When to use a Director/Shareholder loan agreement?
By Will Elton, Last updated: 2022-04-06 (originally published on 2021-01-28)
Here we’ll tell you what a director/shareholder loan is used for and why you may need one.
In a nutshell, it’s common for directors and shareholders to put money ‘into’ the business. Importantly, if this money is coming in as a loan, you should get the terms and conditions of the loan in an agreement to keep a record of the loan. Also, this clearly establishes in detail the obligations of each party in the agreement, along with any other terms or conditions.
You can use a Director Loan Agreement or Shareholder Loan Agreement depending on who is financing the loan to the company.
What is a Director/Shareholder loan?
A Director or Shareholder loan is one of the common ways of debt financing in a company. Typically, this is especially the case for startups before they have a largely profitable business and cannot get conventional bank financing. In essence, it is a loan given by a director or a shareholder to the company to meet its financing needs.
Notably, it should not be mistaken with a loan from the company to the shareholder or director. Usually, this is a restricted transaction and can only be made after meeting certain conditions set forth in the corporate laws.
What is the benefit of a Director or Shareholder Loan?
Contrary to a commercial loan agreement, a loan under a Director’s/Shareholder’s Loan Agreement can be interest free and repayable on demand.
Given the relationship between the borrower and the lender, a Director’s/Shareholder’s Loan Agreement does not contain extensive representations and warranties, nor any obligations or restrictions on the part of the borrower.
What is debt financing?
Chiefly, when a company borrows money that they will pay back at a future date. This is known as debt financing. In fact, any form of loan falls under debt financing. This includes a director/shareholder loan.
Other ways to get money into a company
Additionally, another way to get money into a company is with equity financing. This is where a company raises money by issuing shares of the company. Essentially, the main difference being that unlike a debt/loan, the money brought in through equity does not need repaying.
What is a Director/Shareholder Loan Agreement?
A Director Loan Agreement is a loan agreement for a company to borrow money from its director. Likewise, a Shareholder Loan Agreement is a loan agreement for a company to borrow money from its shareholder. In fact, if a person is both a shareholder and a director, you can use choose either the director loan or shareholder loan agreement.
It includes terms and conditions of the loan such as:
- Principal amount;
- Interest rate (if any);
- Term of the loan or Availability period; and
- Dates for repayment.
Given the relationship between the company (the borrower) and the director/shareholder (the lender), a Director/Shareholder Loan may not necessarily contain extensive representations and warranties, or any obligations or restrictions on the part of the borrower.
Why do I need a Director/Shareholder Loan Agreement?
Generally, it is always best to have a written loan agreement to keep a record of the loan and the obligations of each party. Additionally, it details any other terms or conditions in order to avoid any problems or disputes in the future.
To sum up, when taking a loan from key personnel of the company, such as a director or a shareholder, it is important to keep a record of the transaction. Also, keeping track of the payment terms as well as any other terms and conditions such borrowing might entail.
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