What makes the perfect Bigstone borrower?

Posted by Rhiannon Veness on November 17, 2017

At Bigstone, we are creating a liquid market where creditworthy small businesses are connected to yield-seeking investors. Borrowers get fast and easy access to capital at affordable rates and on fair terms, and lenders get access to a curated investment platform where they can build a diversified portfolio and earn fair returns.

Bigstone does the hard yards for investors so we can deliver a more flexible and attractive lending product. Investors get access to better borrowers, those that are willing to provide more data and use a smarter process. This means lower risk borrowers get even better rates, which attracts more borrowers and enables investors to deploy their funds faster.

Our process is entirely online, resulting in a high quality, seamless application that enables transparency between both the borrower and the investor. We have effectively automated the 5 C's of credit pioneered in the Babylonian temples, systematised by the Medicis and now automated for the modern digital age.

Capacity

Capacity is the most critical of the five factors and tells the investor exactly how the borrower will repay the loan. We consider cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan.

For borrowers to be approved for a loan, the lending platform and investor will need to consider

  • the company’s borrowing history and record of repayment
  • how much debt the company can handle
  • industry relevant financial benchmarks and ratios - some industries can operate with a higher debt load than others.
Debt load - the amount of debt a company has on its books. Companies that don’t need as much liquidity to operate can handle higher amounts of debt.

Collateral

Investors need to be confident that, if a borrower defaults on a loan, the investor will nevertheless get their money back. Collateral provides that assurance because, if the loan goes into default, the investor will be able to recover their loan through the sale of the collateral.

There are two types of collateral a business can put forward ensure that the loan can be repaid - ‘hard’ collateral and ‘soft’ collateral. Loans that have collateral secured against named hard assets, such as real estate and office or manufacturing equipment, is usually referred to as a secured loan.

Hard collateral represents assets that the company pledges as an alternate repayment source for the loan.
Soft collateral, such as accounts receivable, inventory, and illiquid assets can be pledged as collateral. In Australia, the advent of the PPSR (Personal Property Security Register) makes lending against these “movable assets” easier and more transparent.

A totally unsecured loan doesn't have any collateral pledged against it.  But many loans, like Bigstone’s standard loan, don’t have specific ‘hard’ collateral but take a general security over the assets of the borrower and a guarantee from the directors of the borrowing company. Consequently, we evaluate the value of the collateral, subtracting any existing debt secured by that collateral, to calculate the residual equity in those assets, which will play a factor in the lending decision.

Not all collateral will be given equal weight by lenders, and some lenders will be unwilling to lend without it.

Cash flow will always be the primary source of loan repayment, but if cash suddenly becomes unavailable, lenders and investors want to understand the borrower's ability to unlock secondary sources of repayment. Collateral can be an even bigger challenge for service businesses that have fewer hard assets to pledge. Service businesses can rely on their business history, or they may need to provide invoices or terminal receipts to show that they will have a steady stream of cash coming in. Lenders may also look to secure the loan against personal assets or with a guarantee.

 

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Capital

Knowing that directors are financially invested in their company is a strong indication of how much is personally at risk should the business fail.  This shows how motivated and dedicated the directors are. Lenders will often look primarily at a company’s liquid assets and discount the value of these assets to estimate the loan-to-value ratio under stress.

Business owners should be ready to show:

  • How well capitalised the company is - i.e. how much of the director’s own money is invested in the company? Both the company’s financial statements and the value of director’s wealth are keys to this question.
  • If the company is operating with a negative net worth, for example, will the owner be prepared to add more of his or her own money?
  • How far will his or her resources support both the owner and the business as it is growing?
  • Customer lists and payment history.

Character

The way most lenders judge a borrower's character is generally has a lot to do with the directors' credit scores. Despite being a highly developed country, Australia's credit scoring system is in the dark ages. Credit bureaus in Australia only include demographic information, inquiry information (credit checks), failure to make payments (negative information) and legal claims.

Lenders want to put their money with those who have impeccable credentials and references. The way the management treats employees and customers, the way he or she takes responsibility, timeliness in fulfilling obligations are all part of the character question.

For borrowers, this means establishing a good reputation within your industry, your suppliers and your customers. Some lenders measure character with relationship managers who come to your office and meet you (or more often, you go to meet them). In the age of social media and review sites, this is much less cost-effective and necessary than in the past.

Credit history

A company’s credit report is primarily a detailed list of its credit history, consisting of information provided by lenders that have extended credit. The information varies from one credit reporting agency to another, but the credit reports include the same types of information, such as the names of lenders that have extended credit to the company, types of credit, payment history, and more.

In addition to the credit report, lenders often use a credit score. This is a numeric value that rates creditworthiness relative to the population. While most lenders use credit scores to help them make their lending decisions, each lender has its criteria, depending on the level of risk they are willing to accept for a given product, and the cost they charge.

Lenders evaluate the company as a total package, which is often more than the sum of the parts. The most significant element, however, will always be the history and behaviour of the directors. How they conduct business, their business history and personal life give the lender a clue about how she is likely to handle leadership as a manager.

Most banks will not differentiate between the owner and the business. This is one of the reasons why the credit scoring process evolved, with a large component being personal credit history.

Other considerations

Existing debts, the stability of employment, personal factors, and other factors that might affect a person’s ability or desire to meet financial obligations are essential considerations. For example, a business who has moved six times might not be considered a good risk because that indicates problems. Current economic conditions, industry trends (and how the company aligns with those trends) and any contractual, legal, regulatory or political risks that could negatively affect business growth are taken into consideration.

Summary

Bigstone is not looking for the “perfect” borrower - most small businesses are not perfect opportunities to lend funds. What we look for is proper management, financial discipline, and a  pragmatic or realistic view of recent business performance. We recognise that someone with a bruise or two who has done everything they can to stay current with their obligations could be a good customer.

Our credit risk assessment processes ensure that borrowers are given a rate, term and loan amount that matches their ability to repay, significantly reducing the risk of default and improving returns for investors.

Topics: investor

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Rhiannon Veness

About the Author

Rhiannon has over five years of social media and content marketing experience within the financial services and higher education sectors. Rhiannon enjoys creating content that is valuable, fun and engaging to build long lasting relationships with customers.

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