Finance Blog Insider Industry Secrets
Insider Industry Secrets
Written by Larry Johnson Friday, 06 November 2009 19:39
BFA uses a form of triage to determine the viability of a deal. Triage is a process in which things are ranked in terms of importance or priority. The purpose of triage is to assign scarce resources to where they can be used most effectively and efficiently. The common everyday use of triage is in a hospital setting where decisions mean treating the most badly injured patients first leaving the ones with less serious injuries for later.
Here are the 10 golden questions that BFA uses to triage projects:
How old is the business?
How long a business has been operational is a good indicator of its strength. It means they have weathered the inevitable down cycles and have shown the ability to be viable in subsequent years. Business tenure also provides insight into its management capabilities since it is a good indicator of their understanding of its business.
How big is the business?
The larger the business, the more resources it has at its disposal to pursue more and better financing options at attractive rates, terms and conditions. Larger businesses tend to be more credit worthy and have the resources to weather down cycles.
What is their ability to service debt?
The larger the net profit the more secure the lender will be that his money will be repaid.
What is the strength of the guarantee or security?
Many loans are recourse loans, that is, they have personal or company guarantees to provide the lender with more comfort as to the security of the loan.
What is the value of the collateral?
A lender feels more secure that companies with weak cash flow have the collateral and liquid assets in case of loan default.
What is the ratio of debt to equity?
The higher the debt to equity ratio, the greater the risk the lender is taking. As the leverage increases, more pressure is put on the lender to ameliorate the risk by having higher interest rates, recourse options, lower LTV, more collateral required, etc. The ratio of debt to equity risk tolerance varies with the industry.
What is the level of working capital?
The definition of working capital is current assets minus current liabilities. Working capital is a companys ability to meet its short term operating costs. Companies with little or no working capital are experiencing cash flow drains that will probably have much larger ramifications down the road. A negative working capital is a red flag to ask more in-depth questions as to the reasons why there is an operating loss.
How credible are the projections?
Companies that do not have a good handle on their projections may be an indicator that they do not understand its business as fully as it should. Given that scenario, lenders will be less inclined to loan.
What is the assessment of the level of client risk?
The credit risk of the client can be examined in any number of ways, including but not limited to, industry sector risk (e.g., the travel or leisure industry), company risk, product and management risk.
How strong is the management team?
The quality of the management can make or break a business. Good management understands the marketplace, customers, operations, and what works and what does not. A lender will always examine managements' depth, experience and ability to operate the company efficiently and effectively.