Category Archives: Finding Funding

It never failed to amaze me how flustered some very experienced business people became when I responded to their business loan request by saying, “No, the bank can’t make a loan to a bankrupt business.”

After catching their breathe, I got an earful about how they lived in million dollar homes, had children in private schools, and had lots of cash in savings and investments, etc.  

And it was true – they did. They had drained a largess of resources from the very entity that produced it – their small privately-owned business. First they drew large personal salaries, and maybe offered another to a spouse or even children who may have contributed nominal labor. Read More

This blog is last part of a short mini-series on the “art of lending” that covers the 5 C’s of credit. Lenders test each loan application against five elementary lending criteria to determine the strength of the proposed deal. There is no magic formula or defined minimum standard of these criteria for the borrower to attain.   In order to consider the loan request seriously, the lender has to be comfortable with the combined, subjective strength of these criteria.  

Character may be the most important assessment the lender can make about the loan applicant.   Regardless of the positive attributes of the borrower’s capacity, capital, collateral, and credit, if the borrower does not demonstrate integrity and appear trustworthy to the lender, any proposal will be refused.

Character is the most subjective criteria.   The criteria is not only difficult to define, it is difficult to assess.   There is no checklist available to guide the lender’s sensitivity to quantifying someone’s good character, particularly when the other party is a new acquaintance.      

The lender has to observe and study the borrower to evaluate the personal qualities and characteristics.   The lender must watch for potential flaws that may be detected in the attitude, conversation, perspective, or opinion of the borrower about business, ethics, responsibility, and commitment.

The borrower’s character is important because it reveals intent.   If the loan officer senses that the borrower has an ambivalent attitude toward fulfilling responsibilities under the proposed business deal, there is a character problem.   The loan officer must believe that the borrower embraces a moral obligation to repay the loan, superseding even the legal agreement to do so.

When a lender does not feel comfortable with the character of a borrower, this information may not be directly communicated to the borrower.   The loan request will often be denied for different reasons, because the loan officer may have difficulty defending a subjective decision without definitive proof.   This ambiguity is part of the intangible matrix of underwriting commercial loans.

This blog is part of a short mini-series on the “art of lending” that covers the 5 C’s of credit. Lenders test each loan application against five elementary lending criteria to determine the strength of the proposed deal. There is no magic formula or defined minimum standard of these criteria for the borrower to attain.   In order to consider the loan request seriously, the lender has to be comfortable with the combined, subjective strength of these criteria.  

The lender must evaluate the applicant’s previous experience as a borrower.   Studying the borrower’s credit history discloses whether the business or the owners have paid previous borrowings as agreed.   The credit report also discloses whether the business or individuals have ever had difficult financial events that appear on public records.   These events include civil judgments, unpaid tax liabilities, general execution liens (fifa), or protection under bankruptcy.

While clearly not an exclusive indicator of how well the business will perform in the future, this information relates to how the borrower has performed in the past.   Negative information in this category may be indicative that the borrower is unqualified for an extension of credit or reveal that the borrower has not overcome earlier difficulties.   Poor performance with previous lenders may indicate that the borrower does not take the responsibility of repayment seriously.

This blog is part of a short mini-series on the “art of lending” that covers the 5 C’s of credit. Lenders test each loan application against five elementary lending criteria to determine the strength of the proposed deal. There is no magic formula or defined minimum standard of these criteria for the borrower to attain.   In order to consider the loan request seriously, the lender has to be comfortable with the combined, subjective strength of these criteria.  

The term collateral refers to the assets owned and offered by the borrower to support the loan request with tangible security.   These assets will guaranty the lender’s loan recovery by providing a secondary source of repayment.  

Lenders prefer that the loan be supported by assets valued on a discounted basis.     This discounted value provides the lender with a safe margin to cover the time and costs of converting depreciated assets into cash, should that ever be necessary.

Typically, lenders will secure the loan at a minimum of the assets being financed.   However, often the lender is requested to finance a sum larger than the discounted value of the financed assets.  

Sometimes the loan is for even more than the actual cost of the financed assets, because the ancillary costs involved with the acquisition are part of the requested loan proceeds.   Sometimes the borrower is purchasing an asset that the lender could not readily liquidate without incurring expenses.  

In these circumstances, lenders will require borrowers to encumber other assets.   This precaution ensures that the lender has a comfortable margin of value from which the loan can repaid as well as the liquidation expenses, if the business operations do not provide sufficient funds.  

When determining how much collateral is sufficient, lenders discount the market value of the collateral assets.   The discount is required so the lender can maintain an adequate margin of funds in excess of the loan balance.   The excess funds could be needed to cover the loan balance at any point in the borrower’s repayment schedule along with the cost necessary to convert the collateral to cash.  

The excess margin also ensures that the asset values always equal or exceeds the balance of the loan, commensurate with the loan’s repayment schedule.     Lenders try to amortize a loan on a schedule that reduces the loan principal over a period in which the asset is normally depreciated.   The borrower is generally required to provide a minimum of 100% collateral coverage over the entire term of the loan.

This blog is part of a short mini-series on the “art of lending” that covers the 5 C’s of credit. Lenders test each loan application against five elementary lending criteria to determine the strength of the proposed deal. There is no magic formula or defined minimum standard of these criteria for the borrower to attain.   In order to consider the loan request seriously, the lender has to be comfortable with the combined, subjective strength of these criteria.  

When lenders are invited into a transaction, they must quantify the adequacy of the borrower’s investment.   The lender will always limit its leverage in a deal and require the borrower to have a meaningful amount of capital, or ‘equity,’ at risk, thereby ensuring the owner’s commitment to the venture and reducing the lender’s exposure to loss.

Equity is defined by a lender as the portion of the total business cost that is contributed by the borrower.   Different lenders have different requirements for the capital adequacy of a borrower in different situations.   There are varying degrees of capitalization in which a lender may favorably view the borrower’s position, depending on the use of proceeds, the availability and value of collateral, and the nature of the business operation.  

As the company’s profits grow, the lender will watch the borrower’s equity or ‘net worth’ position.     Lenders expect that the company’s owners will permit some earnings to be retained by the business accordingly, rather than constantly drawing down all of the profits with dividends and distributions.  

While this equity-building process may cause the business owner to pay more taxes and limit the growth of personal income, it is a reasonable expectation if the business wants to borrow money to finance its growth.   The business should provide a measure of its own financing to provide a growing revenue base.   This strategy makes good long-term sense for the business and its owners.

Though generally unpopular with small business owners, the requirement of internally generated capital is a smart strategy, since business growth will present a new set of financial demands on the company.   As revenues grow, businesses invariably need new locations, new equipment, or additional working capital to absorb higher receivable and inventory balances.   Retaining some of the profits in the business provides a vital part of this essential funding and reduces future borrowing requirements.

Commercial lending is an art, not a science.   Based on the information provided and confirmed, lenders have a responsibility to make lending decisions that are consistent with the parameters and limitations of their institution and with the principals of prudent business investing.  

Stretching these principals beyond their limitations is not good business for bankers and carries enormous risks that are not worth taking.   Most denied loan requests lack key ingredients that would make the lender confident that the funds could be repaid from the operations of the business.  

Lenders test each loan application against five elementary lending criteria to determine the strength of the proposed deal.  There is no magic formula or defined minimum standard of these criteria for the borrower to attain.   In order to consider the loan request seriously, the lender has to be comfortable with the combined, subjective strength of these criteria.  

If the borrower has an acute weakness in one of these criteria, then that deficiency may or may not be overcome with a stronger position in one of the remaining criteria. It depends on the relative strengths and weaknesses of the borrower.   These five categories include capacity, capital, collateral, credit, and character.

This blog kicks off a short mini-series on the “art of lending” that covers the 5 C’s of credit.