What is that Lender Thinking?

Borrowing money can seem complicated, but lending is really a fairly simple business. Lenders are in the risk business so they constantly juggle the desire to invest in businesses’ success and the need to limit risk of loss. Knowing how lenders think will help you navigate the process and be better prepared to apply for a loan. 

Why Are You Requesting a Loan? 

This seems obvious, but it can be surprisingly hard to answer. Lenders are looking for “productive” borrowing uses, meaning something that will generate more revenue or create efficiencies and cost savings. Examples include purchasing new equipment to create more widgets faster or bridging cash flow gaps between when you start making a product and when you collect cash from selling it. Be sure you can clearly articulate how the money will be spent, how it will improve your business and, ultimately, how you will repay the loan. 

Borrowing isn’t just about money, though. Having a clear understanding of your business and the ability to explain it also reflects strong management, another factor lenders look at when making decisions. 

How are you going to pay the loan back? 

When lenders review loan applications, they look for three ways to get paid back. The main way you expect to repay the loan is the primary source of repayment. Again, this seems obvious but can sometimes be tricky. If you’re purchasing a new piece of equipment, for example, explain how that machine will create more widgets faster and how that translates to higher sales and, ultimately, more free cash flow. If you need bridge or gap financing (aka working capital), explain your cash conversion cycle (number of days between purchasing raw materials and collecting sales revenue) and why you need to bridge that time gap. 

If that doesn’t work, how are you going to pay the loan back? 

Lenders know that sometimes the best laid plans don’t always work and your primary source of repayment is compromised. Let’s say the revenue you anticipated doesn’t pan out (perhaps because of something entirely out of your control) and you aren’t generating enough cash flow to pay the loan back. At this point, lenders will look to a secondary source of repayment, or fallback position. That could be the business’s cash on hand or the sale of a company asset. 

And if that doesn’t work, how are you going to pay the loan back? 

What if the collateral or other assets still aren’t enough to repay the loan? Lenders will now look to the owners’ outside income and assets to repay the loan (through personal guarantees). Nobody ever wants to get to this point, but sometimes it happens. Don’t be afraid to tell your lender when you run into trouble. Hard as it is for both parties, lenders would rather know early. They’ve seen almost every situation and can provide guidance, and they look favorably at borrowers who are willing to work toward repayment even in hard times. If they’re involved early enough, reworking the loan to help you repay is the best solution for everyone. 

Consider your lender a trusted advisor and expert like your accountant or lawyer. If you are prepared with the answers to a few key questions and are willing to share the good, the bad and the ugly, you will build a stronger relationship with your lender.

Lesli Pintor is executive director of Growth Partners Arizona.