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Wednesday, December 24, 2008

Retainers versus Lenders Due Diligence Deposits and Commitment Fees

We are providing the client with a specific lender who can offer financing to them based on the lenders review of the representations made by the borrower with respect to loan size, geography, credit profile type and mix of collateral etc. The retainer paid to us by the borrower is not a deposit to be used for due diligence but rather an engagement fee to arrange for the specific financing.

We require this retainer to protect ourselves against situations where our borrower has inadvertently misrepresented the value of collateral or the cash flows to cover debt service. It would also protect us in a case where the lender finds they cannot perfect a security interest in the collateral being offered or the borrower cannot provide the necessary documentation that the lender requires.

Because we do not require any exclusivity with respect to our fee agreement, the retainer also protects us in the event that the borrower obtains financing elsewhere, secures an equity infusion, or simply decides that they do not require the financing at this time. If the loan does not close for any reason, other that our inability to produce a capable lender, then the retainer covers our time, effort and expense regarding the work done by us.

We represent hundreds of lenders across the country and all generally require the borrower to cover their costs of due diligence prior to loan closing. The only exception to this rule is a local bank ( if the business is bankable ) who typically will not need such a deposit. If lenders were to pay the due diligence costs they would often waste their money traveling to the borrowers company or property and performing appraisals and audits on situations where the results of that due diligence were such that the loan cannot be closed.

If the lender were willing to pay for the examination and investigation necessary to close the loan, borrowers who have problems might not disclose them in hopes that the lender would not discover these issues that may have previously caused the loan to be rejected.

The lender will not require their due diligence deposit until they have issued their formal proposal outlining the specific terms and conditions that will apply based on the representations made to them by the borrower. The purpose of the due diligence is to allow the lender to confirm that the representations made by the borrower are true and correct so that they can close the loan.

Lenders due diligence may include a site inspection at your company focusing on your back office operations relative to the performance of your accounts receivable. Particularly they will want to examine the exact service or product provided, how you bill, to whom you are billing, the net collectable amount paid to you after allowances and deductions, any potential offsets due other parties or issues that could lead to offsets and the historical performance of your AR's collect ability.

Clearly, as the lender is typically expert in such matters you can benefit from such expertise as it relates to the efficient billing of your accounts and the ability to diminish underpayments etc. Real Estate, equipment and inventory appraisals that are more than 6 months old will likely need to be updated or in some cases may need to be redone.

The lender will also be concerned with the character of the borrower (both from a company perspective as well as from the principals perspective) as it relates to previous issues of fraud or bankruptcy etc. They will also need to clearly confirm the viability of the company going forward and any legal issues that might cause them to suffer a loss with respect to the loan to be consummated.

This could include the possible inability of the lender to obtain a first lien against the collateral or the borrower’s inability to cover debt service etc. The lender will be available to explain in detail what could cause them not to close the loan so that there are no surprises once you have agreed to their terms and conditions and before you pay for the due diligence.

Most lenders make the deposit refundable minus specific expenses in the unlikely event that they are unable to conclude the loan. Due diligence deposits vary widely from lender to lender but are generally in the $2,500 to $25,000 range. A loan transaction of $10,000,000 or more might require a due diligence deposit of greater than $25,000.

Once the due diligence is complete some lenders will issue a commitment to fund at which time the borrower will be required to post a commitment fee which will be around 1 point on the loan amount. If the borrower walks away from the transaction prior to closing they will forfeit this fee. Some lenders will go straight to closing after completion of due diligence and will not require a commitment fee. Normally, once the commitment fee is paid the only steps to be taken prior to funding would be the negotiation and execution of closing documents.

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