Definition of Annual payout provision
When a business has to payoff their loan to $0 once per year.
When approved, lenders sometimes have this annual payout requirement.
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In most cases, banks are the institutions that require annual payout provisions on business loans.
The balance has to be paid down to zero at least once per year. This is a major negative that borrowers should be very cautious about.
Don’t mistake this for a minor aspect of the transaction because it could end up being very hard for the companies to do. Very few can payoff a balance on any debt once per year.
If an annual payout provision is not met, what can the lender do? If the company does not pay the balance off once per year, the lender may have the right to:
- Call the loan due and to be paid in full immediately or face a declaration of default.
- Raise the interest rate
- Impose heavy penalties and fees.
Do they have the right to take some or all of the collateral? Can they liquidate any listed stock or bonds that were pledged? If so, how likely is it the lender may do this?
Will the lender liquidate assets fast or only if the borrower goes very far past due? These questions need to be asked. Borrower that pledged free and clear collateral such as real estate as security may have high risk exposure.
The borrower needs to consider the requirements if real estate is secured for the transaction. For transactions larger than $100,000 or more, the borrower must closely monitor their cash flow during the year.
Even for businesses that have high annual sales, coming up with a significant amount each year is challenging.
Consider your average monthly bank balance as an estimate of the most they can come up with to meet an annual payout provision. That amount is the maximum balance they should carry on their loan during the year.