For private companies, access to financing is crucial to the growth and success of the business. Cash may be needed for a variety of reasons, such as investing in property and equipment, acquiring a business, building inventory for growth, or covering shortfalls in working capital. However, not all businesses are able to qualify for financing to meet their needs. There are several factors that impact how a lender evaluates the creditworthiness of your business. Here are some qualitative and quantitative factors to consider:
- Management Team/Ownership – Does the management team consist of high integrity/high character individuals with significant industry experience and knowledge? Is the leadership building for the future? A lender will look for these traits to gain comfort in the borrower’s willingness to repay the financing obligation.
- History and Story of the Business – Is the company mature? Has it experienced profitability and a history of earnings during recent years? How did the business fare through recessionary years? How did management react to a negative event or a challenge faced by the business? The history of the business may identify recent trends and growth cycles for a lender. Additionally, management’s ability to steer through a negative event or downturn may provide a lender confidence that management could handle a similar situation in the future.
- Industry and Economic Trends – Does the management team understand macroeconomic trends in their industry? Are there any industry trends that could jeopardize the business in the future? Examples may include changes in technology, obsolescence or decreased demand of a major product, or a competitor gaining market share. Lenders value companies that understand these market conditions and can quickly adapt to changes in their industry.
- Debt Service Coverage Ratio – The measurement of cash flow available to pay current debt obligations is calculated by taking the ratio of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) to current debt obligations, including interest. Lenders will typically prefer to see this ratio above 1.2 to 1.0, indicating that there is sufficient cash flow from the business to meet current debt obligations.
- Leverage Ratio – This is usually measured by comparing total liabilities to total equity. Companies with lower leverage ratios (typically below 4.0 to 1.0) are more attractive to lenders since there is a greater probability that the company will be able to generate enough cash to satisfy its debt obligations.
- EBITDA – Lenders will look at positive trends of EBITDA since it is a measure of financial performance without the impact of non-operational factors of interest and taxes. This measurement does not factor in the cash that may be required to fund capital expenditures, so lenders may consider unfunded capital expenditures separately.
There are many components that contribute to a lender’s evaluation of the creditworthiness of your business. Lenders will assess both qualitative and quantitative factors when considering a new business prospect or expanding the financing needs of a current customer. Successful businesses looking to obtain financing generally focus on many of these items.
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