What is Net Equity, and Does Your Loan Require It?

If you own a small business, or are considering starting one, you may have come face to face with a term called "net equity." You may wonder what net equity means, and whether your small business will need net equity in order to receive a loan to start up, or a line of credit or similar loan to continue operating. Once you understand what net equity is and what it means for your business, as well as how it is calculated, you will be able to determine whether or not you are required to have it for a loan or line of credit.

What is Net Equity

Net equity is a method of calculating the value and assets of your business to determine how much free valuation is present versus the amount of debt that is present and due to outside creditors. You can think of net equity calculation as a math formula:

  • Current assets of business – inventory and liabilities - short term debt obligations = net equity.

Once you have calculated your net equity in the business, you will be better able to discuss terms of sale and determine whether or not the business loan you are planning to take out will require net equity calculations or not.

Net Equity and Loan Requirements

Most banks will require net equity to be positive, or to the good of the company, before they will approve a business loan, unless you are depositing or currently in possession of sufficient cash or other liquid assets to put down as a down payment or to sell in order to make the net equity calculation positive before the loan is finalized. Lending to a business that has a negative net equity is a risk that most banks will not take, and if the net equity is negative and you are approved, you may find yourself paying higher interest rates or other penalties over the life of the loan.

Regardless of whether or not your loan requires net equity, you will want to calculate the net equity of your business before you decide to sell it, or, if you are planning to buy a business, you will want to see calculations of the net equity of the business you are planning to buy. Because net equity is such a highly common form of business valuation practice, it is used in many business to business transactions and you would be wise to establish your own net equity in any case.

Getting Help

If you are interested in learning more about net equity or its impact on commercial real estate loans, consult with an experienced commercial real estate attorney. Your attorney can provide you with detailed information on how net equity is likely to impact your business transactions.

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