Whether you need a working capital loan, funds for a buyout or cash for a merger or acquisition, working with an underwriter at a lending institution should be a partnership.
We're currently in a historic economic era with rising interest rates resulting from rising inflation. And while economic pundits attempt to predict the future, the reality is simple: Business continues. Today, companies with a sound cash position are taking advantage of the opportunities during this economic period, with owners able to make deals and invest in their companies.
A key job of a lender is to ensure clients maintain financial health, ensuring their clients don't get into a situation where they become overextended. That's why underwriters ask a lot of questions about you and your business, along with reviewing financial data in light of the five Cs of credit—capacity, capital, collateral, character and conditions—to design a framework to support business success.
Whether you need a working capital loan, funds for a buyout or cash to fuel a merger or acquisition strategy, the underwriting process should be a partnership. Here are six tips to understand the role a lending institution underwriter plays in providing funding for your agency's future:
1) Underwriters are your partners. Underwriters should be involved from the outset to support creating a structure that works for your business strategy and goals. If the lending request isn't going to work, it's better to know upfront before spending time working through the process.
And of course, if there's a deal that's sound, the underwriters can assist the salesperson to issue a term sheet, also known as a proposal, to begin moving forward.
2) Underwriters provide financial clarity. Creditworthiness is derived from the predictability of the future cash flow from business operations. As such, underwriters ask for personal financial details, company information and review business financials to examine capital ratios. This means they're looking for how much equity the owner has, as well as how much cash the owner put into this business.
Underwriters will ask about the business structure, ownership team, key employees and business partnerships, how long you've been in business, and future business plans. Lenders need to understand the company's financial strengths and weaknesses to make a loan recommendation and create a framework for client success.
3) Underwriters can assist if a business valuation is required. Some deals may require a business valuation from an independent valuation company. This means a review of a company's financial statements and comparable transactions against industry ratios and other quantitative and qualitative information—and the result is a reasonable assessment of fair market value.
Owners have put time, energy, thought and tears into building a business and often value their company through that point of view. But the final financial valuation is derived through a set of procedures used to estimate the economic value of the business and how it plays into the ability to maintain those five Cs of credit.
4) Underwriters work through the nitty-gritty of a down payment. Clients often ask early in discussions about the amount of cash required for a down payment on a loan. Each deal may have a different down payment requirement, depending on the nature of the loan request. There is no one-size-fits-all answer.
While a down payment is typically required, lenders also want clients to have cash on hand if there's an unforeseen business expense. Once the book of business and company are analyzed, the underwriter will determine the amount of a down payment.
5) Underwriters detail your loan options. Depending on the loan request, a business may have various loan options. For example, one option is a non-revolving acquisition line of credit. If a customer is in an acquisition mode with several upcoming purchases, that may be the best option because it can be used again for future purchases.
Alternatively, if a client has one acquisition on the horizon, an underwriter might recommend a term loan with a secondary line of credit for working capital needs.
6) Underwriters recognize and explain the impact of rate changes. Yes, rates are rising. It'd be remiss to not mention the current economic situation and its impact. But here's some context:
- The Federal Reserve's interest rate increase of 75 basis points in July, according to CNBC, coupled with earlier actions in March, May and June, has now increased the central bank's lending rate to 2.5%.
- At the beginning of the Great Recession in January 2008, the Fed's rate was 3.94%, according to the Federal Reserve Economic Data (FRED).
- And in the 1980s, the Fed upped interest rates to nearly 20%, according to FRED.
During this historic economic era, astute business owners are strategically continuing to focus on growth. Keep these tips in mind when working with your lending institution's underwriting team.
Alicia Chandler is president of Indianapolis-based Oak Street Funding, a First Financial Bank company that offers customized loan products and services for specialty lines of business including certified public accountants, registered investment advisors and insurance agents nationwide.