Basic Business Structures: The Importance of Collateral in Obtaining Loans

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Basic Business Structures: The Importance of Collateral in Obtaining Loans

Small businesses are a very essential component of the economic and financial fabric of emerging market countries such as Mexico.

In order for a company to secure a business loan from a bank in Mexico, the owner(s) will need to put up some form of collateral. The collateral can be in the form of business or personal real estate and/or business equipment/machinery. This allows the bank to secure the loan against that property, thereby allowing the lender to sell the property in settlement of the loan on the event there is a default.

Despite providing the collateral, the banks also mostly require that business owner(s) have good established credit shown by the credit bureau. With this, the banks believe that the borrower has a history of making good on his or her debt obligations.

There are two types of business loans available to small business owners: secured and unsecured. The secured requires that the borrower provides collateral, while the unsecured does not. However they both might require that the borrower possess a good credit history.

An understanding of the types of business ownership schemes would be helpful. The main forms are Sole Proprietorship, Partnership and Corporation.

The Sole Proprietorship indicates a sole owner, who is responsible for planning and operations. He or she might hire a few employees as well. The owner is the sole beneficiary of the business gains, and also shoulders all the liabilities, which are attached to his or her personal assets. Many businesses in Mexico start off this way, and evolve or transform into partnerships and corporations at later dates.

The Partnership involves two or more owners of a business. They might have invested the same or different percentages of capital at the onset and mostly make decisions jointly. Also, by operation of law, they are held jointly and severally at risk for the liabilities of the business in accordance with their executed partnership by-laws.

A Corporation is considered separate and distinct from the owners. Its assets are those of the corporation, and its liabilities do not attach to the owners, unless they violate one or more of the articles of incorporation like co-mingling of funds. In such instances, the plaintiff’s lawyers are able to pierce the corporate shield, have the corporation classified as the “alter ego” of the owners, thereby having it regarded as one and the same, and effectively having the liabilities passed on to the owners.

Since Mexico has mostly been a cash economy for many years, and many people have not been indoctrinated into establishing credit histories with the reporting agencies, they have been unable to secure traditional bank loans for their businesses, even though they possess the requisite collateral.

This has led to a situation where loans are often guaranteed by others.  A business owner can present a guarantor to the bank as a co-signer for a loan. This person can be a friend, family member or other. This guarantor pledges the collateral instead of the borrower, and the loan is secured against his or her assets. In fact, this has become a major aspect of bank financing.

This hindrance has prompted the significant emergence of alternative methods of financing, where credit histories are not considered.

ALTERNATIVE FINANCING METHODS THAT DO NOT REQUIRE COLLATERAL:

Loans from family and friends: A business owner can give family members and friends a small ownership percentage in the business (2 to 30 percent), so that he or she does not have to start draining the much-needed growth cash by repaying them. At a future date, one can buy them out and regain complete control again. Conversely, an owner can have a regular repayment structure.  One reason to pay off outside owners is that this allows the option of accumulating shares so that they can then be distributed to employees as an incentive and/or to reward performance

Credit Extensions: Have suppliers give 30, 60 or 90-day credit payment terms. This gives the space to use funds for other business needs in the interim.

Business Plans: Some banks lend solely on the basis of a business plan.

See World Bank Group’s page on doing business in Mexico:  Act Now

Written by: Junior De O’Tobo, J.D., ChFC, LUTCF  an International Legal Consultant with The Associates. He has a Juris Doctorate (J.D.) Degree with High Honors from Abraham Lincoln School of Law. He also has a Chartered Financial Consultant (ChFC) Degree and a Life Underwriter Training Council (LUTCF) Degree from the American College in Pennsylvania. He possesses post-graduate Certificates from Harvard Business School and the University of Oxford (Said Business School).

2017-01-21T13:59:43+00:00