Commercial Finance
Commercial funding – how does it all work?
Given our strong lender relationships, we also know how lenders work, what they look for, and what they need from you.
How does the lender assess a loan application and interest rates?
Commercial lending is assessed on a number of different components. Whilst serviceability is key, the risk assessment includes value and type of security (such as residential, commercial, industrial, specialised and alike); industry type; management experience; age of business; purpose of funds; financial ratios, margins, profitability and trend analysis; bank account performance and credit history; and business cash flow.
Lenders assess serviceability or repayment capacity slightly differently. Some will require up to the past three years of tax-based financial statements whilst at the other end of the spectrum some will rely on management accounts or even your last BAS statement. In some cases a cash flow forecast complete with assumptions will be required. They will assess the strength of your business in withstanding interest rate movements, trading fluctuations, and your ability to meet principal and interest payments, even if your loan is interest only.
One thing for certain is that lenders treat your ability to repay as paramount in their assessment process. And whilst they make the ultimate decision on whether to approve or not, the most important party in this finance application is you, the borrower – it is important you are comfortable with the ability of your business to meet the financial commitment you are entering.
It should also be noted commercial lenders differ greatly in their risk appetite – some specialise in industry or security types while others exclude certain sectors entirely. Understanding these differences (which are dynamic) is crucial in deciding where to place your finance application. A poor alignment between your needs, your business ‘risk profile’, and the risk appetite of a lender is not ideal for your future business growth and success.
How are interest rates assessed and what type of fees are applicable?
Interest rates are extremely competitive amongst lenders. Generally, the lower the assessed risk, the lower the interest rate, and similarly with the value of security offered and comprehensiveness of supporting financial data.
Lenders will charge upfront fees such as a Loan Approval fee, ongoing loan administration fees, and/or limit line fees, and set-up costs such as valuation fees and government duties, and quite often legal costs, documentation preparation cost, and settlement fees.
Why is cash flow an important consideration in finance product selection?
A general rule is to match the life of the asset being purchased with the life of a loan.
Loan terms to purchase commercial property will vary between ten and 30 years. And whilst property-based security is often required for business loans and will attract longer loan terms, lenders will take into consideration the length of lease remaining on the business premises or license, usable life of fit-out and/or franchise term.
Typically, chattel mortgage finance for the purchase of a motor vehicle or equipment will have a loan term between four to seven years, which equates approximately to the usable life of the item being purchased. This means that when the equipment requires replacement, it has no residual debt outstanding and the business will be able to again purchase new equipment and access asset finance options.
Working capital facilities offer a range of choices largely dependent upon the security offered.
Working capital overdrafts are generally annually renewed and facilitate the funding gap by providing an overdraft limit that fluctuates with the cash flow cycle of a business – that is the variability caused between the timing differences between purchase of stock, sale of stock, and collection of debtors versus payment of creditors.
Similarly, invoice finance is a revolving facility that is repaid in full each time the debtor makes payment and is then renewed upon new invoicing.
Unsecured business loans are typically much shorter in duration and designed for short-term working capital needs. Whilst they provide fast access to funds, they also have relatively quick repayment terms between one month to a year (usually a three-month term) and with fortnightly, weekly, or even daily repayments.
What security will be required?
For commercial loans, lenders will usually seek landed security for business borrowings, which is quite often the owner’s residence. If the borrower is a company or trust entity, they will also take a General Security Agreement over all assets of the company entity, and a Guarantee from the Directors, Beneficiaries, or Unit Holders.
For most purchases of businesses including goodwill and stock, lenders will require property security. For many business owners, this will mean a mortgage over their residence. However, in the case of approved franchise systems, some lenders will provide finance of up to 75 per cent of the value of the business.
In the case of asset finance (plant, equipment, motor vehicles, or green assets), lenders usually secure the chattel or lease finance by the asset itself, although a director’s guarantee may also be required.
There are also specialised lenders who provide finance for specific purposes, such as insurance premium funding secured by the insurance policies themselves, Trade Finance secured by the stock being purchased, Debtor Finance secured by the debtors, and of course Unsecured Business Finance which can be completely unsecured or secured by owner’s guarantee.
Why is the type of security important?
Matching security to the type of finance is important to ensure your risk is correctly weighted and your future borrowing capacity is not artificially constrained or restricted because of the incorrect use of your assets as security.
For example, utilising property security for a general loan to purchase plant and equipment instead of, say, a chattel mortgage, may mean that when your business needs working capital or to purchase additional property, there is insufficient security available.
This is because property can only be used to secure and access equipment finance, but it can’t be used as security for a general purpose or property loan. So, while Asset Finance interest rates may not always be as low as property security, access to finance can be the more important criteria.
What financial information is required?
Depending on lender criteria, supporting information can include an owner’s personal asset and liability statement and tax returns, financial statements of the business (either tax based or management accounts, full year or interim, and up to the past three years in some cases), and cash flow forecasts.