What To Consider When Reviewing The Terms Of An Equipment Manufacturer Financing Program

Today I want to talk about Equipment Manufacturer Financing Programs and some of the things you want to consider when looking at this source of business financing.
 
When you're looking at purchasing equipment from a dealer, it's not uncommon that the vendor will have a manufacturer financing program available for any of the major brands that they're selling.

Manufacturer financing programs can be a great source of financing when the cost of capital is similar to the market at large for a similar financing request. Depending on the amount of financing needed, the application information required by these manufacturer financing programs can be pretty minimal.

And the turnaround time can be very fast,

But when the cost of financing is higher or lower than the rest of the market for a similar deal, there are some things to watch out for.

Let's start by looking at low market rate offers.

Let's say that the current market rates are about 7 percent. And the manufacturer financing rate being offered is 3 percent. In this scenario, the manufacturer's rate is likely being subsidized internally to get to that 3%, which means that part of the cost of financing is either being added into the sales price or it's coming out of the vendor's margin.

It's not at all uncommon for resailers to play a packaging game with interest rates and price in an attempt to increase the appeal of their products to their customers.

Financing rate is subsidized by increasing the purchase price, then there's no net gain to the purchaser. The cost is just being moved from interest to the purchase price to create better price rate bundling.

If any rate subsidy is being paid by the vendor's margin, then there's a clear and transparent gain for the purchaser.

The best way to tell if you're actually getting a benefit is to request a quote for both the cash price and a finance purchase price and see if there's any difference. You may have to go to multiple dealers to get to the true picture, but it may be well worth the effort to uncover if there actually is a financial benefit to be gained.

At the other end of the spectrum are manufacturer financing rates that are above the market rates.

These types of financing programs are typically easy to qualify for, with no money down, and in some cases no repayment period for several months.

If you were to ask the vendor for a cash price versus a financing price, many won't provide a cash price option as everything they sell is internally financed. This is likely because their business model makes more money on the financing than it does on the equipment margin. 

In this scenario, the purchase price plus the cost of financing is likely gonna be higher than the market at large. Under this pricing scenario, the vendor is trying to appeal to potential customers that are more cashflow constrained and that will respond favorably to offers that conserve their cash, both at the time of purchase and for months afterwards.

So regardless of the financing source or ease of access to capital, it's always good to know both the cash price and the financing rate. So you can do your own apples to apples comparison on purchasing options.

If you do see a manufacturer offering a lower than market interest rate or no interest rate at all, it's likely a good idea to collect a bit more information, do the math yourself, and see if what's being offered is actually a benefit to you.

So once again, equipment manufacturer financing programs can be an excellent source of capital to your business. Just make sure the numbers make sense and they're providing a true benefit to you.

If you have a business financing problem, challenge, or requirement you'd like to discuss, you can give me a call or send me a note at the information provided at the end of this video.

I look forward to speaking with you.

Take care.

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Business Financing
Application Strategy

When applying for business financing, its important to have some sort of application strategy to improve your chances of success.  A lack of strategy can cost you time, money, and funding.

So what do I mean by a financing application strategy?

This is an approach you take to create a result that you’re prepared to accept.

The business financing process has a number of do’s and don’ts that you need to maneuver through and around to increase your probability of success.  And as you go through the process of seeking business capital, you may need to continually adjust your course of action which is where the strategy part comes in to play.

Application Strategy can be broken down into three parts ... 1) How to Apply, 2) When To Apply, and 3) Where to Apply. 

Let’s briefly take a look at each one of these.

How To Apply.

In addition to how to put together and properly describe your business financing request, which I will go over in other sections, the “How To Apply” aspect of financing strategy relates to how to convey your information to potentially interested lenders.

For instance, if at all possible, I try to never submit an application package to more than one financing company at a time.  Why?  There are several reasons.  First, an individual financing company will go through your application package and issue an approval, request additional information, or decline your request.  Whatever they issue back to you is a source of valuable information to the overall process.  If you get approved, then is the approval acceptable to you?  If not, why?  Are there areas of negotiation with the lender that could be available?  If more information is required, what is the information requested and why is it required?  Does an information request provide indications as to where your application package is deficient or where the decision-making process may be leading?  If you are issued a decline, what is the specific reason for the “No, we’re not interested” decision.

If the first lender you apply to gives you what you want, then the process is complete.  But if that’s not the case, there is much to potentially be learned from feedback you receive from an application submission that can be highly valuable if you need to move on to another source of business financing.  

From my experience, it is rarely a good idea to send multiple applications for financing out at the same time to multiple financing sources.  I can understand that a business owner or manager wants to get the best deal available in the market, so having something to compare and contrast is helpful in determining the best available deal.  Plus, in many cases, time is of the essence, so multiple applications are viewed to be a way to speeding up the process.

But remember that multiple applications going out at the same time 1) limits your ability to adjust to feedback received from any of the financing companies that received your application, 2) increases the potential for your application to be constrained through multiple submissions to the same lender, and 3) can negatively impact your personal and business credit both from a credit scoring perspective, and a lender interest perspective.

Let’s look more closely at each of these.

When you only apply to one financing company at a time, you have the ability to enhance your application package based on the feedback received.  In many cases information deficiencies or oversights can lead to declines or suboptimal terms.  And once an underwriter or credit officer makes a decision, it’s difficult to get them to change their mind even after providing greater support information or a more complete explanation of previously submitted information. If your application is sent out to multiple lenders at the same time, you lose the ability to adjust to lender feedback when making additional submissions if additional submissions are necessary.

Yes, this “one at a time” approach takes longer to complete.  But it can also be the difference between getting approved and getting declined or getting approved with optimal versus sub optimal terms.

In the haste to get business financing in place, a business owner or manager may decide to take a multi-pronged approach and 1) apply for business financing themselves, plus 2) utilize a consultant or their accountant or their lawyer, plus 3) utilize one or more brokers.

Typically this type of approach is a bad idea for several reasons.  First, your application request can cross paths and end up at the same lender from multiple submitters.  For some lenders, this can lead to an automatic decline, especially if the request has a reasonable degree of complexity to it as many finance companies don’t want to waste their limited resources trying to understand a file if several other lenders are trying to do the same thing.  

Second, there are also finance companies that will accept applications from multiple sources on the same deal and issue dual approvals.  At that point, all the brokers and consultants that receive the same approval for your submission start fighting over the deal which can put you in a more precarious position attempting to manage all individuals that are trying to get paid for their efforts.

Third, every time you make a submission, your credit gets accessed, which can lower your credit score, and your credit history will also show who made inquiries.  This is visible to all lenders that receive your application package.  When some lenders see numerous recent inquiries, they immediately decline the application as they’re not prepared to go through a file that is being broadly shopped around as they can view the odds of success for them securing the deal to be very low and not worth the effort.

In most cases, a multi-pronged strategy is not a good idea for all the reasons mentioned above and is not recommended for the “How to Apply” aspect of a business financing application.

Another consideration for “How To Apply” is to first apply to a financing company that you think can provide you with the best terms possible, with funding requirements you can meet, and in the timeline you need to work within.  There may be several financing companies in this category, but many times, they will all assess deals similarly.  So, if you get declined, or the terms and conditions are no way acceptable to you, then instead of applying to another very similar lender, you may want to consider moving into a different lender category that will view your request and financial situation more favorably.  This might not lead to an optimal outcome, but it may provide for the best outcome available to you at the point in time you require the financing, and the second application also has the opportunity to benefit from the lender feedback received during their processing of your first financing application.

In order to take advantage of this type of approach, you’re going to need to have a pretty good working understanding of the overall market place, or be working with someone that has that knowledge.

When To Apply

The obvious answer would seem to be … when financing is required.  But that’s not always the case.  Ideally, you should apply for business financing when your Credit and Financial Profiles are the strongest or strong enough to secure the financing required.

For simple financing requests, you should typically apply whenever you need business capital. But for larger and/or more complex capital requests, when you apply can matter.

Let’s go over some examples of how the “when” can impact the process.

Financial Statement Freshness.  Financing companies rely on financial statements when assessing a request for business financing.  Accountant prepared financial statements of your last completed fiscal period provide the best available view of your company from an underwriter’s perspective.  The sooner the accountant prepared year end financials are available to you, the sooner you are able to provide them as part of your business financing request package.  In Canada, corporations are required to file year end corporate tax returns 6 months after the year end.   So if you stick to that schedule, your financials are already 6 months old when they become available. 

For many businesses, that is as fresh as the results get.  This is also why it can be beneficial to get your year end completed sooner after the fiscal year end because you’re improving the freshness of the financial statements which provides greater comfort to a financing company that the accountant prepared financial statements are a good representative of the current financial health of the business.

The further you get away from your last completed year end, the longer the period of time a financing company will have to rely on internally generated interim financial statements, which are less reliable to third parties, especially when they aren’t reviewed and prepared by your arm’s length accountant.

For larger, more complex financing requests, it’s not unusual for a financing company to review your business financing request, state their serious interest in providing financing to you, but then put your request on hold until you can provide accountant prepared financial statements that are no more than 6 months old and are “fresher” than what you’ve already provided to them.

Measurable Results.  In situations of expansion and/or diversification where business capital is required for a new line of business, or a substantial change in business operations, measurable results that support the capital request can be extremely helpful to the financing process.  This typically comes from some form of a smaller scale, or phase I completion of your expansion/diversification plans that shows the business has worked through all the necessary moving parts required to generate incremental cashflow capable of providing an acceptable return and to debt service the requested capital.

In many situations business financing is required for an expansion to create a size and scale that can makes sense on paper and can be supported by research, competitor success, and third-party expertise, but can’t yet be supported by internally measured financial performance.  In this situation, the business financing  available to you may be more expensive due to the risk assessment of starting something new, or going in a new direction.  In general terms, business financing is much easier to secure when working with tangible historical performance versus theoretical projections. 

Debt financing companies will assess the risk of potential loss to themselves much higher when something new is being undertaken by an enterprise as compared with a predictable expansion based on verifiable, measured results.

So possession of sufficient proof of performance is a key determinant of when to apply for business financing. 

Removal Of Derogatory Events.  Derogatory events represent things that have happened in the business which have created a negative impact and have the potential to further impact the business going forward either directly through negative financial impact, or indirectly as a reflection of how a business is being managed.

The main derogatory events stem from Credit and/or Legal issues.

Credit issues include collection activities, registered judgements, bankruptcy, debt repayment proposal, late payment history, payment defaults, and high utilization of credit. When one or more of these issues become present in the public record of a business or business principal, its important that the item is both resolved (or a clear, predictable, and well documented resolution process is underway) and properly explained.  Through the annual business cycle and years of operation, its not uncommon for Credit issues to periodically occur.  Lenders recognize this and can be understanding of these types of issues occurring provided that they 1) clearly understand what happened, and 2) are provided with third party evidence that the matter has been resolved.

Legal and Credit issues overlap in many cases.  In the context of this discussion, Legal issues represent ongoing disputes that have not been resolved, but need to be disclosed to properly represent the financial health and financial risks of the business.  Once again, if you can show a lender the financial magnitude of a legal issue as well as the path to resolution, they are more likely to work with you than decline your request because of it.

Therefore, “When To Apply” should take place when there are no derogatory events, or when derogatory events can be properly explained, quantified, and dealt with in a responsible manner. 

If you have a derogatory event attached to you or your business that shows up in the public record, and you don’t disclose it and/or haven’t addressed it, the event can lead to an application for business financing getting declined.  

If you have a derogatory event that is not listed in the public record, or in your accountant prepared financial statements, nondisclosure may not impact you ability to access capital in the short term, but if the issue has a significant financial impact over time, or becomes a public record disclosure, you could end up in breach of your financing conditions for nondisclosure and cause the finance company to take action towards terminating their relationship with you and getting their money back.

Time of Year.  This is likely one of the hardest items to gauge, but potentially relevant non the less.  Financial institutions are also businesses and have their own annual operating cycle, budgetary targets, and fiscal reporting requirements.  Business financing portfolios are risk rated and financing company management promotions and bonuses are driven by financial results, similar to a lot of businesses.

At the beginning of a lender’s fiscal year, they are typically more conservative when making business financing decisions to see what their deal flow looks like as the year progresses and to see if they can achieve their lending goals without aggressively applying their lending criteria.  Once the first quarter results are in, they will become more or less aggressive based on what’s going on with their lending portfolio and fiscal performance to date.

The same is true throughout the year and is even more of an emphasis in the last quarter when final year end results will lead to promotions/demotions and bonuses. 

While there is no way to know exactly what is going on in any particular lending organization from the outside looking in, general economic indicators and reports can provide significant insight as to what you can expect when applying for business financing at a particular point in time.

For instance, debt financing companies, regardless of who they are, price their products based on financial market indicators whether that be the prime rate, the 5 year bond rate, the 10 year bond rate, etc.  Further, economic indicators such as the inflation rate and GDP also provide insight into how lender’s are reacting to 1) rising or falling inflation, 2) lower or high GDP numbers, 3) bankruptcy trends, and so on.

Through tracking the movement in the key publicly available financial and economic indicators, you can  develop a reasonably accurate opinion of what’s going in the business financing market and apply that to your capital acquisition planning process.  The further you can plan out your business financing needs, the better you’re going to be able to determine not only when to apply for financing, but who to apply to at a given point in time.

Where to Apply

When applying for business financing, you’re going to be providing a formal request to one or more financing companies.  So part of your financing strategy is to determine who to apply to, for the financing you require, at a given point in time.

I keep coming back to the point in time you require capital because it can be absolutely critical to getting the capital you require, for the rate and terms you are prepared to accept, in the time period you need to receive it.

Sources of business financing are a bit of a moving target in terms of what you can expect from them at any point in time.  Many business owners would like to believe that the business financing marketplace is relatively static from month to month and year to year, but that's certainly not the case.

Many business owners also work from the premise that they should always apply for the cheapest cost of financing first and that the cost of financing is the key driver in the process for seeking and securing business financing.  And while cost is always an important consideration, it should not be the sole driver of the business financing decision making process.

Return on investment or ROI is the most important factor in the business financing process where you are factoring in opportunity cost over time into the decision-making process.

Let’s look at an example.

A well established company requires incremental working capital of $1,000,000.  Contracts are in hand and everything is in place operationally to immediately increase their bottom line by $100,000 a month.

The company can likely get approved for very low cost financing at their current bank, but the process, for whatever reason, is going to take 90 days to complete.  Alternative financing at a slightly higher interest rate can be secured in two week’s time and funded in less than 4 weeks.

From an ROI perspective, option B makes greater financial sense as it will stop the company from missing out on over $200,000 of revenue which would offset the higher cost of financing many times over.

So where to apply as a lot to do with when to apply. It also has a lot to do with some of the other things I’ve mentioned including deal size and complexity, the point in time in any particular year, how up to date the financials are, how clean the Credit and Legal event status is, etc.

As a general rule, it’s always easier and faster to get more financing from a lender or financing company that you either are currently doing business with, or you’ve done business with in the recent past.  Making a financing decision has a lot to do with the finance company’s understanding and comfort with your business and how you operate. 

So familiarity can go a long way.

That being said, if your existing lender(s) is slow moving, or dialing back their approvals as they head towards their yearend, or have some other complicating factor that does not allow them to 1) react quickly to your business financing request, 2) provide you with terms and conditions you are prepared to accept, and 3) can fund the deal quickly, then from an ROI driven perspective, you need to look for other options.

For the most part, all financing companies will fall into a marketplace category.  If you know what category you can qualify for financing from, for terms you are prepared to accept, in the time you require funding, then it makes sense to focus in on the providers in that market space.  

If you make an application and don’t get what you’re looking for, there is a good chance that you’ll get a similar outcome from other players in the same market category unless there is a point in time industry focus that you can benefit from.

For example, chartered banks have very similar pricing and very similar lending parameters.  They also have portfolios that have concentrations in different industries which they may be increasing or decreasing their holdings in.  Focusing on a lender that is looking to grow in your industry space can yield a much different result than a lender who is not.

The important point once again is that your business financing strategy is all about point in time … what financing company will provide the business financing you require, for terms and conditions you are prepared to accept, at a given point in time?

The business financing market place can very much be a moving target at times, so its important to consider 1) How To Apply, 2) When To Apply, and 3) Where To Apply when developing your business financing strategy.

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Business Financing Application Summary Overview

In addition to the standard information a lender may request, you should always provide your own summary overview of the information package.  This can be short or very comprehensive depending on the capital request being made and the amount of explanation that needs to go with it.

The application summary overview is in many ways like a formal capital request to a business board of directors.  And regardless of business type or industry, most boards want the following three questions answered…

• Where are we at right now?
• How did we get here?
• Where are we going?

Let’s explore each one.

Where Are We At Right Now?

Decisions are made in the present so it’s important to have an accurate picture and context of a business’s financial, operational, and market position in order to have a base to work from.

The current snapshot of the business is grounded in the financial statements and supporting documents for the current fiscal period.  Everything in the business can be quantified into the financial statements and then further elaborated on with summary explanation if required.

The current health of the business is always important to determine before incremental borrowing is added.  Lenders do not typically look at a financing request in isolation but make some effort to see how incremental financing is going to fit into the overall picture and will the impact be largely positive or negative?

This is also where disclosure and context come in.

It’s important to show with numbers and explain in words the financial health of the business.   Part of this health picture is to also provide an overview of the business operations and market position, emphasizing the key areas that directly impact the financial results.

How Did We Get Here?

 This is primarily a historical financial statement review and comparative analysis of past years and the current year.

The current financial position is basically a moment in time.  Answering the question, “How Did We Get Here?”, highlights and explains the key events, initiatives, competitor actions, etc. that collectively explain the key financial drivers as well as any unusual elements in the results.

When I was a CFO, the general manager always wanted me to provide a monthly “bridge report” from the past financial period to the present that showed all the key drivers, revenue or cost item, that collectively created how the current bottom line was formed today over the previous 12 month period.

Whether this is a board of directors, or a lender reviewing an application, this section shows that you had a plan and you have the ability to track the results from your plan.  This shows that the business direction is intentional and is of a make sense nature providing greater confidence in decisions going forward.

That doesn’t mean that all information reviewed is good news.  Things will happen over a course of a year or more that could not have been predicted or planned for.  But the disclosure of negative items, as well as how they were dealt with, also builds credibility.

As previously mentioned, Lender reviews are typically only an inch or so deep, so its not like you have to go to any great lengths to describe your financial performance.  But some effort in this regard can be effective in creating a positive assessment of the business.

Where Are We Going?

This section is all about the business going forward and how your capital request fits into the future view in terms of revenues, operating costs, balance sheet, and cash flow impacts.

Incremental business financing typically has some impact on the go forward cash flow and net revenues, so its important to show the impact of new capital on the business and all the assumptions made to create a financial projection.

With respect to financial projections, the amount of work you need to do when building out a proforma is totally relevant to what you’re planning to do.  For instance, if you’re a new owner operator, you can get away with an average monthly projection of operating revenues and expenses because of the highly predictable nature and month over month consistency of a contracting operation that only requires one piece of equipment.

At the other end of the spectrum, any major change in business operations should look at forecasting for a period of 1 to 5 years depending on the size of the investment and length of time to fully implement and benefit from the capital expenditure.  While balance sheet, income statement, and cash flow projections all provide value to a reviewer, cash flow forecasting is always going to be the most important to determine the debt servicing capacity of the business for any existing and proposed debt.

That being said, when you’re looking at bank financing options, there are likely going to be financial covenants required in any approval that may be granted, so the projected balance sheet and income statement will be necessary to determine if the go forward business operations its capable of meeting bank covenant thresholds.

Many forecasting suggestions will talk about providing some sort of sensitivity analysis to provide a best case to worst case scenario picture of the go forward business plan.  While sensitivity analysis would potentially be useful, it can take a considerable amount of time to prepare a report that is more useful than confusing.  My standing recommendation on this item is to project conservatively to the point where your net cash flow can service debt and also provide for a cushion.  The sensitivity aspect can be covered off in your explanation of key assumptions where you can state the low and high end of the range for each key driver of the business with the projection utilizing the lower end of the range.

The entire summary overview should focus on sufficiently explaining all numbers and assumptions made so that a financing reviewer/decision maker doesn’t need to make their own assumptions.  The primary goal of this summary narrative is to assist with accurate understanding and comprehension of not only the financing request, but the financial health and operation of the underlying business.

I cannot emphasize enough that many business financing applications are not successful because of bad reviewer assumptions or misunderstandings that are borne out of the information provided to a lender. 

Always remember that business financing is a volume business, run by humans with varying degrees of experience and ability.  The more clearly you can convey your information, and present it in a manner that fits what the lender is expecting to see, the more likely you’re going to get an approval for terms that are acceptable to you.

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Standard Lender Information Requirements

A standard loan application for business financing typically includes a variety of information items and documents that provide a comprehensive overview of the business's financial health, the purpose of the loan, and the ability of the business to repay the borrowed amount. Here's what a standard lender information list looks like.  Not all business financing applications will require all these items depending on the capital request and lender. 

1. Business Information

• Business Name and Contact Details: Full legal name, address, phone number, email, and website.
• Business Structure: Whether it’s a sole proprietorship, partnership, LLC, corporation, etc.
• Industry Type: The sector or industry in which the business operates.
• Date of Establishment: How long the business has been operating.
• Tax Identification Number: Federal EIN (Employer Identification Number) for the business.
• Legal and Trading Status: Information on any legal proceedings, bankruptcies, or trading difficulties.

2. Loan Information

• Amount Requested: The specific amount of funding being requested.
• Purpose of the Loan: Detailed explanation of how the loan will be used (e.g., equipment purchase, expansion, working capital).
• Loan Term Desired: The preferred repayment period.
• Type of Loan: Specifying the type of loan product being applied for, if applicable.

3. Ownership and Management

• Owner(s) Information: Names, addresses, social security numbers, and percentages of ownership for all owners.
• Management Team: Key management personnel and their qualifications or resumes.

4. Financial Information

• Financial Statements: Balance sheet, income statement (profit and loss account), and cash flow statements for the last 2-3 years and current interim financial statements.
• Personal Financial Statements: For each principal owner listed in the application.
• Tax Returns: Business and personal tax returns for the last 2-3 years.
• Bank Statements: Business bank statements for the last 6-12 months.

5. Business Plan

• Executive Summary: Overview of the business and its strategic direction.
• Market Analysis: Information on the business’s market, competitors, and place within the industry.
• Marketing and Sales Strategy: How the business intends to attract and retain customers.
• Operations Plan: How the business is set up operationally, including suppliers, production methods, and processes.
• Financial Projections: Detailed projections of income, expenses, and cash flow for the next 1-3 years, including assumptions made in the forecast.

6. Collateral

• Collateral List: Detailed list of assets to be offered as security for the loan, including values and any existing liens.

7. Other Documents

• Business Licenses and Permits: Copies of any required licenses or permits.
• Lease Agreements: If the business operates from leased premises.
• Articles of Incorporation or Organization: For LLCs and corporations.
• Franchise Agreements: If applicable.
• Credit Report Authorization: Permission for the lender to request a credit report on the business and its owners.

Ensuring that a loan application is thorough and well-prepared can significantly impact the likelihood of approval. It demonstrates to the lender that the business is well-managed, has a clear purpose for the funds, and has a solid plan for repayment.

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Here's An Outline Of A Business Financing Application Package

A business financing application package contains all the initial information you will provide to a lender for them to intake and assessing your financing requirements.

While most of the information that should be included in an application package is featured within reports and documents that most businesses should have readily available to them, the process of putting together an application package is about information content, as well as information understanding and context.

So if content is considered “King” then in the business financing world, context would be “Queen”.

Let me explain.

You as a business owner or manager know and understand your business both thoroughly and intimately.  Any Lender that were to consider a financing application for your business does not have any where close to the same level of understanding or comprehension as it relates to your business.  The lender may understand the industry you’re in, and may even have some historical knowledge gained from past interactions with you, but they at best only have a cursory understanding of your business.

Any significant lending organization will intake and process hundreds of applications for business financing a month.  For some, it could be thousands.  One of the main goals of any lender is to assess applications as quickly as possible, zero in on applications that can be approved, and work diligently to get those targeted files through the system and funded.  For all the rest, where a fit is not apparent, decline the file, and move on to the next application.

Lending is a volume based business.  As we’ve previously discussed, lenders are made up of organizational structures and procedures that are designed to work through all the financing requests received.  The organization and procedures are run by individuals with varying levels of qualification and experience. In the quest to be a volume processer, application information received will be reviewed quickly, assessed quickly, and decisioned quickly … for the most part.

So it’s important that the information being provided is done in such a way that 1) the request for financing can be accurately described and supported, and 2) proper context is quickly achieved so that minimal if any assumptions are needed to form an accurate opinion by the decision makers.

That being said, no matter how well you prepare your business financing application package, there is no guarantee that a reviewer and/or decision maker will fully understand what you’re asking or telling them.  There’s no guarantee that they will even read through everything before forming an opinion on your credit worthiness.

But if you don’t take the time to put the information together properly, the probability of success is going to be lower in terms of getting approved and getting approved for the terms that are acceptable to you.

In the last section when we went through lending criteria and the five C’s of Credit, you likely noticed that the potential things which a lender can assess related to your application is pretty extensive.  And from a lender’s perspective, its not like they always have an exact predetermined list of everything they will pay attention to or zero in on.  But they will certainly pay attention to 1) information you provide, 2) information they find in credit reports, and 3) anything else about your or your business that they find in the public domain.

So while the 5 C’s can be described in fairly specific terms, they can be applied in very broad context to take into account anything that could be potentially relevant to making a financing decision.

This is where relevance, disclosure, and context come in.

 Relevance

This is where you need to step back from yourself and put on a lender’s hat to try and better understand what they might be looking for from you to support your financing request.  Too often business owners don’t take the time to say to themselves, “if I was the lender, how would I look at this?”.   Put another way, let’s say you have a spare $10,000,000 or so, and someone you know asks you for a business loan.  In that situation, what would you want to know about, what questions would you want answered before deciding if you could give them a loan or not?  

The more relevant the information in the loan request the better.

Disclosure

Most lenders will outline a standard information package they would like to receive.  And in most cases, business owners and managers will mechanically assemble the required information and submit it.  While this is certainly disclosure, it can also fall well short of what they should be providing.  There are three parts to proper loan application disclosure … 1) the information requested, 2) information that supports your application that is not requested, and 3) the proactive explanation of information that a lender could find in the public domain about your business that could cause confusion or concern.

An example of a proactive disclosure would be something negative or derogatory on your personal or business credit report that was reported in error and you have the supporting information to confirm the error.

Context

When reviewing all information components that you plan to include in your application package, you should always ask yourself the following questions …

• 1.  Are all items submitted, that were directly or indirectly created from the same information sources, congruent?  Example, do sales, bank deposits, GST reports, bank statements, and accounts receivable balances all reconcile to the source information?  If they don’t, they need to be proactively explained so that incorrect assumptions are not made.
  
  
• 2.  Do any items showing on financial statements need to be explained? Example, are equipment capital lease expenses shown fully as operating expenses or are they broken down into interest cost and depreciation?
  
  
• 3.  Are there any items showing in business bank statements that could cause multiple interpretations. Example, deposits where the source of the deposit is confusing based on the description provided by the bank.
  
  
• 4.  Is the capital request you’re making fully, completely, and accurately described? Example, with the purchase of equipment, the quote provided does not include the terms of sale, the condition of the equipment, or sufficient evidence to determine if the vendor is a dealer or a private seller.

Context is all about providing additional explanation to standardized information sources to make sure that the reader understands 1) what they’re reading, and 2) how it applies to your financing application.

At the beginning of this section when I was going through the application package, I mentioned that lenders run a volume business.  In the process of going through a continual inflow of applications, there will be times when context will not be achieved and bad assumptions that work against your application will be made.

It’s not possible to eliminate the potential for bad assumptions to be made in the first place, but they can be greatly reduced by taking the time to make sure that relevance, disclosure, and context are properly represented in the information provided.  

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Lending Criteria Used By Canadian Debt Lenders

The "C's" of a financing assessment performed by lenders, commonly known as the "Five C's of Credit," are a set of lending criteria used by sources of business financing to evaluate a borrower's creditworthiness.  

The Five C’s of Credit are made up of …

1. Character: This refers to the borrower's reputation or track record for repaying debts. It includes factors like credit history, public profile, and business background.
   
   
2. Capacity: This is an assessment of the borrower's ability to repay the loan. It looks at income, historical revenue trends, and debt servicing requirements. Lenders typically use measures like debt-to-income ratio to assess capacity.
   
   
3. Capital: This refers to the money a borrower has invested in the business or the down payment for a purchase. A large contribution by the borrower decreases the chance of default.
   
   
4. Collateral: Collateral is any asset that can be used to secure a loan. For a mortgage, the property is the collateral. If the borrower defaults, the lender can take possession of the collateral.
   
   
5. Conditions: This pertains to the terms of the loan and how the borrower intends to use the money, along with the broader economic environment. Conditions can include the interest rate, the amount of principal, the purpose of the loan, and the prevailing economic situation.

These factors provide a comprehensive view of the borrower's financial situation and help lenders make informed decisions about different lending opportunities.

All lenders will apply the 5 C’s in some way shape or form.  Some will focus more on Capital and Capacity, while others will be much more comprehensive in their use of these assessment categories.

Each lender model will devise their own application of the 5 C’s of Credit lending criteria when assessing an application for debt financing.

Here’s a deeper dive into each of the “C’s” to give you a better idea of what lenders may be evaluating when you apply for a business financing.

Character

From a lender's perspective, "Character" in the context of the 5 C's of credit refers to the trustworthiness, reliability, and creditworthiness of a borrower. It’s an assessment of the borrower's reputation and history in managing debt and financial obligations. Character is crucial in a lending scenario because it helps lenders gauge the likelihood that a borrower will repay a loan on time. Since lending is inherently risky, understanding a borrower's character provides insight into their financial behavior and commitment to honoring debts, which cannot be fully captured by numbers alone.

Why Character is Important:

1. Indicates Responsibility: A strong sense of character suggests that the borrower takes their financial responsibilities seriously and is likely to prioritize loan repayment.
2. Risk Assessment: It helps in assessing the risk involved in lending to the borrower. A good character indicates lower risk.
3. Historical Performance: Past behavior is often considered a predictor of future actions. A history of responsible credit management suggests a continued behavior pattern.
4. Trust Building: Lenders are more willing to negotiate better terms or extend credit to borrowers who have demonstrated integrity and reliability.
   
   

How Lenders Determine or Assess Character:

1. Credit History and Credit Score: A thorough review of the borrower's credit report and credit score is a primary method for assessing character. Lenders look for a history of on-time payments, the length of credit history, types of credit used, and how much credit is utilized versus available.
2. References and Background Checks: Lenders may require personal or business references and conduct background checks to verify information provided by the borrower and to gather opinions on the borrower's reliability and business acumen.
3. Interviews and Personal Interactions: Direct interactions with the borrower can provide insights into their character. Lenders may consider the borrower's attitude towards debt, understanding of the financial commitment, and their seriousness about the business or purpose for the loan.
4. Review of Public Records: Searching for any history of bankruptcies, liens, judgments, or legal issues that might reflect on the borrower's character and financial management skills.
5. Social Media and Online Presence: In some cases, lenders might review the borrower's social media profiles and online behavior for any red flags or indicators of character and lifestyle that might impact their ability to repay the loan.
6. Past Financial Relationships: The history of the borrower's relationships with other financial institutions or creditors, including previous loans and banking relationships, can be indicative of character. Lenders may look into any past issues or successes.
7. Stability Factors: Lenders may also consider time in business, length of residence, and community involvement as indicators of character. Stability in these areas can suggest a responsible and reliable borrower.
   
   

While the quantitative measures lending criteria like income and credit scores are important, the qualitative assessment of character plays a crucial role in the decision-making process for lenders. It's about building a comprehensive picture of the borrower beyond just the numbers, ensuring that the risk of lending is mitigated by understanding who the borrower is at a fundamental level.

Capacity

From a lender's perspective, "Capacity" refers to a borrower's ability to repay a loan. It is an assessment of the borrower's financial means to service debt, considering their income, expenses, and other financial obligations. Capacity is crucial in a lending scenario because it directly impacts the borrower's ability to make timely payments on the loan. Evaluating a borrower's capacity ensures that the lender is not extending credit beyond what the borrower can afford, thereby minimizing the risk of default.

Why Capacity is Important:

1. Indicates Repayment Ability: Assessing capacity gives lenders insight into whether the borrower can comfortably manage loan repayments along with their existing financial obligations.
2. Reduces Default Risk: By ensuring that borrowers have adequate capacity, lenders reduce the risk of defaults, late payments, and non-payment situations.
3. Financial Health Assessment: Capacity evaluation helps in understanding the borrower's overall financial health and stability.
4. Loan Structuring: Information about a borrower's capacity can guide lenders in structuring the loan amount, terms, and repayment schedule in a way that matches the borrower's financial situation.
   
   

How Lenders Determine or Assess Capacity:

1. Income Analysis: Lenders review the borrower's sources of income, including employment income, business income, rental income, and any other sources. Consistency and stability of income over time is particularly scrutinized.
2. Debt-to-Income Ratio (DTI): This key ratio compares the borrower's monthly debt obligations (including the potential loan) to their gross monthly income. A lower DTI indicates a better ability to take on and repay new debt.
3. Cash Flow Analysis: For business loans, lenders will examine the business's cash flow statements to assess the company's ability to generate enough cash to cover loan repayments, after accounting for operational expenses.
4. Financial Statements and Projections: Analysis of past financial statements and future projections can help lenders assess a business's capacity to repay. This includes looking at profit margins, revenue growth, and expense management.
5. Credit History: Past management of credit can also inform lenders about a borrower's capacity. A history of managing credit well can be a positive indicator of capacity.
6. Savings and Liquid Assets: The presence of savings and easily liquidated assets can serve as a buffer for borrowers, showing lenders that there are additional resources available to make loan payments during financial difficulties.
   
   

Lenders use a combination of these lending criteria to assess a borrower's capacity thoroughly. This analysis helps ensure that loans are provided to borrowers in a way that aligns with their financial ability to repay, thus safeguarding both the lender's interests and the financial well-being of the borrower.

Capital

From a lender's perspective, "Capital" refers to the assets or resources that a borrower can use to repay a loan. It includes the borrower's own investment in the business or project for which they are seeking financing. Capital is a critical component in a lending scenario because it represents the borrower's stake in the success of the venture. A substantial investment by the borrower reduces the risk for the lender, as it shows the borrower's commitment to the business and their confidence in its success. Additionally, it provides a cushion that the lender can fall back on in case of default.

Why Capital is Important:

1. Risk Sharing: A borrower who has invested a significant amount of their own capital into a project is perceived to be more committed to its success and less likely to default on the loan.
2. Financial Resilience: Capital demonstrates the borrower's ability to support the business during tough times. It shows that the borrower has skin in the game and resources to draw upon if needed.
3. Leverage and Repayment Source: The more capital a borrower has invested, the less they may need to borrow, resulting in a lower debt-to-equity ratio. This can make it easier for the borrower to manage repayments.
4. Collateral: In some cases, the capital itself (e.g., equipment, real estate) can serve as collateral for the loan, providing the lender with an additional layer of security.
   
   

How Lenders Determine or Assess Capital:

1. Review of Financial Statements: Lenders analyze the borrower's balance sheet to assess the amount of capital invested in the business. This includes looking at equity, retained earnings, and invested assets.
2. Equity Investment: The lender evaluates the amount of money the borrower has personally invested into the business or project. A higher personal investment is often seen as a positive indicator.
3. Asset Evaluation: Lenders consider the quality, liquidity, and value of the assets that constitute the borrower's capital. This can include real estate, equipment, inventory, and other tangible assets.
4. Collateral: The lender assesses the assets that the borrower is willing to pledge as collateral for the loan. This provides a secondary repayment source and reduces the lender’s risk.
5. Debt-to-Equity Ratio: This ratio compares the company’s total liabilities to its shareholder equity. It helps lenders understand how much the company is financed through debt versus its own capital.
6. Capital Contributions and Withdrawals: Lenders look at the history of the borrower's contributions to and withdrawals from the business. Frequent withdrawals can be a red flag, while additional contributions show commitment.
7. Financial Reserves: The presence of cash reserves or easily liquidated assets provides further assurance to the lender about the borrower's ability to handle unexpected financial challenges.
8. Business Valuation: For established businesses, lenders may consider the overall valuation of the business, which reflects its market position, earnings power, and potential for growth.

By assessing capital, lenders gauge the borrower's commitment, financial stability, and the level of risk involved in extending credit. Borrowers with significant capital investment are often viewed as lower-risk, as they have more to lose in case of failure and are presumed to be more committed to ensuring the success of their venture.

Collateral

From a lender's perspective, "Collateral" refers to tangible or intangible assets that a borrower pledges as security for a loan. It's a form of protection for the lender, ensuring that there is a way to recover the loaned funds if the borrower is unable to make repayments. Collateral can include real estate, equipment, inventory, accounts receivable, and even intellectual property, depending on the nature of the loan and the agreement between the borrower and the lender.

Why Collateral is Important:

1. Risk Mitigation: Collateral reduces the risk the lender takes on by providing an alternative means of repayment if the borrower defaults on the loan.
2. Loan Securitization: It enables borrowers to secure a loan that they might not otherwise qualify for based on credit history, income, or other factors alone. This can be particularly important for new or small businesses without a long credit history.
3. Interest Rate Determination: The presence of collateral often results in lower interest rates compared to unsecured loans because the lender's risk is reduced.
4. Loan Amount: The value of the collateral can influence the amount of money a lender is willing to provide, as it directly impacts the lender's ability to recover the loan amount in case of default.
   
   

How Lenders Determine or Assess Collateral:

1. Valuation: The lender assesses the market value of the collateral through appraisals or market analysis to ensure it covers the loan amount. This process might involve professional appraisers, especially for real estate or specialized equipment.
2. Liquidity: Lenders consider how quickly and easily the collateral can be converted into cash. Highly liquid assets, like marketable securities, are generally more favorable than assets that may take time to sell, such as specialized machinery or inventory.
3. Legal Ownership and Documentation: The lender verifies that the borrower has clear legal ownership of the assets being pledged as collateral, free of liens or other encumbrances that could affect the lender's ability to seize the asset if necessary.
4. Condition and Depreciation: For physical assets, the lender evaluates the condition and potential depreciation over the loan period to ensure that the collateral will retain sufficient value.
5. Insurance: Lenders may require that the collateral be insured against loss or damage, ensuring that its value is protected throughout the loan term.
6. Perfection of Security Interest: The lender takes legal steps to secure its interest in the collateral through a process called "perfection," which involves registering the security interest to establish the lender's legal right to seize the collateral in case of default.
7. Environmental and Regulatory Compliance: For certain types of collateral, such as real estate or industrial equipment, lenders may also assess environmental risks and ensure that the asset complies with relevant regulations.
8. Future Value Assessment: In some cases, lenders consider the potential future value of the collateral, especially if the loan term is long or if the asset is expected to appreciate.

By thoroughly evaluating collateral, lenders not only secure their loan but also gain insights into the borrower's financial health and commitment to the loan. In terms of overall lending criteria, collateral assessment is a critical step in the lending process, helping to balance the interests of both the lender and the borrower by enabling access to capital while managing risk.

Conditions

From a lender's perspective, "Conditions" refer to the specific circumstances surrounding a loan request, including the purpose of the loan, the amount requested, and the broader economic and industry-specific environment. Conditions also encompass any external factors that could affect the borrower's ability to repay the loan. This component of the 5 C's of credit helps lenders assess the level of risk associated with a particular loan, beyond the borrower's financials and the value of collateral.

Why Conditions are Important:

1. Loan Purpose: Understanding the purpose of the loan helps lenders evaluate the feasibility and the risk associated with the funding request. For example, a loan for expanding a well-performing business may be seen as less risky than financing for a speculative new venture.
2. Loan Terms: The interest rate, repayment schedule, and amount of loan influence the lender's risk. Conditions help determine the appropriateness of these terms relative to the risk profile of the borrower and the economic environment.
3. Economic Environment: General economic conditions can significantly impact the borrower's ability to repay. Lenders consider factors like inflation rates, interest rate trends, and economic growth indicators.
4. Industry Conditions: The health and stability of the borrower's industry play a crucial role. Industries facing downturns or rapid changes may pose higher risks for loans.
5. Regulatory Environment: Changes in laws and regulations can affect the borrower's operations and profitability, impacting their repayment ability.
   
   

How Lenders Determine or Assess Conditions:

1. Review of the Loan Application: The lender examines the details of the loan application, including the stated purpose of the loan, to understand how the funds will be used and to assess the rationale behind the request.
2. Market Analysis: Lenders conduct market research or use existing studies to gauge the current state and outlook of the borrower's industry, including competition, demand, and regulatory challenges.
3. Economic Data Review: Analysis of economic indicators, such as GDP growth rates, unemployment rates, and central bank policies, helps lenders understand the broader economic landscape.
4. Regulatory Compliance and Changes: Lenders review relevant regulatory frameworks and recent or upcoming changes that could affect the borrower's industry and, consequently, their ability to succeed and repay the loan.
5. Risk Management Policies: Lenders apply their internal risk assessment frameworks to evaluate how the loan fits within their portfolio, considering the current economic and industry conditions.
6. Historical Performance in Similar Conditions: Lenders may look at how similar loans or borrowers in the same industry have performed under comparable economic or market conditions.
7. Consultation with Industry Experts: For niche or complex industries, lenders might consult with experts to better understand the specific risks and opportunities.
8. Borrower’s Contingency Plans: Understanding the borrower's plans to address potential future challenges can also inform the lender’s assessment of conditions.
   

By carefully evaluating these conditions, lenders can make more informed decisions about whether to proceed with a loan, what terms to offer, and how to structure the loan agreement to mitigate risks. This comprehensive approach ensures that both the lender and the borrower are positioned for success, even in the face of changing external factors.

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Types Of Canadian Business Financing Debt Lenders

In Canada, there is a fairly broad spectrum of debt lenders that cover the country, although some regional areas are more representative of financing options across the risk spectrum that others.

For instance, there tends to be less specialty lenders operating in the province of Quebec compared to other provinces in Canada.  This is due to 1) language, and 2) legal system.  There are a multitude of lenders that will work across Canada with the exception of Quebec.

Quebec still has a lot of access to business Capital, but there are certainly lenders that choose not to do business there for the reasons outlined.

Regardless of location, small and medium-sized businesses (SMEs) in Canada tend to have access to wide variety of debt financing options through different types of lenders. These lenders offer various loan products suited to the diverse needs of SMEs, from starting up and covering operational costs to expanding business operations.

Here's a list of the different types of business financing debt lenders available in Canada:

1. Banks and Credit Unions: These are traditional lenders that offer a range of products including term loans, lines of credit, business mortgages, and equipment financing and leasing. Banks may have more stringent lending criteria, while credit unions might offer more favorable rates to their members.
   
   
2. Government Programs and Institutions:
• Business Development Bank of Canada (BDC): Offers business term loans and advisory services to help Canadian businesses grow, with a focus on small and medium-sized enterprises.
• Farm Credit Corporation (FCC): Offers a comprehensive range of financial services to farming operations, agribusinesses, and agri-food enterprises including providing specialized and personalized financial services to farming operations including loans, leases, mortgages, and other financial products.
• Export Development Canada (EDC): Provides financing and insurance solutions for businesses that export goods or services.
• Canada Small Business Financing Program (CSBFP): A government-backed program that makes it easier for small businesses to obtain loans from financial institutions by sharing the risk with lenders.  The majority of the CSBFP programs are approved and funded through the Chartered Banks.
  
3. Alternative Lenders: Include online lenders and fintech companies that offer a variety of financing products such as merchant cash advances, invoice financing, and short-term loans. These lenders often have more flexible eligibility criteria and faster approval processes than traditional banks.
   
   
4. Peer-to-Peer (P2P) Lending Platforms: Connect businesses directly with individual investors or smaller institutional lenders, offering an alternative to traditional bank financing. P2P platforms often provide competitive rates and terms for business loans.
   
   
5. Asset-Based Lenders (ABL) : Offer loans based on the value of a business’s assets, such as inventory, accounts receivable, and equipment. This type of financing is useful for businesses that may not qualify for traditional bank loans but have significant assets.  ABL lenders tend to service companies that are starting up, in distress, or growing rapidly.  All these scenarios typically fall outside the normal or traditional bank parameters.
   
   
6. Microfinance Institutions: Provide small loans, often to startup businesses or entrepreneurs who may not have access to traditional banking services. Microloans can be used for a variety of purposes, including startup costs, inventory purchase, and working capital.
   
   
7. Factoring Companies: Specialize in invoice financing by purchasing a business's outstanding invoices at a discount. This provides immediate cash flow to the business based on the value of its accounts receivable.  Most ABL’s require a working capital facility to be in place as part of their engagement with the working capital facility predominantly done through  a factoring line.
   
   
8. Leasing Companies: Offer equipment leasing and financing, allowing businesses to use the equipment they need without the upfront cost of purchasing it outright. Leasing can also provide tax benefits and preserve working capital.  These companies are provide a significant amount of equipment term lending for both acquisition and refinancing or sale and leaseback.
   
   
9. Mezzanine Financiers: Provide a hybrid form of financing that combines debt and equity, often in the form of subordinated debt or convertible debt. This type of financing is typically used for expansion or acquisition and is most commonly seen in commercial construction.
   
   

Each type of lender has its own set of advantages, terms, and conditions, making it important for SMEs to carefully evaluate their options based on their specific needs, financial health, and business goals.

Additionally, the Canadian business landscape is dynamic, with new financing options and lenders emerging as the market evolves.

While each lender category, and individual lender within a category, will likely assess risk and apply terms and pricing differently, they all follow the same fundamental risk assessment process that we will discuss in the next section.

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The Potential Impact Organizational Structure, Size, and Complexity Can Have On A Business Financing Application

I can’t complete this lender profile section without speaking a bit about the organizational size and operational complexity of lending organizations.

Let’s start with Banks.

They typically will provide the lowest cost of funds for deals they approve and fund.  They also tend to be large monolithic structures with thousands of employees, procedures, and moving parts.

There is a saying in the industry that cheap money is slow money.  And when you’re dealing with a major bank, even if they love you and are confident they can help you out with your business financing needs, don’t expect them to help you quickly.

Part of the reason that the bank financing process can be slow is that they are huge brands that everyone knows about and that everyone applies to for financing.  So they always tend to have a glut of applications to go through.

Another thing that drives how long a request for business financing can take are the processes involved and the number of hands an application has to touch, and all the back and forth that needs to happen to get through approval and funding.

This is further complicated by approval and funding responsibilities.  Throughout the banking system, bank managers and account managers have largely been stripped of any credit granting authority.  This was done to remove the bias that would inevitably form when bank employees built relationships with bank clients.  It was also removed to more centralize the management of lending targets and portfolio risk. 

So when you sit down with your banker and discuss your business financing request, you’re truly at step one of what could be a very long process before someone with the right authority can actually issue an approval in your favor.

Dragging things out even further is the separation between the people that approve a deal and the people in the bank that fund a deal.  Approval and Funding are separate and distinct from each other so that there is independence created to make sure all the rules are being followed.

Put another way, there is no guarantee that any bank approved deal will ever get funded or funded quickly.  It’s the classic we’re both on the same team, but not on the same page or sharing the same priorities.

To be clear, as a business, this type of role separation in the organization structure is important and necessary to reduce the issuance of bad loans or loans that don’t meet the bank’s risk rating, which in turn doesn’t line up with the pricing provided.

But from a time perspective, the overall process takes longer to complete.  How long?  That’s nearly impossible to tell as there are so many factors and people involved, but it’s not unusual for bank or credit union business financing approval and funding process to take several months.  Is it possible things can move faster.  Absolutely.  Is it probable?  No it’s not.

One last thing to mention on this subject is that many banks don’t always formally decline business financing applications.  Depending on when you apply, and how long the process is taking, and how tight the numbers are, they may tell you that they’d like to see your year end accountant prepared financials when they are available before they can proceed further. 

Or they may say they want to see 6 more months of financial results before making a decision. 

Or they may come up with a bunch of other suggestions that push you out into the future, but at the same time don’t give you a flat out “No”.

I’m not exactly sure why they take this approach.  Perhaps its because they may hold your mortgage, RRSP’s, and sell you insurance and don’t want to lose your business.

Perhaps its because they are a major brand and don’t want people constantly complaining about being declined in public.

Perhaps the people you ended up dealing with were too green and lacked the experience or the organizational connections to get your request pushed through the system and properly advocated with a decision maker.

The takeaway here is that if you’re looking for the lowest cost money, make sure you have the time to go through the process.  And if the process is taking too long, develop a Plan B and implement it before you run out of time.

Non Bank Lenders

Most non-bank lenders are nowhere near the size of banks and no where near the operating complexity.  In most cases, these specialized lenders are much smaller organizations with less complex operational systems to assess, approve, and fund business financing requests.

But that’s not always the case.

I would consider the Business Development Bank of Canada and Farm Credit Corporation as non-bank lenders because they only provide B to B Financing, where banks provide both B to B and B to C financing on a much larger scale.

Both BDC and FCC are crown corporation that are funded by the Federal Government.  Both are specialized term lenders and both are pretty large in size, which results in the same complexity challenges as banks.

BDC and FCC are also well known major brands, so they are both going to receive lots of business financing requests over the course of a given year, and it takes time to process larger volumes of activity, especially when your organization is multi layered, national, and full of its own organizational complexity.

Both BDC and FCC are great lending options.  But like the banks, they are not typically going to be very fast.  And referring back to the Risk Management section, these organizations have regional portfolios with their own risk ratings which can vary considerably at any given point in time from one region to another.

Smaller specialized lenders may have multiple locations, but for the most part, they are much smaller in size from banks, credit unions, and crown corporations.  The smaller size, for the most part, results in greater speed.

But that is certainly not always the case.

As we discussed in previous sections, specialized lenders will align their public offering with their cost of funds and associated level of risk.

For specialized lenders that focus on the lower risk end of the market, their interest rates can be very comparable to banks at times.  Even if their rates are higher, they also tend to have greater flexibility in the features they can provide with their financing approvals.  Many times features can be as important as the rate, which helps them be more competitive in the overall market.

Specialized lenders that focus on the higher risk end of the market, typically are closer to banks in terms of their processing, decision making, and funding speed.  This is not due to organizational size or complexity. Its more related to higher risk deals requiring greater scrutiny and many times the analysis process can depend heavily on third party experts to provide reports on asset values, financial performance, industry analysis, etc.  Third party reports not only cost borrowers money to complete, but they can also require considerable amounts of time to complete inspection, analysis, and report creation.

Specialty lenders like equipment financing companies, are focused on making decisions quickly and funding quickly to meet the demands of the market.  As such, speed and additional features can also allow them to charge more than banks and thus have access to a larger market than otherwise would be available to them if cost of money was the only determining factor.

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Portfolio Risk Management

As mentioned in the previous section, the cost of business financing is directly related to the degree of risk that a lender or debt provider is willing to take on when providing funds to satisfy a business financing application.

The risk that is calculated by a lender has to also align with the supply and cost of money available to the lender so that a spread or margin can be built into their pricing.

Using the equipment financing market again, an equipment financing company has access to a source of capital that is prepared to advance capital to the finance company to fund loans and leases that are fully secured by equipment and potentially other assets pledged by a business or its shareholders.

In simple terms, if the equipment finance company can borrow funds for 5% and build in a margin of 2%, the end customer will be provided with an approval for 7%.  The margin, just like the margin built into any other business, has to cover operating costs and profits.

In the case of banks and credit unions, they are focused on the lower risk end of the lending spectrum and typically only provide pricing related to business financing applications that they determine to provide low risk of loss.

With more specialized lenders like equipment financing companies, they typically will provide pricing over a broader spectrum of risk.  So instead of having one basic pricing point, they may have several, and for each pricing point, the risk assessment, cost of supply, and customer pricing are going to be different.

This broader risk spectrum approach is designed to cover a larger percentage of the available market with the goal of lending or leasing larger volumes and generating higher profits.

The scale and longevity attained by any specialized lender will be in direct correlation to how well they determine risk, price out their offers, and manage their outstanding portfolios across ever changing economic conditions.

Lender Portfolio Risk is a very important concept for business owners to understand.

Every active lender has an outstanding portfolio of loans/leases/mortgages/etc.  Each borrowing in that portfolio will have a risk rating of some sort, and the portfolio as a whole will have an average risk rating.

Lenders also have annual and quarterly lending targets to hit in order to cover costs and generate targeted profits.

Lending targets and portfolio risk ratings work hand in hand.

The presidents, VP’s, directors, and managers working for various lenders are graded against their targets and portfolio risk which in turn will drive their behavior.

For instance, if a lender is not hitting their targets, and the portfolio risk rating is low, they are more likely be more aggressive with approving and funding business financing applications.

On the other hand, if targets are being exceeded, and the portfolio risk rating is also low, then the lender may become very selective with respect to approvals issued as their may not be any monetary gain for the people in charge to take higher levels of risk.

At the other end of the spectrum, when risk levels are too high, lending is likely going to get cut back regardless of whether lending targets are getting hit or not.

This is a dynamic that plays out in the background with every debt financing company, every single month of the year.

This is why “Business Financing Is A Point In Time Event”.

The basic meaning hear is that when you apply for business financing it’s always about who can provide you with 1) the amount of capital you require, 2) for terms and pricing that are acceptable to you, 3) at the time you require it.

The impact of lending targets and portfolio risk ratings can have a significant impact on whether or not a given application will get approved.

I’ve personally seen this on several occasions where a certain size and type of deal will get approved by a particular lender and then 6 months later a very similar deal with a very similar borrower profile is declined by the same lending institution.

There’s nothing you can really do about this except to remember that business financing is a point in time event.  And when you’re looking for business capital, you need to figure out who can give you what you need when you need it.

Even if you have a long standing and fruitful relationship with a particular lending organization that’s always been able to meet your needs, there can be points in time when all of a sudden they can’t help you and you’ll be left to wonder why.

You may have just showed up at the wrong time.  And if that’s the case, its time to pivot and work on similar lender options because it may not be that you can’t get the financing you’re apply for, you just can’t get, right now, from your preferred lender.

There are times in the year that lending targets and portfolio risk ratings are more likely to come into play.  For instance, if a lender gets off to a slow start in the first quarter of a year, especially if the lender’s first quarter is the first quarter of the calendar year when overall economic activity can be slower, then there is a higher probability they are going to be more aggressive looking for deals in the second quarter.

Another example is the last quarter of a lender’s fiscal year.  Going into the last quarter, are the lending targets on track, or are they below the line?  You can get signals from the market place that lenders are being more aggressive putting money out, or they’re being very selective and pulling back, depending on their lending volumes at a particular point in time.

Just remember, that if you have a solid business financing request, someone likely has the funding for you … it just may not be who you expected.

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Lender Business Models

A lender business model, like any business model, needs to have a targeted customer base, a competitive offer that can allow it to profitably compete against known competitors, and a market large enough to provide opportunity to gain and hold market share.

For business financing companies that provide debt based solutions in Canada, we will continue to focus on the portion of the overall market place that consists of small and medium sized businesses.

Each company’s business model primarily starts with their source of capital and cost of capital.  As mentioned in previous sections, outside of an individual private lender with money sitting in their own personal bank account, every debt lender gets their funds to borrow from someone else…every single one.

And the different sources of funding available to Canadian Lenders will require a certain level of return that may or may not be backed by tangible, marketable security to manage the level of risk that is built into the pricing.

In very general terms, I believe there are only two types of lender business models in Canada.   The first one is what we see from banks and credit unions where those organizations serve both consumers and businesses. Banks and credit unions access most of their funds from deposits, but also have numerous other sources of capital available to them including their own retained earnings, external borrowings, capital markets, government programs, institutional investors, member capital in the case of credit unions, foreign exchange trading in the case of banks.

The bank and credit union business model serves both consumers and businesses and can have the size and scale to segment the market with several products including loans, lines of credit, credit cards, mortgages, and other financial services over a wide spectrum of consumers and businesses.

The second lender business model sources capital from a limited number of sources and is more highly specialized in terms of the products it offers small and medium sized Canadian businesses.  Examples would include mortgage companies, equipment financing and leasing companies, micro finance companies, asset based lenders, factoring companies, etc.

In this model, the source and use of funds are closely linked to establish the lending risk to be taken and the corresponding pricing and lending terms that match the risk.  Lending in this case is highly specialized and more targeted to specific industries and business profiles to better control risk and return.

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