The rules around underwriting, require that lenders ensure the following when they underwrite new loans especially for private companies/SMB. Here are 4 considerations to think of when underwriting for this segment.
Who created the financials
With the strain that private firms go through to get the right funding or approval, self reported financials (unaudited) are a creative exercise. Depending on what the goals are, their purpose are designed for one time use, not continuous.
Are the financials timely
It is known that financials are never up to date with private companies. By the time, you have reviewed your preferred credit agency’s data log (most have very limited private company data coverage) or annual tax filing, it is out of date. In fact, in some cases, it’s dramatic the differences in financials and fundamentals within a 3 month time frame – market shocks, internal issues, investor rounds end, high burn rates, multiple resignations can mean a different business. It is worth investigating other real time proxies for financials, for example signs of guaranteed revenue
Are the balance sheet and P&L statements in sync
Creative accounting is easier in private companies because there is no regulation with reporting – no quarterly or annual (SEC) statutory requirement. So those provisions in liabilities, are those overstated account receivables? These are the things that lenders struggle with when making a decision. Have you validated the P&L for that year with the bank account statement and cash flows for that period?
Is this a real business or a fictitious shell
The prevalence of shell companies are on the rise. A recent inquiry by the Financial Crimes Network over several years, found $18B affected in suspicious activities such as money laundering. While shells can be completely legal structurally, multiple shells under one business umbrella is worth an inquiry.