For a small business to meet its loan obligations, it must possess the ability to compete in the marketplace. What factors should a lender consider in assessing a prospective borrower’s ability to compete? Analyzing financial statements can uncover important intelligence. But when you couple this analysis with efforts to probe the four areas detailed below, you’ll gain an even greater understanding of a small business and its ability to compete:
1. The competitive environment. Ask the owner to explain what makes customers choose his or her business over others. Determine whether there are any threats facing the industry that could affect the business’s ability to operate — such as the impact of extreme weather, or a product or service that customers might use less when the economy sours.
It’s also important for an owner to stay current with industry trends. So ask the owner to provide the names of journals and websites that cover the business’s sector.
2. Tangible and intangible resources. Competitiveness can hinge on the resources to which a small business has access and how it employs them to earn a profit. What types of tangible — and intangible — resources does the business have at its disposal?
For example, does it own state-of-the-art technology that allows it to produce superior products more quickly and cheaply than its competitors do? What about its reputation within the marketplace and whether its target audience is aware of its brand?
3. The business owner’s background and capabilities. Small businesses need a strong leadership team in place. Take the time to meet with the owner to become familiar with his or her personality, background and business practices. In addition to meeting at your office, arrange to meet at the owner’s place of business.
Pay close attention to how he or she interacts with employees. For instance, such interactions may reveal an underlying tension between the owner and his or her employees.
4. The relationship with suppliers and customers. For a small business to function, it must rely on suppliers and nurture strong relationships with its customers. If the business is subject to regulatory oversight, it has to cooperate with local, state and federal officials.
Ask the owner to describe the steps the business takes to measure and manage the state of its relationship with each of these groups. For example, does it pay vendors on time? How often does it offer customers promotions and discounts? What does the owner do to maintain compliance with applicable laws and regulations?
These four factors can help you to more clearly assess a small businesses ability to compete in the marketplace, and therefore better evaluate their strength as a borrower. However, they should not be the only factors in a lender’s final decision, and should be considered an addition to, and not a substitute for, typical due diligence.