One of the main reasons businesses start up to make money from a skill or product that the owner possesses. The profit motive is generally the biggest motive for entrepreneurs to venture into business and face the various risks of running and building a business. The start-up process in itself already requires a significant amount of resources from the business owner or owners which normally includes time, effort, and money. But sometimes, this is not enough and the business needs to inject more money in order to either continue its operations to generate cash flow or to grow the business to a larger scale. It may sometimes need to do both of those together at the same time. There are generally two approaches to this: either the business gets it through additional equity, or secures it through debt.
Financing or securing a loan can be a challenge in itself for businesses faced with cash flow problems and/or capital requirements. The business has the burden of proof to show an established track record on cash flow generation of their business operations. A caveat loan eases that burden as it adds a layer of assurance to the lender that the borrower intends to repay.
Banks or lenders typically look into the 5 C's of Credit (character, capital, capacity, collateral, and conditions) when evaluating a credit relationship with a borrower. Caveat loans address the main concern of the “Collateral” category.
But, first, What is Collateral?
Collateral is an asset offered by a borrower to the lender as security in a pledge of repayment of a loan. In the event of borrower default, the lender has the recourse to forfeit the pledged security in its favour as a form of repayment.
The acceptability of the security offered as collateral depends on the risk appetite of the lender. More conservative lenders tend to require more liquid instruments such as cash, cash instruments, marketable securities and such. On the other end of the spectrum, lenders could also provide financing to a borrower even without requiring security at all should the lender's overall evaluation of the borrower suggest an acceptable credit risk. Somewhere in between that spectrum are loans secured by Real Property, that is, a piece (or pieces) of real estate that the borrower owns. There are two ways for the lender to secure a real estate property from a borrower: one, through a mortgage loan (link here), and, two, caveat loans. Both are normally short-term business loans which are considered secured business loans because they are bound by an agreement wherein the borrower agrees to offer his/her real estate property (or properties) as a form of reassurance to the lender that he/she will repay the loan. A caveat loan is one of the ways a borrower gives this reassurance.
Let’s first discuss what a Caveat is.
Caveat stems from a Latin word that when translated literally means “let him beware.” A caveat then works as a warning for any third party looking to purchase the party, if in any case the owner of the property decides to sell it, that a lender has initial interest in the land. This also lets the third party be aware that the owner of the land with a caveat over it has not yet paid the debt. A caveat prevents or stops the owner and holder of the title of the property, who in this case is the Borrower, from making encumbrances on the property without the consent of the Lender.
Banks take great comfort in less risky loans on their part so giving short term caveat loans to businesses which effectively grants them priority on the title of the property that has a Caveat attached to it that businesses use as a security. This makes it a secured business loan.
Below are the 5 reasons why caveat loans are great for business owners:
1. Lesser documentary requirements
Common sense will tell us that a caveat solidifies the borrower’s commitment to repay a loan because the borrower has the intent to reacquire control of the offered real estate after the repayment of the loan. Given such, the lender is able to ease or lighten the normal loan documentary requirements. Of these, one of the most tedious to comply with would be the historical financial records of a business which would show the business’ cash flow and ability to generate sufficient funds to repay. Removing this requirement alone greatly lightens the documentary requirements.
2. Lower interest rates
Because caveat loans are considered secured business loans, they have lesser risk and, thus, enjoy lower interest rates.
3. Increased Lender Confidence
Underlying caveat loans is a caveat agreement that is an enforceable legal instrument. The lender has recourse to pursue legal options should the borrower default on his or her obligations. This fallback leads to increased confidence on the lender’s side.
4. Unlock liquidity from owned real estate
Borrowers who own real estate property have what is considered a hard asset. This means that the property is classified as an asset but it will take time and effort to liquidate the same into cash, or in other words, to sell the property. Selling the property can be an option for a borrower to finance his or her business needs. But since this takes time, a caveat loan is one way for him or her to temporarily convert this asset into readily available cash. With this method, the borrower still retains ownership of the property while temporarily giving up total control over it.
5. Easier approvals
Given the above, caveat loans have an easier and higher chance of approval from the lender.
