Security Interest. At some point your business may have to incur corporate debt in order to fund operations, expansion, or a partner buyout. This article will introduce you to corporate debt, collateral, and security interests.
Business debts are pretty similar to personal debts. The bank or other lender will determine credit-worthiness of your business by reviewing cash flow, past tax returns, and assets. For smaller businesses, banks will require personal net worth statements of the individual owners. Banks do this because if the business doesn’t pay back the loan, the bank will look to the individual owners to do so. Private lenders may not look that deeply into either the business’ or owners’ finances, usually for newer businesses or startups that have no cash flow but that the private lender feels is a good risk because of the product being developed.
Business debt can be used to fund ongoing operations such as payroll or to purchase inventory. Other reasons for a business to incur debt are to purchase new equipment, expand operations such as to open a new retail location or develop a new product, or to buy out a departing partner. In the case of the first two, and possibly in the buyout scenario, a lender may require collateral.
Much like a house is collateral for a mortgage; or a car is collateral for an auto loan, the business assets can be used as collateral for a business loan. Often the collateral is related to the purchase. So if the business is buying a new printing press with the lent funds, the bank will retain an interest in that press. When the press is sold, the bank gets paid its money first.
When the lender retains this kind of interest in specific equipment, or on rotating inventory, it’s called a “security interest”. That security interest will be registered with the State’s Secretary of State office, so that a subsequent purchaser of the equipment, or creditors in bankruptcy, know that someone has a right to at least some of the money being used to buy the equipment, before the seller gets any remaining proceeds. If the security is on rotating inventory, such as when a vendor provides raw goods on credit of getting paid when the goods are converted to a product and sold, that’s called a “purchase money security interest” and only needs to be registered one time instead of for each individual product provided.
Corporate debt, collateral and security interests are a great way to keep your business operations running smoothly, or to expand your business. Understand that superficially they’re not that complicated, although individual situations are always unique, and you should consult an experienced business lawyer like myself to help these transactions go smoothly.
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