How an underwriter sees your business

By Rieva Lesonsky

You believe in your business and yourself. You built your company from the ground up. But when you apply for a small business loan, the underwriter doesn’t see any of that. What do underwriters see when they look at a business and how can you impact that review?

I spoke to Rudy Maki, Vice President at C2FO, a global working capital exchange, to find out.

While both you and the lender want your business to succeed, Maki explains, you look at it from opposing perspectives. “Owners think about the potential of the business; lenders think about what can go wrong.”

What do underwriters see?

Cash flow is an underwriter’s number-one focus, Maki says, because a business’s cash flow is what will repay the small business loan. “Collateral and personal guarantees from the business owner are secondary and tertiary considerations.”

Specifically, underwriters want to see a 1.25 coverage ratio for fixed charges. In other words, the ability for a company to meet financial obligations on recurring charges like insurance, loan payments, lease.

“A 1:1 ratio between cash flow and fixed charges is too tight,” Maki warns. You need enough cash flow to manage your obligations and then some.

Underwriters view your business from a historical perspective.

“I look to see how they’ve operated in the past and make predictions about how they’ll operate in the future,” Maki explains.

That’s why lenders like a conservatively-managed balance sheet that shows you’re retaining earnings in the business instead of distributing all the profits. A strong balance sheet reassures the underwriter that even if you have a “hiccup” on the income side — an unexpected expense or the loss of a customer — you have the cash to get through the rough patch.

“There will be another recession — it’s just a matter of when,” says Maki. “During times of strength, is the owner building a foundation so when the next downturn comes, they can make it through the cycle?”

Financial statements are vital to conveying this information.

“The financial statements you submit to the lender are the first impression, and if they’re sloppy it can be the last impression,” Maki warns. “If the balance sheet doesn’t balance; if there are errors, omissions or mistakes; if it’s prepared in an unorthodox way; if you’re applying for debt financing in May and don’t have your first-quarter financial statements done—all that will give an underwriter pause. It tells them you’re not on top of your reporting.”

Think like an underwriter

What can you do to give lenders a more favorable opinion of your business? Maki suggests five steps:

Retain money in the business
“Distributing all the cash out of the business is a huge red flag—especially in our type of lending, which is non-recourse,” Maki says.

Manage by metrics
“It varies by industry, but generally you don’t want to have more than 2x leverage (your debt to equity ratio),” says Maki. Aim for a 1.25 cash flow ratio and a working capital ratio (current assets over current liabilities) greater than 1. Maintaining these metrics shows your business is properly managing working capital and can meet its obligations.

The optimal debt to equity (D/E) ratio varies widely by industry, but the consensus is that it should not be above 2. While some large companies in fixed asset-heavy industries may have ratios higher than 2, these are the exception rather than the rule. A D/E ratio of 2 indicates that the company derives two-thirds of its capital financing from debt and one-third from shareholder equity, so it borrows twice as much funding as it owns.

Pay down debt
“It’s important to have an investment in the company yourself,” Maki explains. “If, as an owner, you have no skin in the game and it’s built on the backs of lenders, what’s to prevent you from walking away?”

Show consistency in your reporting
“If your numbers are up one year and down the next, it’s hard for lenders to predict your future.” Explain that any variations are truly due to nonrecurring expenses, so the lender doesn’t think your business is simply losing money.

Separate business and personal assets
Personal assets such as vehicles or homes run through the company are another red flag.