How Risky Is Your Business? A Lender's Perspective
Following up on our Guest Blog post with lender Jill Behnke, we want to dive further into what criteria lenders use to evaluate potential and current customers. This criteria is both objective and subjective. If you are in the market for financing, it can sometimes seem like a detail that is no big deal for one lender is a deal breaker for another. It can be daunting and scary to put yourself (and your company) out there and risk rejection, but it's necessary to gain the funding you need to grow. Today we will explore further, what does a lender look for in a business?
Let's play pretend - if you were the lender, would you loan your business money? Lenders often compile risk ratings to evaluate different customers on a few different criteria and here are some of the components.
No surprise, Financial Stability, is the first main grouping. This includes profitability, ability to make debt payments and equity in the business. Working capital and cash availability play a part as well. If some of your financial metrics are not as strong as you'd like right now, have ready a reason why and a plan to better your financial standing. A strong business plan with realistic projections can go a long way to assure the lender that you have a plan for your business. "Winging it" with every decision is a sure way to get denied your request for money.
TO DO: Gather an accurate balance sheet and an up to date profit and loss statement. Evaluate for weak spots. Write down plan to strengthen those areas. Read through business plan for relevancy and completeness.
In addition to looking for a profitable business, lenders look for Security on their loans. This ties directly to the collateral, or assets, pledged against the loan. How risky are those assets? Are they liquid or more difficult to convert to cash? Some assets, like land, are easier to evaluate their value, but more difficult to convert to cash. Others, like inventory, can be converted more quickly but are difficult to value. The lender wants a good handle on what the assets are worth to better determine the overall credit risk of the loan.
TO DO: Note which assets are currently collateralized on other loans, and calculate the loan to value ratio (loan amount/market value). This will allow you to see what available collateral you have left. Keep in mind you cannot typically borrow 100% of the value of your assets.
Although 85% of the evaluation is about you and your business, there is a component related to the Environment in which you operate. Do you have a lot of aggressive competitors? Is it a changing marketplace? Once again, being honest in your business plan about the business environment in your industry and your plans to thrive within that can help put any fears to rest.
TO DO: Evaluate your competitors. Write down three differentiators for your business.
Another subjective topic, and one that can greatly impact your lending relationships is YOU. The Owner and Manager are a key component to the riskiness of a loan. Are you, as the business owner, trustworthy? Do you seem competent in your field and as a manager of people, finances, products, etc? Do you have a strong work ethic and a passion for what you are doing? These strong leadership traits prove commitment to the business. The lender never wants be working harder for the business' success than you are.
TO DO: Evaluate yourself. Write down three of your strengths and three goals you are working toward.
Being prepared can take some of the fear away from seeking funding. Make it a point to sit down and work through these to-dos. Equip yourself with a strong business plan, updated financials and a little confidence and you can secure a loan to grow your business to the next level.