As successful entrepreneurs of growing businesses, many of our clients have borrowed money to fund their company’s growth. As a result, over the years, we’ve come to learn what lenders are looking for when considering the creditworthiness of a company. While there are many factors that go into a lender’s decision, like length of time in business, personal credit history, industry, etc. there seem to be 5 factors that are usually considered by lenders in making their decision:
- Consistent profitability – Lenders want to see a company that is steadily profitable over a long period of time. Too many spikes up and down mean uncertainty. If the term “smoothing your earnings” comes to mind here, that’s not what I’m talking about. That is, many companies save some profitability for rainy days and don’t show all of it at once. A good lender will sniff this out, so it’s not something you want to do. Consistent profitability means having real, solid, reliable and stable and steady profits over a given period of time.
- Debt to Tangible Net Worth Ratio of less than 4 to 1 – Lenders want to make sure that you’re not going to be taking on more debt than you can handle. So this ratio compares your total would-be liabilities (after you borrow the additional money) to your Tangible Net Worth, which is just your tangible assets (intangible assets, like intellectual property, trademarks, goodwill, etc are not included). Basically, lenders don’t want you to be borrowing more than 4 times your tangible assets.
- Reliable, accurate and timely financial statements within 30 days of each month-end – this is a big one, but it’s one that you as the business owner should be getting anyway. If your accounting department is not able to produce useful financial statements consistently within 30 days, there’s something wrong. The inability to produce regular reporting are considered signs of a broken and unreliable accounting infrastructure, which then calls into question the very accuracy of the numbers themselves.
- Current Ratio (current assets to current liabilities) of at least 1.25 to 1 – The Current Ratio is one of the most commonly used liquidity ratios in the lending world. The ratio tells a lender whether or not the company can cover its own short term obligations (like accounts payable and credit card bills) with its own short term assets (like cash and accounts receivable) and by how much. When a lender is looking at the Current Ratio, he/she is learning how much of the money you want to borrow is going to be used for working capital vs financing losses, buying equipment, purchasing inventory, etc. The answer to this question will also help the lender decide what type of lending product is right for you (i.e. line of credit, vs long-term loan, etc.)
- An honest and straightforward business owner – if a lender feels you are not forthcoming or are trying to paint a picture that doesn’t exist, that’s going to get your loan declined in a heartbeat. Lenders, like everyone else, want to work with people they can trust. If you were lending someone your own personal hard-earned money, wouldn’t you want the same? I’m not saying you shouldn’t highlight your strengths and present the future of your company in a positive light. I’m just saying be realistic and don’t be afraid to share the challenges you expect to have as you grow. Think of the lender as someone who is going to be your business partner, because that is exactly how lenders are thinking about you.