The business landscape is currently in disarray due to the recent Covid-19 pandemic, causing a prolonged worldwide economic shutdown. Although there have been several working capital relief options such as the Economic Injury Disaster Loan (EIDL) and the Paycheck Protection Program (PPP), these options have since dried up. For businesses looking forward to their first business loan here is a breakdown of what to expect.
The loan approval process starts with the loan application. The typical loan application will ask for the company name, phone, address, industry, list of owners, type of loan, and the purpose of the loan. There are many different types of loans: line of credit, revolver loans, mezzanine loans, term loans, SBA loans, etc.
The loan application will also require additional financial information such as:
Prior year’s tax returns
Historical financial statements
3-year Pro-forma financial statement forecast
Working capital schedules like Accounts Receivables, Accounts Payable, and Inventory.
Capital expenditures schedules
Personal Assets (for personal guarantees)
As the loan progresses through the initial application, negotiations on the terms of the loan begin. The lender will send a term sheet summarizing the primary terms of the loans including the interest rate and fees, maturity date, repayment, covenants, and security. The term sheet is a non-binding agreement that will be the basis used to draft the formal agreement.
Once the terms are in negotiation, the lender will perform their due diligence. This would typically be in the form of field exams and audits on the company’s financial statements and an assessment of the quality of any collateral used for the loan. In some cases, a financial advisor is required to vet the quality of the financial forecasts as well.
The underwriter will be assessing the lender's risk in facilitating the loan. In general, they are making considerations using the five ‘Cs’ of credit: Character, Capital, Capacity, Conditions, and Collateral.
Character: Management's capability to deliver on strategy and track record of success or failure. History with other lenders and repayments.
Capital: The lender wants to know if the debt to equity levels are sufficient. they want to know if the owners have enough “skin in the game”.
Capacity: The borrower’s ability to repay the loan. Is there enough working capital and does the projected cash flow support the loan repayment.
Conditions: Political, economic, social, technological, and the competitive environment of the borrower's business. How will these external conditions affect the borrower's business.
Collateral: depending on the type of loan this collateral can be accounts receivables, inventory, equipment, real estate, and personal guarantees. The lender takes into consideration how easily the company can liquidate these assets if the borrower cannot repay its loan
Once the lender approves the loan application they will send the borrower a commitment letter. The commitment letter is now a legally binding document showing intent of both parties to enter into a loan agreement.
The Loan Agreement
The final part of the process is the formal contract between the borrower and the creditor. It is a comprehensive document consisting of documentation from the loan application, term sheet, commitment letter, and other supporting documents.
After the loan is approved, the lender will continue to monitor the credit risk of the loan. The lender will require that the borrower submit documents which could occur either daily, weekly, monthly, or annually. Below is a list of documents that is typical of a lender monitoring their loan.
Monthly financial statements
Accounts receivables aging
Accounts payable aging
Other covenant calculations
Before applying for any type of financing, it is important for businesses to have their books in good order. GFT's accounting services can help get your books ready for a loan application. Continued monthly accounting will help borrowers maintain a healthy relationship with their lenders. GFT corporate finance services can help guide your business with the loan application process.