I have been asked many times
what lenders look at when receiving a loan request (e.g. line of credit,
equipment loan, owner occupied real estate etc.) for a for profit business*
My goal
here is to provide information that offers some guidance on a few of the
facets that are generally taken into consideration when a loan
request is received.
Please not
the ‘M’s and the ‘C’s’ do overlap.
The 4
M’s:
Money, Management, Markets and Materials are all important risk factors
that are taken into consideration.
·
Money: Financial
Analysis (ratios, historical performance etc.), Guarantors, Financial
Preparation (e.g. audited, reviewed, company prepared ) - I have provided some
ratios below.
·
Management: Ownership
Structure, Succession Plan, Management Strengths, Weaknesses etc.
·
Markets: Industry
the business operates, size, competitors, entry to market, customer
concentration etc.
·
Materials: What is
the collateral, costs, length manufacturing process, condition of inventory
etc.
The 5 C’s:
·
Character/
Credit Score: What type
of person are you. What is the general impression you make when people meet
you?
·
Conditions: What
affects the industry, segment, overall market
·
Capacity: What is
your ability to repay the loan
·
Capital: The money
you have personally invested in the business. This is an indication how much
you have to risk if the business had to fail.
·
Collateral: What will
be securing the loan (what is the quality)
Financial Consideration:
Balance Sheet:
·
Current
Ratio (liquidity CA/CL) >=1.2 This is an indication of your
company's ability to
meet short-term debt obligations; the higher
the ratio, the more liquid the company is. If the current assets of a company are more than twice the
current liabilities, then that
company is generally considered to have good short-term financial strength. If
current liabilities exceed current assets, then the company may have problems meeting its short-term obligations.
·
Leverage
(net worth TL/TE) <= 3.0. The degree
the business is utilizing borrowed money. Companies that are highly leveraged may be at risk of bankruptcy if they are unable to make payments on their debt; they may also be
unable to find new lenders in the future.
Income
Statement:
·
Sales – what is the trend
·
Gross Profit Margin trend (sales – cost
of goods sold)
·
Net Profit Margin trend
·
Net income
·
Earnings before income & Depreciation
(EBIDA) = NI + Dep + interest +- one time event
Calculation:
·
Debt
Service Coverage (DSCR) EBIDA/ total debt service >= 1.25. This is
a measure of the business revenue to cover the cost of its loan payments. It is calculated
by dividing the net operating income by the total debt service. (looking to
generate 25 % more revenue that is required to cover the debt payments)
Please take note that there are many
additional factors taken into consideration besides what I have listed. The
information is for guidance purposes only and to help you put together a good
loan package for your lender. It will hopefully help you prepare for some of
the questions that you now know that will be asked. It does not guarantee
a loan approval or a decline if you do not meet some of the criteria listed in
the financial consideration.
Knowing
the five ‘C’s, 4’ ‘M’s and financial considerations is a good start in
preparing yourself for a small business and lower middle market loan request.
Good Luck.
* There is different criteria when looking at
a for profit business and non for profit and if you use an SBA program
