The Basics of Business Lending: Understanding What Lenders Look For
If you are growing a business chances are that you will need capital to grow your business. Often businesses will use banks or alternative lenders to achieve this. Have you ever wondered what the banks look at when assessing a funding application for business lending?
Here at Vesta, we are here to pull back the curtain and help you understand what lenders look at so that you can put your business’s best foot forward.
When you're applying for a business loan, understanding what lenders are looking for can significantly improve your chances of success. While the specifics may vary between different lenders and loan types, most will evaluate your business based on a few key factors.
These are often referred to as the 4 C's of Lending:
Character
Capacity
Collateral
Capital
These four factors help lenders assess the risk of lending to your business and determine the terms of the loan.
1. Character: Trust and Reputation Matter
Character refers to the borrower’s reputation, track record, and overall trustworthiness. Lenders want to know who they’re dealing with and whether they can rely on the borrower to honor their commitments.
What lenders assess:
History of Performance/Experience: Your track record in managing businesses and your experience in the industry.
Reputation and Trustworthiness: How others in your industry view you and your business.
Credit History: A look at your past financial dealings, including any past loans or lines of credit.
Follow-Through: Whether you do what you say you're going to do and meet your business goals.
Governance and Advisers: Strong management, trustworthy advisors, and a solid team are crucial.
Risk Management: How well you’ve managed and mitigated risks in the past.
Communication: Clear, open communication with lenders, stakeholders, and customers.
Why It Matters: A strong character reduces the lender's perceived risk and makes them more likely to approve your loan application. Lenders want to feel confident that they are dealing with a trustworthy borrower.
2. Capacity: Can Your Business Repay the Loan?
Capacity evaluates your business’s ability to repay the loan. This involves an assessment of your financial health, including income streams, profitability, and overall financial stability.
What lenders assess:
Financial Statements: Profit and loss, balance sheets, and cash flow statements.
Cashflow and Profitability: Lenders will examine whether your business generates enough cash to cover loan repayments and operating expenses.
Forecasting: Lenders want to know your business’s projected financial health. What does the future look like?
Debt Service Coverage Ratio (DSCR): This ratio helps lenders understand if your business can cover its debt payments from cash flow.
Terms of Trade: How you handle transactions with customers and suppliers.
Diversification: How diversified are your revenue streams? A diversified business is less likely to face financial strain.
Industry Stability and Economic Conditions: Lenders will consider the overall health of the industry in which your business operates and broader economic conditions.
Why It Matters: Demonstrating a solid financial position and reliable income streams reassures lenders that your business can handle repayments and manage financial obligations.
3. Collateral: What Security Can You Offer?
Collateral refers to the assets your business can provide as security to back the loan. Lenders prefer businesses that can offer valuable assets as collateral, as this reduces the risk for them.
What lenders assess:
Property: Residential or commercial properties owned by the business or its owners.
Vehicles and Machinery: Equipment and machinery that can be sold or used as collateral.
Plant and Equipment: Valuable machinery or production assets.
Accounts Receivable: Outstanding invoices or debts owed to the business.
Inventory & Stock: Physical products and stock that can be liquidated if necessary.
Term Deposits: Financial assets that can be accessed in case of need.
Why It Matters: Collateral helps lenders mitigate risk. In case your business is unable to meet its financial obligations, collateral offers a fallback option or a secondary exit strategy.
4. Capital: How Much Skin Do You Have in the Game?
Capital refers to the financial investment you have personally made in your business. Lenders want to know that you have a financial stake in the success of your venture.
What lenders assess:
Owner’s Equity or Investment: How much of your own money or assets have you invested in the business?
Liquidity: The amount of easily accessible capital in the business.
Retained Earnings: Profits that have been reinvested back into the business.
Financial Reserves: Emergency funds or reserves that can be drawn on in tough times.
Why It Matters: A strong capital base shows lenders that you are committed to your business and can weather financial setbacks. It also shows that you have a cushion to absorb unexpected challenges.
IN SUMMARY:
Understanding the 4 C's of lending can give your business a strong foundation when applying for finance. By focusing on building your business's character, capacity, collateral, and capital, you can enhance your chances of securing a loan with favorable terms. At Vesta Finance, we work with businesses of all sizes to ensure that you're well-prepared for the lending process.
If you’re ready to take your business to the next level, contact us today for expert advice on business lending solutions tailored to your needs.
Vesta Finance & Advisory - The Trusted Partner for Ambitious Business Owners.
Book a discovery call with one of our financial advisers to discuss how Vesta can help you grow your business through strategic funding solutions.