How Can a Lender Determine the Eligibility of the Borrower?

Lenders want to attract high quality borrowers because that is crucial to growing their business. But who is a good borrower? What are the factors that a lender needs to consider while determining the eligibility of the borrower?

 

Credit history

 

This is of utmost importance. Before making a loan, the lender has to verify the personal credit history of the borrower. Lenders should see how well the borrower has handled their personal and business debts in the past.

 

If the borrower hasn't obtained loans in the past, assessing their credit history may not be easy. Then the lender should rely on the person's work history, job security and personal references. If these are satisfactory, the lender should consider making a loan.

 

Credit score

 

The lender should use a reliable credit-rating agency to analyze the borrower's payment history to their business obligations. The lender should also ensure that the borrower is up-to-date with payments on their existing loans.

 

Repayment capacity

 

The lender should consider unforeseeable events. For example, the company may suffer an unexpected downturn after obtaining the loan. This will affect its repayment capacity. The lender has to verify that the borrower has the capacity to turn other assets into cash should profits dip. Assets can be investment certificates, real estate holdings, machinery or equipment.

 

Cash flow

 

A cash-flow based lender should look at the income of the company. Cash flow is the company's net profits. Generally speaking, in order to obtain a loan worth $100, the borrower / company should have $150 in cash flow.

 

Collateral

 

Most lenders offer both secured and non-secured loans. When the lender makes a secured loan, it asks the borrower to pledge an asset as collateral. This can be real estate, machinery, inventory, and equipment etc.

 

Before applying for a business loan, the borrower has to consider quite a few factors:

 

·         Ideally, the loan applicant should be the chief decision maker in the company.

·         The company should be operating in the sector for at least 3 years.

·         The company or its owner must not have filed for bankruptcy in the last ten years.

·         The loan applicant should have paid his / her bills on time.

 

Factors that might affect your chances of obtaining the loan

 

If there is a lawsuit or a tax lien against the loan applicant or the company, the lender may reject the loan application. Having multiple sources of credit may also reduce the borrower’s eligibility for a loan.

 

What to expect after applying for a loan

 

The loan application should be filed by the owner of the company. If the company has several owners, at least two of them should sign the application. Companies that have been around for three or more years are more likely to receive funding.

 

If the owner or the company has declared bankruptcy in the last ten years, the lender will probably not entertain the loan application. However, a company can improve its chances of getting a loan by repaying its creditors. If there a lien or a judgment against the company, it should release all of them before applying for credit.

 

Profitability

 

The lender will typically look at the company’s tax returns to see if it had made profits during the past few years. If it hasn’t reported profits, the company will probably find it difficult to make loan repayments. In this case, the loan application is more likely to be rejected.

A Comparative Analysis of Asset-Based and Cash Flow-Based Loans

When a company gets an asset-based loan (ABL), it is putting its assets at risk. An ABL uses a company's assets as collateral. These loans are much more expensive than regular bank loans. However, they are a boon for companies that don't have a huge cash flow.   

Let’s say there is a business owner trying to get a loan. He has got more than one option. He can, for example, get a loan on the basis of his company's cash flow. If his company makes huge profits, this is the only option he needs to consider. Banks prefer this kind of lending because cash flow based loans are less risky.

What if his company doesn't make huge profits? He may still require funding. In that case, his only option is to obtain an ABL. Traditional banks don't prefer this kind of loans. Most of them don't even offer these loans. However, there are several lenders who make asset-based loans.

An ABL is based on the value of the assets. That means if a company has assets of substantial value, getting an ABL is relatively easier. The lender might still consider your cash flow, but it comes only second.

Collateral

Different lenders accept different kinds of assets as collateral, but they all insist that the assets have to be salable. Lenders will not accept assets that cannot be sold quickly. The assets that are typically accepted by lenders include equipment, machinery, real estate, accounts receivable and inventory.

When the borrower gets the loan, it gives the lender the first security interest in the collateralized assets. So if the borrower fails to make the payments, the lender can seize the collateral, sell it and recover its investment. When a borrower gets a cash flow-based loan, they don't have to offer collateral. These loans are based on the company's credit rating and expected income.

Suitability

ABLs are suitable for some businesses. In the same way, cash-flow based loans are suitable for some other companies. ABLs are usually obtained by companies that don't have a good credit rating or surplus cash flow. However, its assets should be of substantial value. Otherwise, the lender will not approve the loan.

If the company has a sizable amount of cash flow and a decent credit rating, it should consider getting a regular bank loan which carries lower interest rates.

Assessment

Both kinds of loans have their advantages and disadvantages and it is hard to say whether one kind of loan is better than the other. It depends on the credit requirements and financial situations of the borrower.

It is true that asset-based loans are more expensive because they carry a higher risk. On the other hand, they help small businesses get financing even if they don't have sufficient income to justify the amount of cash they need.

ABLs have higher interest rates and processing fees. The borrowers should be able to use the loan amount to make profits. They can, for example, use the money to buy more machinery and increase their productivity. They may also use the loan amount to make acquisitions. If they fail to use it profitably, getting an asset-based loan would be a mistake.

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How Do Lenders Determine the Loan Eligibility of a Real Estate Company?

When a lender receives a business loan application from a real estate company, they will consider several factors before sanctioning the loan. What are these factors?

It is true that lenders do not use a single criterion for approving a loan. In fact, they use several criteria to determine the eligibility of the borrower. For example, as a lender, you may review your business relationship with the firm requesting the loan. You will also get the financial statements of the company scrutinized by a credit analyst. In addition, you may gather reports from third party credit agencies. You do all this to ensure that the borrower has the financial capacity to repay the loan.

After analyzing the financial statements of the company, if you feel that the loan applicant meets your credit standards, you will approve the loan request.

Credit Rating

Before approving the loan application, you need to try and obtain a credit report on the real estate company from a credit rating agency. These credit reports include information about public filings, credit scores and payment histories. Any negative information (e.g. past-due payments or outstanding tax liens) that appears on these reports should act as a red flag. In that case, you may contact the company and ask for an explanation. If the loan applicant fails to provide a satisfactory answer, it’s best to reject the loan application.

It is true that these credit reports are not always up to date; however, they provide useful information about the credit history of the company seeking the loan.

Financial standing

You need to ask the real estate company to show its annual statement for the last two years. You may also request an interim financial statement for the month before. By analyzing these statements, you can get a better idea about the company's financial standing. In particular, what you want to know is the financial status of the company – whether they can repay the loan or not. You may insist that the company should get its annual statements prepared by a reputed public accounting firm.

Collateral

Most lenders require collateral for the bank loan. If the loan is secured with collateral, you can seize the collateral and sell it if the borrower fails to repay the loan. If a real estate company is requesting a loan for buying land, it can pledge the title to the land as the collateral. Some assets do not make good collateral. For example, you might not want to accept the assets that are not readily salable to a third party.

Personal guarantees

You may also require each owner of the firm to offer personal guarantees. Each owner will have to submit personal financial statements. These personal guarantees provide additional security. You can verify these personal financial statements and after approving the loan, ask the owners to execute a guarantee.

Relationship between the lender and the loan applicant

While processing a business customer's loan application, you will have to verify its past and current relationship with the customer. The loan committee is more likely to approve a loan application if the applicant has been a valuable depositor for years before requesting a loan. Community bank officers are more likely to approve loan applications submitted by companies that are actively involved in civic affairs.

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How B2B Lending Can Facilitate Economic Recovery

SMEs play a significant role in ensuring economic growth. In fact, roughly 95% of all enterprises belong to this category.

Most small and medium sized businesses depend on banks for financing. But bank financing can be very reliable. Many enterprises learned this the hard way during the recent financial crisis.

Since many banks now lend less than they used to, SMEs are finding it difficult to get affordable debt finance. And when capital adequacy requirements increase, banks will be forced to lend even less. As a result, the need for more viable sources of funding is increasing.

On the other end of the spectrum, there are institutional investors who need long term investment opportunities. Since many of them have already burnt their fingers in capital markets, they are looking for more viable investment opportunities. Unfortunately, there aren't many investment options that generate yield and security.

It is an interesting situation. SMEs need investors and investors need opportunities for investing. There is one problem, though. Big investors do not find SMEs all that attractive and consequently, the gap between investees and investors is widening. What we need right now is a financial solution to close it.

Theoretically, there are two options to bridge this gap between small investees and larger investors.

The first method is to pool enterprises that require investment in bond structures. Since this method will be based on capital markets, it is risky in many aspects. There are several other challenges as well.  For example, the risk profiles of investees may be incompatible. The structuring cost will be high and there will be intermediary fees.  Another problem is the slow execution and the inability to change credit terms over times. What's more, this method involves the same financial institutions that were instrumental in bringing about the collapse of the economy.

The second option is to encourage large investors to make small direct investments in SMEs.

Mainstream institutional investors are yet to warm up to this concept because these direct investments are usually small. In addition, finding a suitable company or project for investing in can be difficult.

However, by deploying crowdfunding through digital investment platforms, these problems can be overcome to a certain extent.

Some large scale institutional investors have already understood the potential of this platform. An advantage of using the digital platform is that eliminates the need for intermediaries. Consequently, the yields are higher than traditional investments. Furthermore, it provides better protection against risks as small investments are spread over many companies.

Since capital market movements have only a negligible impact on the performance of these investments, they are less risky. As far as investees are concerned, it helps them attract long term investments from several sources. This also reduces the cost of capital. When investees get direct investment from investors, they do not have to depend on banks.

Digital investment platforms have the potential to revive the global economy. Any investment in SMEs should be encouraged because they help bring world economies back on their track. What's more, B2B lending is not facilitated by banks and as such, it is more resilient.