You may be familiar with BOMAD, otherwise known as the Bank of Mum and Dad. According to MOZO, a finance comparison website, it’s Australia’s fifth largest residential lender and parents are forking out on average $73,522 to help children buy their first home.[1] But it’s not just parents who are helping out with money. High earning individuals and those with significant wealth also enter into lending agreements with friends and business associates, and often without clear instructions for repaying the loan.
Here I overview why a lending agreement is important and why security arrangements are imperative should the borrower default on their repayments or have other financial difficulties.
The continuing COVID-19 event has created financial problems for business owners who, largely through no fault of their own, now find themselves cash strapped. High earners with surplus cash are more frequently providing funding for business associates and others to see them through difficult times.
For anyone entering into private finance transactions, it’s important to do what banks and lenders do, and implement loan terms and conditions to protect the money they are loaning.
Generally, a lender should take some form of security that will leave them in a far better position than they would otherwise be in if the borrower were to become insolvent.
The most common forms of security a lender should consider when making a loan to a small to medium business will be one or both of these:
General Security Agreement under the Personal Property Securities Act 2009:
This is basically a security over all of the assets held by the borrower. This type of security interest tends to have more value where the business has more tangible sale-able assets such as plant and equipment or a large inventory of stock in trade.
Personal guarantee from one or more directors/shareholders and a mortgage over their real property:
In this scenario, the lender would take security over any equity that the owners of the Company have in the real property they own.
In both instances, the value of the securities will still be limited by any other secured creditors that may already be in place, including any existing substantial bank debt. But as a general rule, being a secured creditor, even in line behind a bank, will place a lender in a much stronger position than an unsecured creditor.
If you are lending to an individual, the most common form of security taken is a mortgage over any real property that they may own.
For many individuals who lend money to family and friends, the security is regarded as important for protecting the loan amount from third party creditors that would otherwise share in it.
Once you make the decision to take some form of security, it is vitally important that you properly document both the loan and the accompanying security documents. Security is generally only as good as the underlying liability to pay a debt. It’s important that the loan agreement itself is enforceable and a security interest will generally only be valid if it is provided at the same time as the original loan.
This will include properly documenting the amount of the advance, any applicable interest and the time for repayment.
Even if you do not have particular expectations around repayment, nominating a repayment time frame in the loan agreement gives certainty and increases the enforceability of the loan. If you reach the stated time you can provide an extension if required.
It’s important to understand that taking these sorts of measures isn’t about putting oppressive obligations on your family members or friends. It’s simply in the spirit of good practice and protecting your interests, especially from third parties.
To learn more about implementing private funding arrangements that can help your family, friends and business associates, please contact Craig Hong on +61 (0) 7 3007 2000 or email contact@resourcesunearthed.com.au .
[1] https://mozo.com.au/home-loans/articles/bank-of-mum-and-and-dad-report-2020
Resources Unearthed is a solutions hub that provides integrated financial, legal, property and accounting & business advisory services for executives, professionals and business owners in the mining and resources sectors.
No responsibility will be taken by Hillhouse Legal Partners for loss occasioned directly or indirectly to any person acting or refraining from acting wholly or partially upon or as a result of the material in this publication.
