Reading a Business Loan Sanction Letter Line by Line

A sanction letter sets out the terms on which a lender has approved your loan. The headline interest rate is only one of perhaps a dozen terms that decide what the loan really costs and how much freedom the business keeps while it is outstanding. Most of the expensive surprises in business borrowing were written in the sanction letter, and signed without being read closely.

This guide goes through the clauses in the order they usually appear, with what to check in each.

Amount, purpose and disbursement

The letter states the amount sanctioned and what it may be used for. A term loan sanctioned for machinery may be disbursed directly to the supplier against invoices, in stages, rather than into your account. Interest usually runs only on what has been disbursed, but check whether a commitment charge applies to the undrawn part, and by when the loan must be fully drawn.

Using the money for something else, even something sensible, can be a breach of the terms.

Interest rate: the number and what it is linked to

Business loan rates are commonly written as a benchmark plus a spread, for example an external benchmark rate plus 2.5%. Three questions matter more than the starting figure:

• Which benchmark, and how often the rate resets when the benchmark moves.
• Whether the spread can change during the loan, for example after a credit rating review or if financial covenants are missed.
• What happens to the EMI on a reset: whether the instalment changes, or the tenure is extended.

On a ₹50 lakh loan over five years at 11%, the EMI is about ₹1,08,712. If the rate rises to 12% after the first year, the EMI on the remaining four years rises to about ₹1,10,766, around ₹2,050 more every month. That is manageable for most businesses, but it should be in the cash forecast before it happens, not after.

Fees: what they do to the real rate

Processing fees, documentation charges, valuation and legal fees for the security, and stamp duty on the agreements are paid upfront or deducted from the disbursement. They are real costs of borrowing.

A 1% processing fee on ₹50 lakh is ₹50,000, plus GST. If the business receives ₹50 lakh less the fee and its GST but repays the full loan, the effective cost over five years rises from 11% to roughly 11.5%. Ask for a list of every charge in rupees, not percentages, before accepting, and compare offers on that basis.

Security and margin

Primary security is the asset being financed or, for working capital, the stock and receivables. Collateral is extra security, often property. Margin is the share of the asset’s cost you must fund yourself: a 25% margin on a ₹40 lakh machine means the bank lends ₹30 lakh.

Check what happens to collateral when the loan is repaid, and whether it is also securing other facilities. Property pledged across several facilities cannot be released until all of them are closed.

Guarantees

Personal guarantees from directors or partners are common for small-business loans. A personal guarantee makes the guarantor personally liable for the debt if the business cannot pay. Read whether it is limited to a stated amount or covers everything owed, including interest and costs, and whether it continues after the named loan is renewed or replaced.

Covenants: the clauses that restrict the business

Covenants are promises you make for as long as the loan is outstanding. Two kinds matter.

Financial covenants set minimum or maximum ratios, such as a minimum DSCR or a maximum TOL/TNW, tested on your annual or half-yearly accounts. Model them before signing: will next year’s plan, including any new borrowing, keep the business within them?

Operational covenants require the lender’s permission before certain actions: taking other loans, paying dividends, changing ownership or management, selling significant assets, or opening accounts with other banks. A business planning to raise equity or bring in a partner should check these first, because the lender’s consent will be needed.

Breaching a covenant usually gives the lender the right to charge a higher rate, demand additional security or, in serious cases, call the loan.

Prepayment and foreclosure

Some business loans charge a percentage of any amount repaid early. Check the rate, whether it applies to part-prepayments as well as full closure, and whether prepayment from the business’s own cash is treated differently from refinancing by another lender. If you expect strong cash flow, a clause allowing free prepayment has real value.

Penal and other charges

Look for charges on late payment, on delayed submission of stock statements or financial statements, on cheque or mandate returns, and on non-compliance with covenants. Check whether they are a fixed charge or an addition to the interest rate, and that every one is disclosed in the letter or its schedule. Lenders regulated by the Reserve Bank of India are subject to its fair practice rules on how such charges are levied and disclosed; ask the lender to point to where each charge is stated.

Reporting obligations

Working capital limits often require monthly stock and debtor statements, and most loans require audited accounts within a set period after year-end. Missing these is a common, avoidable source of penal charges and of friction at renewal. Put the dates in the compliance calendar on the day you sign.

Before you sign: a short checklist

1. Every fee and charge listed in rupees, with GST.
2. Benchmark, spread, reset frequency and what happens to the EMI on a reset.
3. Covenants modelled against next year’s plan.
4. Prepayment terms for partial and full repayment.
5. Scope and duration of any personal guarantee.
6. Reporting dates entered in the calendar.

Sanction terms are often negotiable before acceptance, particularly fees, prepayment charges and covenant levels. They are much harder to change afterwards.

Where this fits

• Test EMIs and resets: EMI calculator · what happens if rates rise 2%
• How lenders decide the amount: DSCR · TOL/TNW ratio
• Prepaying later: loan prepayment calculator
• Whether to borrow at all: debt vs equity funding