Security or Collateral are the assets that a borrower provides to a lender, as security for credit. For the credit provider, this serves as a protection against potential loss of capital.
There is no simple formula for security, and it is a material part of the process for the credit provider and borrower.
Tangible Security usually takes the form of acceptable property or cash. This is the most common form of commercial lending especially in the small to medium business market. A registered first mortgage is taken over property and is commonly supported by personal and directors’ guarantees, and a "charge" over the borrowing entity and other entities in the group that directly or indirectly provide serviceability support for a loan.
Most SME lending in Australia is secured by some form of collateral.
Intangible security is sometimes referred to as “Cash flow Lending” and is more difficult to obtain especially in the small business market. Businesses that can demonstrate strong balance sheets and future cash flows may be able to obtain lending facilities without the provision of property or cash security.
Some financiers support these types of lending arrangements by developing policy criteria across certain industries, (e.g. Pharmacy, Accounting, Franchise Systems) that outline the general parameters by which these arrangements will be considered.
As a very general principle, the greater the risk or complexity of a transaction, the greater the security that will be required by a credit provider to approve new lending.
Commercial loans are of course more complex than mortgage lending. It is therefore important to work through all the components of security offered by the customer in support of existing arrangements. This will provide the foundation of the security that is available for any lending application put forward by the customer.
Security typically can include:
Most of us are familiar with a registered real property mortgage. In Australia, this is typically a Torrens title mortgage, which operates as a statutory charge on the relevant lot or interest in the land for the amount of debt or liability secured. It may be over a Lease too.
Guarantees & Indemnities
In most cases, an individual guarantee and indemnity will be required from the natural person(s) that support the borrowing entity.
For example, Jane Smith provides a “guarantee and indemnity” in respect of the obligations/conduct of the borrowing entities, Smith Group Pty Ltd & Smith Holdings Pty Ltd.
This means the personal assets of the borrower are at risk!
Supported versus Unsupported Personal Guarantees
Supported Guarantees are secured against an asset that you own; typically a property. Unsupported personal guarantees aren't secured against Assets.
Guarantees are very common in Australian financing transactions. In addition, financiers will often require cross guarantee from all parties in the group (that is, each guarantor guarantees the performance of each other guarantor's obligations).
For example, Smith Group Pty Ltd & Smith Holdings Pty Ltd. provides a “corporate guarantee and indemnity” in respect of the obligations of the borrowing entities, Smith Group Pty Ltd & Smith Holdings Pty Ltd.
General Security Agreements &” PPSR”
The Personal Property Securities Act 2009 (PPSA) is a law regarding security interests in personal property. This is a significant shift and has changed how security interests are both termed and registered.
• A General Security Agreement (“GSA”) over the general assets of a grantor, including tangible movable property and other property such as intangible property.
• A specific security agreement over specified goods.
For example, Smith Group Pty Ltd & Smith Holdings Pty Ltd. provides a “General Security Agreement” over all present and after-acquired property.
Financial Position & Background of the Principals / Directors
In most instances, the personal financial position of the directors / shareholders will need to be reviewed as often supporting guarantees or security will be required. The financial strength of the individual should indirectly reflect the historic performance of the business, and there will be a significant focus by the financier in this regard. Often, marginal performance by the business historically can be mitigated by the growth in Net Worth from the directors, especially where there has been no material outside equity interests.
In all cases, financiers will request a signed Asset & Liability Statement, with a Privacy Act consent.
The other key determinant is the applicants’ experience in their industry. This must be evaluated in considerable detail to ensure that the necessary business expertise is present.
Retirement of Debt
The financier will also want to show a demonstration of the way the debt will be retired. The sale of an asset/security is not a sufficient explanation in most instances.
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