Fueling business growth and expansion requires huge financial outlays. Whether it's securing capital for a startup to launch a groundbreaking product or providing working capital for an established business to seize new opportunities, the right infusion of funds can be a game-changer.
In today's economic circumstances, however, options for securing such adequate capital are limited with business loans emerging as the most common and preferred method among entrepreneurs.
However, the processes for securing a business loan are not clear-cut. Each business loan application is scrutinized through the lens of the lender, who seeks to assess the potential risks and rewards associated with the borrower. By gaining insight into the criteria that lenders typically consider, one can strategically prepare and tailor applications that exceed the lender’s expectations.
Therefore, this article will shed light on some of the key factors that lenders typically prioritize during the loan evaluation process, providing valuable insights for businesses to improve their chances of securing a business loan.
THE BUSINESS LOAN REGIME
Various types of business loans are available in Ghana, each having its distinct terms, interest rates, pre-conditions, drawdown conditions, and repayment arrangements among others.
The identification of a suitable loan facility that aligns with one’s business objectives will require thorough research and analysis to understand the benefits and risks. Largely, each type of business loan requires some form of guarantee for the repayment serving as an assurance against defaults.
Even where such credit arrangements are as overdrafts, allowing withdrawal beyond the available credit balances usually as a means to meeting cashflow shortfalls, the borrower must demonstrate some assurances of receivables in the short term.
Generally, term loans, including short and medium-term have become the commonly sourced financial assistance from lenders, serving multiple business use cases such as capital investments or working capital financing.
Also, emerging strongly is the practice of Purchase Order (PO), Invoices, and Post-dated cheque discounting, which is accelerating the due dates of values from confirmed commercial arrangements with 3rd parties for immediate cash advances to borrowers.
THE BUSINESS LOAN ADVANTAGE
A business loan offers a distinct advantage over the alternative equity financing option. Unlike equity financing, where a portion of ownership of a business is traded for capital, a loan leverages borrowed funds without dilution of ownership of the business. This financing option provides a flexible and empowering solution for business owners who strive to secure the funds needed to propel their ventures forward while preserving their autonomy and ownership rights.
Business loans are also well-suited for medium to long-term borrowing needs, providing flexibility in terms of loan amount, repayment schedules, length of term, and type of interest rate. This allows businesses to tailor the loan to their specific requirements, taking into account factors such as cash flow and income generation.
Moreover, business loans often offer the option of repayment holidays, providing temporary relief during challenging periods.
Additionally, the interests associated with these loans are generally tax deductible, providing potential financial benefits to the related businesses.
By matching long-term loans with fixed assets, businesses can improve their net asset position on their balance sheet, contributing to their overall financial stability and credibility. Furthermore, making timely loan repayments can have a positive impact on a business's credit score, potentially opening doors to enhanced financing opportunities in the future.
THE LENDER’S CHECKLIST
When it comes to securing a business loan, being prepared is key. Obtaining a bank loan may seem daunting, but with the right knowledge and preparation, it can be a smooth process.
Lenders require a plethora of information to assess one’s eligibility and ascertain potential risks before making approvals and disbursements. While specific requirements may vary among lenders and loan types, some commonly requested information include:
- Business Plan: All loan programs require a sound business plan that includes projected financial statements (profit and loss, cash flow, and balance sheet). Lenders want to see a well-developed business plan that outlines the company's goals, strategies, market analysis, and financial projections including the use of funds. A comprehensive business plan must demonstrate the borrower's commitment and ability to repay the loan.
- Credit Bureau Report: To ensure responsible lending practices and mitigate risk, the Bank of Ghana mandates participation in a loan registration database by all lending institutions. This centralized system allows banks to verify a borrower's creditworthiness by accessing their complete loan history. A history of responsible borrowing and repayment behavior documented within the database establishes a borrower's positive credit profile. Conversely, a history of defaults or delinquencies would be reflected, offering valuable insights into a borrower's financial responsibility. This transparency fosters trust and stability within the financial sector, ultimately benefiting both lenders and borrowers.
- Income Tax Returns: Most loan programs require personal and business income tax returns for the previous three years. Ensure you have these returns prepared and organized. Providing personal and business income tax returns is essential, particularly for well-established businesses. These returns verify your income, demonstrate financial trends, and help lenders determine the loan amount for which you qualify. For startups, personal finances may be considered in the absence of business tax returns.
- Financial Statements: Lenders require various financial statements, including profit and loss statements, balance sheets, and cash flow forecasts. This information provides insight into the business's financial health, liquidity, and ability to make timely loan payments. It's advisable to have a professional review your financial statements to ensure accuracy and understanding. A balance sheet is a vital document that showcases your business's financial position at a specific point in time. It provides an overview of your assets, liabilities, and equity sources. This snapshot allows lenders to assess your financial stability and determine the feasibility of approving your loan.
- Bank Statements: Many loan programs require at least one year of personal and business bank statements to assess your financial position. However, with the rise of digital and mobile payments, some businesses are adopting alternative payment options as a preference over traditional bank accounts. Platforms like “MTN Momo” and other mobile money services (collectively referred to as "momo" statements) securely facilitate transactions and payments without the need for a bank.
For businesses operating primarily through digital payment networks, momo statements may serve as an emerging alternative type of record to evidence cash flows. They provide a comparable view into revenues, expenses and cash balances over time.
Lenders working with the digital finance sector are increasingly appreciating momo statements as a valid replacement for traditional bank statements, especially in regions where mobile payments are more ubiquitous than bank accounts. Of course, any alternative document would still need to provide a full audit trail of transactions for the required period.
Borrowers using new payment rails should ensure any relevant momo or digital payment platform statements are organized and up-to-date to present to lenders as part of an application, alongside personal details. Doing so can help open new opportunities for financing assessment and approval. This allows lenders to analyze deposit and withdrawal patterns. - Accounts Receivable and Accounts Payable: Prepare details of your business's most current financial position by organizing accounts receivable and accounts payable information. Accounts receivable refers to money that is owed to the business by its customers or clients. These are unpaid invoices or bills that are outstanding. As a business provides goods or services to its customers on credit, the amounts owed are recorded as accounts receivable until payment is received. Tracking accounts receivable allows a business to monitor how much customers owe and when payment is expected. Receivables are an asset on the balance sheet since they represent potential future cash inflows. With this item on the balance sheet, lenders are able to identify a business’s capable of generating cash through sales on credit.
Accounts payable, on the other hand, refers to money that the business itself owes to its suppliers or vendors for goods or services that were purchased on credit. These are unpaid invoices or bills owed by the business. Recording accounts payable allows a business to manage what it owes to others and plan cash outflows for payments. Payables are a liability on the balance sheet since they represent potential future cash outflows to satisfy debts. Payables provide insight into payment obligations. Knowing what bills need to be paid and when helps lenders assess repayment capacity and risk of default.
In most instances, both receivables and payables are weighed against each other to establish a business’s credit worthiness, and the lender can forecast risks. - Collateral: Collateral requirements vary depending on the loan program and risk factors involved. If you are seeking a secured loan, you may need to provide proof of collateral to mitigate the lender's risk. Collateral can be in the form of assets such as property or equipment. The attached asset should maintain a value sufficient to cover the loan amount in case of default. However, it's important to carefully consider the potential risks associated with collateralized loans before pledging your valuable assets.
It is interesting to note that in this current dispensation, secured loans can be granted using a third party's property, provided these third-party consents to the use of his or her property. In such cases, lenders seek assurance by way of a duly executed consent letter and additionally producing proof of ownership of the asset to be used. Also, the consent letter serves as proof that the third party understands the legal implication of their property being used as collateral and that they may suffer a loss in cases of a default. - Management Team: When evaluating a loan application, lenders carefully assess the experience, qualifications, and track record of the business's management team. A strong management team is a critical factor in the success of any business, and lenders understand that a team with a proven ability to navigate challenges and achieve financial goals is more likely to repay a loan. To assess a management team's capabilities, lenders will consider factors such as the management team's experience in the industry, and their track record of success in previous ventures.
For sole proprietorships, lenders may also consider the risk of the business being overly reliant on a single person. This is known as "key man risk." To mitigate this risk, lenders may require the sole proprietor to have a succession plan in place or to take out life insurance. - Legal Documents: Depending on the loan requirements, you may need to submit various legal documents such as business licenses and registrations, articles of incorporation, contracts with third parties, franchise agreements, commercial leases, and other relevant paperwork. Lenders will meticulously examine these documents to ensure the business adheres to all applicable laws and regulations. This includes reviewing licenses, permits, contracts, and other legal documentation to confirm the business operates within the legal framework. When providing this paperwork, it’s not just about submitting current documentation but also being mindful of upcoming renewal or expiration dates. Many permits and licenses have specific timeframes before they need to be reissued. Lenders want reassurance that the business will remain compliant for the entirety of the loan term.
It is advisable to cross-checking all legal documents you submit against an organizational calendar to note renewal milestones. Highlight key dates on your application, along with any conditions or steps required to maintain continued approvals. For example, indicate whether license renewals involve simple online payments, or require updated inspections or certifications. Note frequency - are items annual, biannual or longer? - Existing Debt: Lenders consider the borrower's existing debt obligations, including outstanding loans and credit lines. They evaluate the borrower's debt-to-income ratio and debt-to-equity ratio to determine the borrower's capacity to take on additional debt.
When disclosing existing debt obligations to a lender, it's important to be fully transparent about your current financial position.
Lenders will appreciate honest and accurate information that allows them to properly assess repayment risks. They may be able to help restructure some debt if needed.
If your debt levels are high, don't try to hide or understate liabilities. Explain clearly how obligations like loans, credit cards or leases are impacting cash flow.
You could approach lenders proactively to discuss debt consolidation or restructuring existing debt as part of the new loan process. They may offer favorable terms to lower payments.
While high debt levels increase risk factors, honesty shows integrity and willingness to address financial challenges responsibly. The lender's role is to review real circumstances and offer customized solutions if the business proves viable overall.
The extensive information required by lenders serves two crucial purposes: regulatory compliance and risk assessment. Lenders will verify the information provided, and any false or misleading information can result in your loan being denied. Remember that the approval process starts with the application itself, and errors or inaccuracies could potentially delay the process or impact your chances of approval.
CONCLUSION
Following the tips provided and understanding the key factors lenders evaluate will increase your chances of success. Start your loan journey today and achieve your financial goals with confidence. It's important to note that different lenders may prioritize these factors differently based on their lending criteria, risk appetite, and the type of loan being applied for.
ABOUT THE AUTHOR
ADWOA BIRAGO NYANTAKYI is an Associate at SUSTINERI ATTORNEYS PRUC (www.sustineriattorneys.com). Adwoa specializes in Banking and Finance, Green Financing, Capital Markets, Projects, Infrastructure, and Construction, as well as Property and Land related legal matters. She welcomes views on this article via birago@sustineriattorneys.com