This happens more times than you can imagine. An early stage company is getting going and they need some extra cash to start out. The owners go to their local bank and ask for a loan. Being an early stage company they don’t have historical profitability or real assets. What they usually have are personal assets, like home equity, or stocks to put in escrow, or even a well off friend or relative that will sign the loan as a “guarantor”.
So the bank processes the loan request and gives its approval. They have decided that the equity in your house is enough collateral to loan you the money. Mind you there’s not much happening at the business, yet, so they are not basing the loan on the value of any business assets.
Day comes you go to your loan closing. Papers are slid across the table for you to sign. You sign figuring that’s what you’re supposed to do, and you are happy to get the loan. But, there’s one item that you might sign that could have significant ramifications to your future success.
It’s called the UCC-1 financing statement. (read https://www.ccassociates.com/ucc1.html) The banks as a normal course of business assign all the tangible assets of your company. What this means is, six months or a year later you are looking for more operating capital. You contact a factoring company and ask to finance the accounts receivables. Well we can’t because you signed a piece of paper that gives ownership of your A/R to the bank. Your access to capital has just become more complicated just by signing that paper. You will have to pay off the bank, pay down a significant portion of the loan, or get the bank to simply “subordinate” the A/R which effectively releases their ownership of it.
And beware, leasing companies, suppliers that offer credit terms, previous owner financed loans, all of these potentially will secure your receivables as collateral.
Moral of the story: When securing credit, ask about the UCC-1. Ask what collateral they will be securing. If it’s not what you had agreed on, tell them before going to closing.