Crazy Business - Legal costs for bank financing

The nub of this piece is the perverse amount of paper and the attendant legal costs  involved for owners of small businesses to borrow modest amounts from banks. In a recent file involving a $50,000. loan and a $30,000 line of credit, the bank required over 40 documents to be generated, in triplicate of course, with legal costs of approximately $5,000.



Imagine this. A young man working in a small, light industrial shop. He is ambitious. He has his trade ticket. He is a hard worker. He sees the potential of the business, and knows it is unrealized. One day, his boss, the owner of the small shop decides for personal reasons he has had enough. He wants out of the business. He wants out quick. And surprisingly, he offers to sell the shop, the equipment, the goodwill, the whole shebang to the young man we'll call Steve.

Steve can hardly believe his good fortune. That an opportunity to have his own business, to be in control, has come his way serendipitously at such an early point in his working life is a stroke of good fortune. Better yet is the state of the business. There are customers knocking at the doors daily, and the potential for more seems easy.

So, the owner and Steve sit down to work out the key elements of a deal. The owner names a price, $60,000. That sum would buy Steve all the shares in the incorporated company that operates the business. Steve would get control over all the assets of the business and would assume all the debts.

Steve gets to look at the books and sees that the assets have a value of $150,000. and the debts are only $40,000., making for a book value or net worth of $110,000. This he can have for a paltry $60,000. And for that Steve can hope to earn more than $100,000 a year from the business just on the basis of current sales levels.

Here's the rub. Steve does not have $60,000. And, the owner wants cash on closing, meaning the owner will not help to finance the sale.

So Steve does what thousands of young entrepreneurs do - he phones his local bank and arranges an appointment with a business credit officer. The bank is happy to meet him. The credit officer is eager to put another loan on the books, in no small way so that he can meet his monthly target for new business. The banker says he believes he can help Steve.

The banker asks a lot of questions and fills out a lot of forms. Some of the questions require Steve to get papers from the owner to satisfy the bank. This all takes more time than first anticipated. Throughout though, positive words are exchanged and Steve's expectations rise as they get closer to processing the loan.

Eventually, the bank agrees to give the young man 2 credit facilities - one a loan to help purchase the shares, and the other an operating line of credit to smooth out the hills and valleys of cash flows that al businesses experience. The loan will be $50,000 for the share purchase, meaning Steve has to put $10,000 up from his meager savings. The credit line will be $35,000, a figure thought to be generous enough to allow some business growth.

to be completed