When you've decided you need business finance of some description, it is quite likely you will be building relationships with a new lender, considering today's market of multiple options.
They will undoubtedly ask many questions about your business and more than likely your personal financial situation as well. However, it is important you ask about them too!
In my experience, lenders or funders vary in their customer service and delivery levels. It is all very well going with the cheapest lender, but if they are going to be problematic throughout the loan period, then it can be more trouble that it's worth. Equally, the lender that advertises the cheepers rate is not necessarily the cheapest, as we will discuss.
Below are 9 questions you can fire back at a business finance lender that will help you understand their business model, and decide whether they are the right way forward for your business:
1. How are you funded?
It might not sound that important, but it can give you a glimpse into their business model. If nothing else, it will tell you how transparent they are.
For the record, a lot of newer business funders are financed by High Net Worth Individuals, pumping in several million at a time. In the case of short-term property loans, these individuals can be charging up to 15% per annum for their funds, with actually very little going to the operational aspect i.e. the firm you are dealing with. It's not uncommon for these lenders to be taking only 2-3% per annum from any loan, and therefore have little room for negotiation on rates.
2. What are the total costs?
This sounds obvious, but it surprising how few lenders are able to give an accurate view of what the funding will cost you.
In the debt field for example, there is typically an arrangement fee, the loan interest, an exit fee, and possibly an early redemption fee. Some may charge an upfront admin fee to cover the cost of work done should you decide not to go ahead. On top of this will be your legal fees and, in the case of a property deal, a valuation, both of which are upfront. The exact nature of the interest is one of the most important to understand.
3. Understand their interest rate: Is interest charged on the facility or on the amount borrowed?
It is really important to understand how the loan interest works, as this varies from facility to facility, as does the impact it can have on your business. Different business sectors benefit from different offerings.
In property development, some lenders charge interest on the overall facility agreed (e.g. 100k facility agreed, interest each month charged against 100k), whilst others charge interest on what has been drawdown so far (e.g. 100k facility, 20k drawdown in month 1, interest charged on 20k, not 100k). In the second instance the amount you are paying back will be much less than the first, and therefore the interest rate can only be applied at the end to give a true cost of finance. So in this instance and sector, any monthly interest rate quoted does not give a full picture of your total costs, and it is critical to ensure you are comparing like for like properly.
However, in other sectors, if the interest rate is charged on the facility instead of on each transaction/what is drawdown, there is the opportunity to reduce the interest rate if your business can recycle funds quickly.
In some of the newer stocking plans for second hand car dealers for example, interest is charged on the facility. However, if a 50k facility can be paid off and 50k used again within a 30 day period, the monthly interest rate halves.
So the interest rate is a far more complex instrument than it first appears when understanding cost. The above hopefully demonstrates that just judging firms based on the cheapest advertised rate tells you only a small part of the costing story.
4. What security do you require?
Most forms of funding will need some type of security, so it’s important to be clear about what they want. You don't want to waste time dealing with firms who want more than you can give, and quite often it comes out towards the end of the process. Ask them upfront so you're not wasting your time.
5. Do you require a Personal Guarantee?
As an addendum to the above, a lot of funders want a supported, or unsupported PG. If you're not willing to give one, or cannot support one, make sure you ask this question quickly. No matter how attractive the loan may look, PGs are typically non-negotiable. However, in some sectors, like export/import, insurance can sometimes be provided as an alternative.
6. Are there any penalties for finishing the loan early?
As part of the total cost conversation, ensure you understand any fees at exit, particularly if you plan on finishing a loan earlier than the timeframe agreed. In property it is not uncommon to agree a longer facility than is likely, in case of bad weather, problematic building or sales. Early redemption fees are typical in the commercial banking world, and in many other lending environments. Ensure you factor in that cost to your sums.
7. How much control over my business process do you require?
This is very important to ask, as it will give you an idea of how the funding will work once up and running. Typically there is more control required for equity funders than debt funders, but that is not always the case. Control in general refers to what ongoing management may be required.
For example, a commercial mortgage for a hotel or care home is likely to have a minimum occupancy clause in place that the borrower must keep to on a 3-6 monthly basis in order to keep the loan, and its rate, from being reviewed.
An equity investor or company may well need regular, extra, financial information to ensure the business is performing to their satisfaction. They may also want voting rights on the board, with the right of veto on certain matters.
So whether you have debt or equity funding, control can be an issue for both lender and borrower, and a tug-of-war can easily ensue if it is not understood from the outset. Ensure you understand the full implications of control early.
8. What separates you from your competition?
With many choices out there, the borrower has an element of power, depending on their financial situation. Asking this question shows that you are not committed to one lender, and may indeed be speaking with other players in the market. Get the funder to describe their Unique Selling Points (USPs), and why they should be your choice of funder. The answers should be helpful in deciding whom you use, if choices exist.
9. If my business runs into problems, or I'm unable to continue paying the loan, what's your procedure?
Numerous businesses run into trouble at some point or another. Depending on the type of funder you are dealing with, some can be flexible (i.e. give you a holiday period), and some are not flexible at all (i.e. the loan goes straight into default with major consequences like repossession of property/stock, etc.).
Everybody wants a business finance transaction to succeed for both sides. However, if you spoke to virtually every lender, they would acknowledge a 'default rate' within their loan book. That is to say, there are always loans/funding that don't work out in the end for a variety of reasons. It's a good idea to ask, if it all goes wrong, what happens? The better funders will usually say tell us as quickly as possible if something is going wrong, and will try to work through the issue with you before the consequences become too dire.
Being informed helps your internal decision-making
So knowing which questions to ask does 2 things. Firstly, it shows competence to a lender, and if they feel they are dealing with a business savvy borrower, they are far more likely to lend. Secondly, and just as importantly though, it helps your business make the right decisions when it comes to assessing future funding partners.
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About Chris Davidson
Chris Davidson is Managing Director of Discover & Invest Ltd.
He believes passionately in providing businesses with market-leading financial insights that have a positive impact on the bottom line. As a result, Chris helps get the best rates and terms available at any one time.