One of the primary users of the Accounting Standards for Private Enterprises (ASPE) financial statements is a lender or potential lender. Other users could include passive family member owners who have an interest in a family-managed business and need to consider many of the same factors that a lender does.
Interest rate
Canada’s prime lending rate currently stands at 4.95%. While interest rates are expected to gradually decline, the path is uncertain, due to ongoing U.S. tariffs. Although the interest rate is important because it drives the cost of borrowing, it’s not the only factor that you should consider.
Loan term
Even the best plans can go sideways due to unforeseen developments and/or circumstances. Although a longer loan term is often associated with a higher cost of borrowing, it might be worth the added expense to reduce the possibility that your business runs into cash flow problems when trying to pay back the loan in a shorter timeframe.
The lender’s flexibility on repayment
It’s also important to discuss with the lender what would happen if your business was unable to make its scheduled loan repayments. For example, would the lender let you temporarily suspend principal repayments if it ran into cash flow difficulties? This discussion should take place ahead of time, not during a crisis. Furthermore, some businesses may benefit from a flexible repayment schedule such as one that offers deferred initial payments or variable repayments based on seasonal income.
Guarantees and collateral
It’s critical you also consider the lender perspective. When they can’t collect on loans, it’s obviously bad for their business. As a result, lending agreements often contain certain conditions and stipulations designed to ensure that the lender is able (or at least more likely) to collect their debts. Before signing a loan agreement, you should consider the requests made by the lender. For example, lending agreements often contain requirements regarding guarantees and/or collateral, ongoing reporting requirements and conditions that demonstrate the enterprise’s financial health.
Lenders typically require collateral to secure a business loan, which may include accounts receivable, inventory, or liens on equipment and real estate. Another way that the lender can protect itself is by obtaining a guarantee. The guarantee could come from another business, the owners, or even another party. When you provide a personal guarantee, you’re effectively agreeing to repay the loan using personal assets if your business defaults.
Ongoing reporting requirements
Lenders also often demand some form of ongoing reporting to demonstrate, on an ongoing basis, that your business is performing in such a way that the collectability of the loan is not at risk. Generally, this reporting is completed through your financial statements.
Audits vs. reviews: To obtain some comfort over the records, lenders often require that your financial statements be either audited or reviewed by an independent accountant, which is a cost to you as the borrower. An audit provides the lender with the highest level of assurance and therefore will be more costly as your accountant will dedicate a fair amount of time to the engagement. Alternatively, a review engagement provides the lender with a lower level of assurance, but you’ll pay less.
You should consider whether you’re comfortable with the reporting requirements imposed by the lender and in some cases, you may be able to negotiate a different requirement.
As the borrower, you should also consider the frequency of the reporting requirements and whether the deadlines are attainable. In some cases, you may only need to provide them annually. If required on a more frequent basis, however, such as monthly or quarterly, then there could be an added cost to prepare, especially if you’re not already preparing ASPE compliant financial statements on a regular basis.
Conditions regarding financial health
Finally, the loan agreement might stipulate your business maintain certain ratios (essentially imposing covenants to be met). You should be comfortable with your business’ ability to meet these covenants from the start and if not, you should consider negotiating that aspect of the loan agreement.
There may be additional factors aside from those shared here, for example, the lender may want to have some involvement over business operations, such as conversion option introduced to convert debt to shares, or perhaps Board representation.
Overall, before approaching a lender for a loan, you should have a clear idea about your wants/needs and what you’re willing to accept. Getting a loan is a process of negotiation, so you must know your objectives and the limits above or below that you’re not willing to accept. Finally, it’s important to be open and honest with the lender because you’re building a relationship based on trust.
A strategic advisor can help position your business for loans or refinancing by understanding lender requirements and guiding you through the process, so you're prepared and confident to reach your goals.
Visit our Helping businesses gain financial clarity and confidence hub for more insights.
