Investing often requires money. If this money needs to be made available by external moneylenders, for example banks or other investors, then there are two themes that prominently ask for attention: the provision of securities and Due Diligence. As an entrepreneur it is good to know what is expected in this respect and what you need to take into account.
If a corporation or a bank provided capital by granting a loan then it is important, and often also required, that security is provided for the repayment of it. The best-known example hereof is the granting of a right of mortgage on real estate (for example business premises) by way of security for compliance with the obligations pursuant to a loan or credit. If the obligations are not complied with (e.g. if the monthly interest or repayment is not paid) then the moneylender can enforce the right of mortgage and sell the collateral by public auction. On account of the fact that real estate usually retains its value, this is often an attractive collateral for a moneylender.
In case of starting entrepreneurs or corporations with little equity capital, it is also often expected that a right of mortgage is granted on personal real estate, for example a residence. Entrepreneurs must realize that the consequences of problems in a corporation (e.g. a bankruptcy) may in that case also extend to the personal situation whilst the incorporation of a private or public limited corporation actually tries to avoid that.
A similar type of security as a right of mortgage is a right of pledge however on property other than real estate, for example business inventory (tables and chairs) or accounts receivable. If the obligations towards the moneylender are not complied with then the property can be sold at a public auction or the creditors must pay the moneylender. As movable property is often less indexed-linked and yields (considerably) less at an auction than the value when new, a right of pledge is usually used as an additional security right.
Moreover, in case of investment transactions guarantees or collateral are often also required. Through a collateral someone warrants compliance with the obligations of a corporation. Collateral is often required of stockholders in a corporation when a bank provides credit. Many entrepreneurs do not realize that collateral can have far-reaching consequences, because it may also imply that financial problems within a corporation (for example when credit obligations can no longer be met) affect the entrepreneur in person. After all, in case of collateral the bank can address the entrepreneur directly for overdue payments and may seek recovery from the personal assets, savings or the residence.
In addition, personal collateral also frequently requires attention in case of the transfer of (parts of) a corporation or stocks in it. If a bondsman transfers his interest in a corporation by, for instance, selling his stocks then this does not automatically imply that the collateral also transfers to the new owner. This requires arrangements between the bondsman and the new owner and the bank will also need to agree with it. It occasionally happens that on the basis thereof the bank does not agree with a transfer of the collateral because the new bondsman offers considerably less options of recovery. In that case a situation may arise where the original bondsman (who is no longer involved in the corporation due to the sale of his stocks) can nonetheless be held to make a contribution due to the collateral if the credit obligations are not met. Hence, it is of utmost importance to agree on proper arrangements about this with all parties concerned.
Due Diligence is an English term that has gradually become a household term that means ‘proper investigation.’ A Due Diligence comprises the definition and analysis of the financial and legal situation of a corporation in order that an investor can obtain a picture of the opportunities and risks of its investment. In particular if there is question of a takeover of a corporation then the performance of a Due Diligence is required.
When performing a Due Diligence the term ‘dataroom’ is often used in which a corporation places documents that provide insight into the day-to-day affairs of the corporation. Examples are credit agreements, lease agreements, title certificates, agreements with other corporations, information about legal proceedings, potential patents, protected trademarks, etc. Investors can then obtain access to the dataroom (of course after having signed a confidentiality agreement) and ask questions in order that they obtain insight into the corporation. Large Due Diligences often require a lot of time because advisors (lawyers and accountants) need to go through all documents in order to determine if they contain matters that are important to reaching an investment decision.
In case of a Due Diligence at a smaller scale it is about, for instance, ensuring that the corporation is, indeed, the owner of buildings and lots as a result of which the investigation can often be limited to consultation of the public registers.
There is a lot involved in investment decisions. In the phase of collecting information a Due Diligence offers a handy tool after which a well-considered investment decision can be reached. Moreover, some moneylenders will require securities in the form of a right of mortgage or pledge. Sometimes even collateral is requested. In this situation an entrepreneur must be aware of the risks that this brings about.
Tom Peeters is an experienced and specialized real estate lawyer and head of our Bonaire office. He regularly publishes about project development, sustainable energy projects, cooperative structures and (public) procurement. Via this blog he shares his knowledge about these and other legal topics that concern entrepreneurs in Bonaire.