Three Borrower Traits Asset Based Lenders Need to Recognize in their Loan Portfolio

Author: Ashley Trexler, Supervising Field Examiner


If a borrower possesses significant fixed assets, owns its real estate, or operates several lines of business, you may be exposing your bank to unnecessary risk. To avoid that situation, be sure you review your loan portfolio for clients with certain traits.

Risky business

Commercial property ownership can be quite risky, especially for retailers. Why? Because the store’s owner can be held liable for crimes or accidents that occur on the site if a victim proves there’s inadequate security.

Liability insurance can help mitigate losses. But many policies may be based on outdated business appraisals, and damages might exceed the borrower’s coverage.

For an added layer of protection, borrowers may want to create a separate legal entity for their real estate ventures. That way they can lease the property to the operating business at a fair market value. The same will hold true for businesses with significant fixed assets.

Doing so will protect the operating business entity from property liability claims. The real estate venture can still be pledged as collateral for loans to the operating entity.

Legal entities

Suppose a dry cleaning establishment diversifies and explores the health food market. If the experiment doesn’t work, it will drag down the dry cleaning business (or vice versa). If the borrower sets up a separate legal entity for each business segment, however, the borrower will not only limit its “spillover liability,” but it will also allow for more flexibility in the ownership structure. Keeping things separate from the get-go — with separate bank accounts and balance sheets — can be quite helpful if the owners subsequently decide to sell or seek additional financing.

Estate planning

If a family business wants to transfer wealth to subsequent generations, the company will likely benefit from establishing separate legal entities. For example, suppose an operating business carves out its real estate into an LLC or a trust. Those who are active in the operating business are “gifted” interests in the company. Passive heirs are then given pieces of the real estate venture.

ABLThis setup serves several goals beyond limiting liability. First, the parents can use the annual gift tax exclusion ($14,000 in 2013) and the lifetime unified credit ($5.25 million in 2013) to gradually lower their taxable estate. Gifts are typically discounted for marketability and lack of control.

Second, those who are active in the business will get a stake in something they can directly impact — the value of the operating business. Passive investors will have access to a steady income stream. Plus, the family will be able to minimize its overall tax liability if the children are in a lower tax bracket.

If you have any questions about lending risks or any other asset based lending issue, give us a call at 716.847.2651, or you may contact us here.

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