A common practice of small and early-stage businesses that provides the enterprise with faster access to working capital.  The primary benefit is that factoring allows the business to turn accounts receivable  (i.e., invoices) into cash more quickly, and thereby do more business with less working capital.  The downside however is that factoring is far more expensive than a revolving line of credit.  For more information, check out  http://findcapital.org/2010/05/06/invoice-factoring-pros-and-cons/

Federal Deposit Insurance Corporation (FDIC) — Federal agency that both regulates and insures the deposits of commercial banks and savings institutions.

Federal Reserve System (also “The Fed”) — The Fed is the central bank of the United States, consisting of 12 Federal Reserve Districts (Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, San Francisco). Each of these districts includes member banks regulated and served by a Federal Reserve Bank. The Fed’s principal responsibility is the management of monetary policy, but in the wake of the credit crisis which began in 2008, the Fed has played (and seeks to play) a larger role in Bank regulation.

Fiduciary Duty — A fiduciary duty is a legal or ethical relationship of confidence or trust between two or more parties. For executives and business owners, a fiduciary duty is owed to the Company’s stakeholders, which includes shareholders, creditors, and in some cases, employees.  Issues of fiduciary duty tend to arise when a business is in distress, and the officers of the business are expected to act not in their own best interest, but in the best interest of the principals to whom the duty is owed.  For example, when the chief financial officer realizes that the Company has failed to contribute a sufficient amount to the pension fund, she has a fiduciary duty to the fund’s beneficiaries, and failing to act accordingly could be later construed as a breach of fiduciary responsibility.

Fiduciary Services — Services provided by an individual or a corporation acting in a trust capacity. A bank authorized to do a trust business may act as executor or administrator of estates, guardian of minors, and trustee under wills.

Financial Buyer (also “Financial Investor”) — See Private Equity

First Day Availability  —  Banks don’t want a borrower’s line of credit to be tapped out immediately upon issuance.  They want the borrower to maintain some level of available funds for emergency working capital.  Typically, a new line of credit will require that the borrower have a certain amount of credit available (typically 10-20% of the line) on the day that the loan documents are signed.  For example, a borrower seeking a working capital facility of $5 million would likely be required to have $1 million of first day availability, therefore allowing the borrower to tap the line for $4 million on the day the loan begins.

Forbearance Agreement – When a borrower defaults on a loan, the lender may enter into an agreement to postpone, reduce, or suspend payment due on a loan for a limited and specific time period. The lender agrees to certain concessions in order to avoid the expense and risk associated with an asset seizure, and the borrower agrees to certain concessions in order to avoid bankruptcy or foreclosure.  Typically, the lender will charge a one-time forbearance fee, and the borrower will be billed for all of the lender’s legal fees in connection with drafting the forbearance agreement.  The interest that accrues during the forbearance period, as well as the additional fees, is added to the principal balance of the loan.  In some forbearance agreements, the borrower will be expected to hire certain professionals (a turnaround specialist or an investment banker) to take action in order to protect the lender’s interest.

Foreclosure –  A foreclosure is a standardized procedure in which secured creditors (e.g. banks), are authorized to obtain the title of the real estate or other property that has been pledged as collateral for a loan.

Foreclosure Sale –  A standardized procedure overseen by state courts (rather than the U.S. Bankruptcy Court) in which a secured creditors (e.g. banks), are authorized to obtain the title of any assets that have been pledged by a borrower as collateral for a loan and sell them to a third party – and if necessary, do so without the consent or cooperation of the borrower.

G

Gross Margin (also “Gross Profit”) — A measure of how profitably a given product can be manufactured and sold.  Or how profitably a  service can be delivered.  The equation for determining gross profit is:  GROSS PROFIT = [GROSS SALES - DISCOUNTS - COST OF GOODS SOLD - DIRECT LABOR]     The equation to determine gross margin is: GROSS MARGIN = GROSS PROFIT ÷ GROSS SALES.   Understanding the gross margin of a business relative to its peers is a primary indicator of business success.  Most grocery stores have gross margins of 1% to 3%, so a grocery store with 5% gross margins would be exceptional.   Most software companies by contrast have gross margins in excess 90%, so a software company with 40% gross margins would most likely not be considered a success.

Guarantee (also “Personal Guarantee”) — A written promise by one party (the guarantor) to be liable for the debt of another if the principal debtor fails to meet the obligation.  It is common for one or more shareholders of a small business to provide a personal guarantee to a bank for monies owed by the business.  In the event of a default, the bank has the potential remedy of seizing personal assets of the principals in order to satisfy the debt.  The upside to the business owner is that by agreeing to a personal guarantee he might qualify for a loan that is not otherwise supported by the collateral of the business, the upside for the bank is by having the business owner’s home at risk, the owner tends to operate the business more conservatively.  A non recourse loan would be a loan with no personal guarantee.

I

Installment loan — A loan with several scheduled repayments at specified intervals.

Interest — The amount paid for use of money or credit.

Interest Rate — The price of borrowing, expressed as an annual percentage of the amount borrowed, such percent to be paid periodically on the outstanding balance. Typically the interest rate on a business loan will be either fixed for a certain period of time (if not for the duration of the agreement), or variable.  Variable interest is typically a function of adding a pre-determined interest rate “spread” to a benchmark rate such as the Prime Rate or LIBOR (see “Prime Rate” and “LIBOR” for more information about these rates).  For example, 150 basis points over Prime (meaning the Prime Rate plus 1.50%).

Investment banker — An intermediary who brokers a financial transaction.  An investment banker can be a broker of securities or an advisor who represents the buyer or seller (or in some cases both) of a business.   Jamie Grant, the editor of this Blog, is an investment banker and a partner in the investment banking firm Mirus Capital Advisors.

IRB (Industrial Revenue Bond) — An IRB is a loan to a company to build or buy a facility or buy land and/or equipment, and IRBs are commonly used as an incentive to encourage a business to invest in a community.  Most states and many local governments offer industrial revenue bonds (IRB) as a way to encourage relocations and expansions of companies that provide jobs and expand economic opportunities for residents and the community.  For an excellent explanation of IRBs, visit this link http://www.cabq.gov/econdev/irbs.html

L

Lender Liability  —  A legal claim or action of a borrower against a creditor, in which the borrower alleges unfair enforcement of loan covenants or violation of implied terms of a loan agreement in a manner that causes damage to the borrower.  For example, if a general contractor were to submit its financial statements two days late and their bank called their loan – such action by the lender could force the Company to miss a deadline – costing the business thousands or even millions of dollars in lost revenue. In such a case, if the loan agreement required 7 days notice by the bank, the borrower could bring a lender liability suit against the bank.

Letter of Credit (also “LC”, “L/C” or “LOC”) — An instrument issued by a bank by which the bank substitutes its own credit for that of the corporation that purchases the letter.  Typically, the bank issuing the letter of credit would have a pre-existing relationship with the corporation – such as a loan agreement in which the bank already had a secured claim against the corporation’s assets.  Alternatively, the corporation might put cash or securities into an escrow account as collateral for the LC.  Corporations generally use LCs to secure credit from a vendor or a lender.  LCs are commonly used in international trade as a means of guaranteeing payment for a shipment of goods. 

Line of credit (also “LOC”) — An arrangement whereby a bank commits to lend up to a specified amount at the borrower’s option.  See also “Revolving Line of Credit”

LIBOR (London Interbank Offer Rate) —  LIBOR is the interest rate charged on interbank loans. As banks have become more efficient with lending – which is how they make money, they tend not to have excess cash on hand.  As such, banks borrow from each other on a regular basis in order to meet the short term needs of their customers.  As LIBOR is the rate banks charge each other, it also approximates the cost of capital.  As LIBOR is their cost, it is increasingly used as the base rate to determine the rate banks charge to borrowers.  In 2007 at the height of the credit bubble, banks were charging small borrowers LIBOR + 175 basis points for a loan (approx. 6.5%).  By mid-2009 that same borrower was paying LIBOR + 400 basis points (5.6%). 

LIBOR Floor  —  see “Rate Floor”

Lock Box  —  A cash management system whereby the borrower’s customers mail payments to a post office box near the borrower’s bank. The bank collects checks from the lock box-sometimes several times each day, deposits them to the account of the firm, and informs the borrower by phone or other means. This process reduces processing float and puts the borrower’s cash to work more quickly. The larger the borrower’s float (the daily measure of outstanding loan balance), the more interest the borrower will pay, so the lock box process can often save money for the borrower. The bank’s fee for this service must be weighed against the savings from reduced float to determine whether this arrangement is cost-effective.

Loan Participation (also “Club Deal” or “Syndicated Loan”) — Credit extended to a borrower in which a group of lenders each provide a fraction of the total financing, typically arising because individual banks are limited in the amount of credit they can extend to a single customer.

Long Term Debt — An amount owed for a period exceeding one year, from the date of last balance sheet/accounting year. Otherwise known as funded debt, long term debt refers to those loans which become due after one year from the last balance sheet/accounting year. Such debts can be a bank loan, bonds, mortgage, debenture, or other obligations.

M

Maker — The person who signs and executes a note or other promise to pay. The drawer of a check is sometimes referred to as a maker.

Maturity — The due date of a financial instrument.  A bullet loan or term loan

Mortgage — A term loan in for which the borrower has pledged real property as security for a debt so that the lender may foreclose if the borrower defaults.

Mutual institution — A thrift institution or insurance company that has no stockholders and is owned by its depositors or policyholders.

N

National Bank — A bank which is chartered by the federal government and is a member of the Federal Reserve System by default, is called a national bank.

Non Recourse Loan — A loan which is secured by collateral and for which the borrower is not personally liable, is called a non recourse loan. 

O

Origination Fee – The charges a lender or creditor levies for processing a loan. It includes cost of loan document preparation, verification of the credit history of the borrower and conducting an overall appraisal.

Original Principal Balance – The initial amount borrowed by any borrower is called the original principal balance.

P

Par value — Of a bond, note, or other obligation, the amount agreed to be repaid, exclusive of interest.

Personal Guarantee – See Guarantee

Prime rate — A base rate to which many loans (particularly business loans) are indexed. In the past it was the rate that banks charged their best, most creditworthy customers.

Principal — The face amount or par value of a note or other instrument.

Private Equity (also “Private Equity Group” or “PEG”, “Financial Buyer”, “Financial Investor”, or “Venture Capitalist”) — Private equity groups (PEGs) are similar to a mutual fund in that they are operated by a management group which raises capital from investors and then invests that capital into various business enterprises.  What distinguishes PEGs from mutual funds are (a) their investors and (b) the types of companies in which they invest.  Unlike mutual funds, PEGs require investors to contribute a significant amount of capital (usually several million dollars or more) for a pre-determined period of time, typically 10 years.  As such, their investors tend to be “institutional investors” such as pension funds.  And unlike mutual funds, PEGs don’t generally invest in publicly traded companies, but rather they invest in private companies.  Some PEGs, commonly referred to as “venture capital” firms, will invest primarily in start-ups and high-growth businesses.  The term “Private Equity” however more commonly describes a firm that invests in growth capital or buy-outs in more mature businesses.

Promissory note — A written promise by the maker (in essence the borrower) to pay a certain sum of money to the payee (the creditor) on demand or at a specified future date.

Q

Qualified Opinion – When a business has its books audited by an accounting firm, the auditor is required to give an opinion on whether in fact the books reflect the true profit and loss, assets and liabilities of the firm.  When an auditor’s opinion holds some reservations regarding the process of audit, it is called a qualified opinion.  If the auditor’s opinion is that the business may not be able to continue operations due to ongoing operating losses, that is called a “going concern” qualification.

R

Rate Floor (also “Absolute Rate Floor”) —  Many lenders tend to “borrow long and lend short”.  That is to say that they issue fixed rate CDs, bonds, and other long-term securities that provide them with a forseeable cost of capital, and then they lend that capital to borrowers at a mark-up (referred to as the “spread”) for shorter time periods or using variable interest rates. During periods when interest rates are declining or unusually low (e.g. 2009), lenders saw their profit margins decline on existing loans without rate floors.  As a result, they institute a rate floor that protects the bank from declining interest rates.  For example, a bank in 2009 might have issued a loan at LIBOR + 375 basis points with a LIBOR floor of 1.50, thereby guaranteeing that the applicable rate will not drop below 5.25% over the course of the loan agreement.

Reserves — Funds set aside by a bank to enable it to pay its depositors. Reserves may consist of vault cash, deposits in other banks, and deposits with the Federal Reserve. The term sometimes refers only to those reserves that meet Federal Reserve requirements.

Revolving Line of Credit (also “Revolver” or “Open end credit”) —  A line of credit that can be used a number of times, up to a certain limit. Typically, a revolving line of credit will be used to fund working capital and will be secured by a borrower’s receivables and inventory as well as other assets.  An asset-based or formula-based line of credit provides the borrower with the ability to draw funds from the line within certain formula-driven parameters.  For example, the bank would allow the borrower to draw an amount up to 80% of eligible receivables plus 50% of eligible inventories.  (Also see “First Day Availability”, “Eligible Receivables” and “Eligible Inventory”)

Refinance – Refinance means clearing the current loan with the proceeds of a new one and using the same property for collateral.  

Reconveyance – In banking terms, reconveyance is transfer of property to its real owner, once the loan or the mortgage is paid off.   

Reference Rate –  The basis of a floating rate or variable rate security is called as the reference rate.   

Repossession –  The act of a creditor taking back property from the borrower due to default of payment.  Typically personal property, such as vehicles and equipment.

Residual Value – A term used in the valuation of a business for estate planning or other purpose.  Residual Value is the anticipated value that a company calculates, to sell its assets at the end of its full life.  Hypothetically, the value of a business is equal to the present value of all anticipated future cash flows plus the residual value.

Return on Capital – A measure which determines how a company will optimize its use of funds. A high-growth technology business (if successful) will have a high return on capital, whereas a real estate investment – which requires a large initial investment and modest returns, will have a lower return on capital.

Risk Rating — At some point during the underwriting process, a lender will assign a risk rating to a business (generally 1 to 10).  The rating system differs from one institution to another, but for banks and thrifts the system is required by their regulating body.  Factors that impact the credit rating include number of years in business, financial performance, debt repayment history, quality of receivables, customer concentration, industry trends, regional economy, financial controls, audit history, and the completeness of the management team. The better the risk rating, the better the terms the lender will offer.

S

Sale Leaseback – A transaction in which there is a sale of property, wherein the title is transferred to a third party (the buyer), on condition that the property will be leased back to the seller on a long-term basis, after the sale.  It is particularly common for a business owner to sell the real estate holdings of a business to a holding company (freeing up cash to invest in the business) and then sign a long-term lease for the real estate.

Savings & Loan Association (also “S&L”)  — See “Thrift”

SBA – The U.S. Small Business Administration (SBA) has three popular programs for small business, including loan guarantee programs and the SBIC program (see “Small Business Investment Company”) . The loan guarantee programs include: the 7(a) Loan program used for lines of credit and term loans for equipment, working capital, etc.; and, SBA 504 Loans, used for the financing of real estate such as a new factory or office building. Both programs require in depth business plans.

Small Business Investment Company (SBIC) – The SBIC Program is one of many financial assistance programs available through the U.S. Small Business Administration. The structure of the program is unique in that SBICs are private equity firms (privately owned and managed investment funds), licensed and regulated by SBA, that use their own capital plus funds borrowed with an SBA guarantee to make equity and debt investments in qualifying small businesses. The U.S. Small Business Administration does not invest directly, only through SBICs and via SBA Loan guarantees.

Securities — Documents evidencing ownership or a creditor position in a corporation, such as a stock or warrant, a note, or a bond.

Secured Debt / Secured Creditor — A loan or debt instrument which is backed by the borrower’s pledging of real or personal property (collateral). In the U.S., the Secured Creditor (the party making the loan) must “perfect” their security interest by filing a claim with the Secretary of State for whichever state in which the borrower’s collateral resides.  This filing is a public record to put all future creditors on notice that there is an existing (senior) security interest on a particular asset.  Unlike unsecured loans, which are backed by a mere promise by the borrower that he will repay the loan, in the case of a secured loan, the lender can initiate legal action against the borrower to reclaim and sell the collateral (a foreclosure process).

Senior Lender (also “Senior Secured Lender”) — If there is more than one lender with a security interest in the borrower’s assets, there will typically be an intercreditor agreement between the first secured lender (the “Senior Secured Lender”) and the other lenders.  Generally, the senior secured lender is paid first in the event of liquidation, followed by the second lien holder and all subsequent “junior” creditors.

Straight Line Amortization —  This is the simplest amortization method. Basically, it just spreads out the cost of an asset equally over its lifetime. Alternatives include: (a) declining balance amortization; (b) annuity; (c) bullet (See “Bullet Amortization” above); and, (d) increasing balance (negative amortization).

Syndicated Loan  — A very large loan extended by a group of small banks to a single borrower, especially corporate borrowers. In most cases of syndicated loans, there will be a lead or “agent” bank, which provides a part of the loan and syndicates the balance amount to other banks.

Sweep Account  — A sweep account has several implications: (1) sweep accounts are primarily used as a legal workaround to the prohibition on paying interest on business checking accounts. In this system, the funds are described as being “swept overnight” into an investment vehicle of some kind, such as a money market account; (2) the “loan sweep account” service allows you to set up an automatic sweep between your business checking account and your line of credit, which similar to a lock box (see “Lock Box” above) pays down your line of credit from the excess cash; and, (3) some loan documents are written in such a way that in the event of a default by the borrower, the lender has control over the borrower’s cash by virtue of the loan sweep feature.  This is not unusual, but it is one of the many reasons why a business borrower should carefully review their loan document with an attorney experienced in such matters.

T

Term loan — Business loan with a fixed maturity in excess of 12 months, usually used to finance the purchase of fixed assets such as equipment or real estate, but also used to finance the acquisition of a business.

Thrift (also “Thrift Bank”) — A bank that specializes in taking deposits for checking and savings accounts, as well as making home mortgages. Thrifts tend to be smaller than other banks, and are more focused on the local communities in which they operate. It is sometimes (but not always) easier to obtain a loan from a thrift because it may have better knowledge of the local market. Thrifts derive most of their funds from customer savings accounts, but they also generally have easy access to loans from the Federal Home Mortgage Banks. They are also known as savings & loan associations. They are regulated by the Office of Thrift Supervision.

U

Usury laws — Legal ceilings on the interest rates that may be charged on loans. 

V

Venture Capital (also “VC” or “Venture Capitalist”) — Venture Capitalists are investors who specialize in making direct equity investments into early stage and high growth companies.  Because these companies will typically have to absorb significant operating losses before generating sufficient revenue to turn a profit, VCs will typically invest equity capital in several “rounds”.  These “rounds” of investment (the “A” round being the first, followed by “B”, “C”, etc.) are geared to coincide with specific milestones for the business.  Typically, each round is meant to provide sufficient capital for the business to operate for 6 to 18 months and reach the next stage of its development.  By limiting the amount invested in this way, VCs are able to manage their risk, and the founder(s) of the business are able to avoid excessive dilution.  (See also Private Equity)