Ever wonder how financial institutions assess whether or not they will give you a loan and how much they will lend? Well, here are the most important factors they access:
1. Do you have a solid reputation? Any lender needs to determine if their borrower will pay them back, so the first thing that they look at is the borrower’s history of paying its creditors, including CRA. Poor credit scores or high debt can eliminate a borrower’s chance of being approved for any loan. Afterall, why would any a lender’s employee want to risk their reputation or job by recommending a loan to a slouch? HINT: If you are a potential borrower, prepare yourself by investigating your credit score at lease 6 months prior to a loan request, so that you have time to address any errors or improve your credit score. If you have significant blemishes, own up to them and prepare explanations including dates, amounts, reasons and your plans to eliminate the debt. DON’T brush these off with excuses.
2. Can you actually afford the loan? Sounds basic right? People will approach lenders without doing the math. Lenders need to see that a borrower’s annual net income (from recurring revenue) exceeds a loan’s principle & interest payments. Their calculation is called the Debt Service Coverage Ratio (DSCR) and it is simply the business’ annual Net Income from Recurring Revenue, divided by all principle & interest payments due that year. HINT: Lenders need to see at least a 1.25:1 ratio. This extra .25 allows for unforeseen circumstances such as lower than anticipated revenue or higher than anticipated expenses.
3. Do you know what you are doing? Lenders need to understand that you are a solid business manager who has shown that you can find and retain clients, manage staff and build a profitable business. They will access your competence by way of education, years of experience, a strong resume, your business plans and your business results. HINT: This is no time for modesty. Be prepared to sell yourself and your team to prove that you are a sure bet!
4. Do you have a strong business case for your investment? Lenders’ need to write a convincing recommendation to their credit team to get them to sign off on your investment loan. Be prepared to share how an investment fits with your business strategy. For example, if you are presently selling insurance, you may want to become dual licenced and acquire an investment book, so that you can cross sell insurance to these clients. Be prepared to explain how you know this investment is a good one and how you have the skill and capacity to handle the project. HINT: Lenders love unbiased opinions, so business valuations by 3rd party valuators can boost their confidence in your dream project.
5. How can you back up your loan if things go wrong? Let’s face it, entrepreneurs are natural optimists and credit people are well… natural pessimists. It’s the lender’s credit department’s job to dream up the worst-case scenario and create an escape plan for the lender. They do this in the form of security taken for the loan. Basically, lenders want to know what you will pledge to them of tangible value in the unlikely event that you default on your loan. Tangible assets for commercial loans typically include land, buildings, equipment, inventory or Account Receivable. If a business doesn’t possess these assets, the lender will look for the owners’ personal assets such as real estate (located in Canada), the CVS on life insurance, non-registered investments and some vehicles. In the case of Independent Financial Advisor practices, a few enlightened lenders also see a portion of the commission as tangible assets-hooray! Before you get upset about this concept, ask yourself “Who would I lend hundreds of thousands or millions of dollars to without security? HINT: While lenders vary on their security guidelines by industry and loan size, most require security equal to 50-200% of the loan’s value, which naturally restricts the loan amount.