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Sunday, May 22, 2022

Entrepreneur’s Notebook—Use Savvy Consumer Skills When Choosing a Lender

Having been notified by the DMV that it was time to get a smog check on my car, I found a discount coupon in the local newspaper, presented it to the manager of the garage when I arrived one early Saturday morning, and proceeded to have the smog check performed. When all was said and done, I was told that my car didn’t “qualify” for the discount price. Needless to say, I was annoyed, but further discussion with the garage manager proved pointless. There wasn’t much I could do. The work was completed (they also conveniently still had the keys to my car), so I paid the full price and left but with a very bad taste in my mouth.

The manager didn’t say anything up front about my having to pay more; he waited until I was too far along in the process to back out. I wasn’t happy, but I paid his price.

My smog check scenario in some ways is similar to that of a company needing financing:

Smog check scenario: I need a smog check. I check out various providers. I then select a provider who can do the work, is experienced, has added benefits (e.g. open on Saturday when many are not) and whose coupon sets up an expectation of what I will pay for the service.

I get the work performed. Following the smog check, I’m told that circumstances dictate I’ll have to pay more than what was originally proposed. I’m too far along in the process to do anything else, so I pay.

Financing scenario: Company X needs financing. Company X checks out various providers. Company X selects a lender who can provide needed funds, is experienced, has added benefits (says it can fund faster than others) and whose proposal sets up an expectation of what Company X will pay for the loan. Company X has an audit performed. Following the audit, Company X is told that circumstances dictate it will have to pay more than what was originally proposed. Company X is far along in the process with no time to do anything else, so it pays.

There are occasions when audits do bring to light circumstances that will change the parameters of an initial proposal. In fact, that’s precisely what audits are for, to bring to light the true circumstances of the business in question. What’s really unfortunate, however, is that sometimes, a lender (just like the garage owner) knows up-front that his proposal is probably too low. He hasn’t done all his “homework” on the company to fully evaluate what’s needed and what he can provide. He’s pretty sure he’s going to raise the price after the audit, but by then the borrower (like me) feels hooked, and won’t back out.

When something like this happens, even if infrequently, it’s extremely unfortunate for the borrower. However, this situation can be avoided. It’s a matter of the borrower keeping a few things in mind during the lender-selection process.

Generally, financing proposals are obtained from two or three lenders. Proposals are reviewed, and typically, the initial reaction of the borrower is that the proposal offering the lowest price is the best deal. But that’s not always the case. If the proposed cost of funds from a particular lender is significantly lower than the other proposals, it pays to find out why before going to audit. When reviewing proposals, the first thing to do is to make sure that the lenders have done all these:

– Evaluated a complete financial package.

– Used the same assumptions in arriving at their pricing structure.

– Come up with a realistic view of the company’s situation.

– Offered the right amount of financing for the situation.

– Structured the transaction to really meet the company’s needs.

– Explained any fee or rate increases that could be assessed down the line.

Once this evaluation has occurred, you know you’re comparing apples to apples.

Usually, lenders who provide the most realistic proposals will tell you that, if the audit brings nothing new to light, there may be something they can do to lower the rate outlined in their initial proposal. Also, that if something negative does show up in the audit, they’d be willing to provide rate reductions as the company “cleans up” the issues identified.

All that being said, there will be times when the lender with the lowest price will honor the initial proposal after the audit is performed. Just be aware that a much lower rate can also equate to lower levels of customer service. Basically, this lender, in charging less, has less incentive to go above and beyond the bare minimum for their clients. Therefore, you shouldn’t expect this lender to be there for you if your business gets into trouble or if you need an over-advance or side loan from time to time. Also, be prepared for more restrictions and conditions (i.e. covenants) placed on the transaction from this lender, and make sure you understand their impact, as they could affect how you run your business or even hinder your ability to grow the business.

The bottom line sometimes cheaper doesn’t always turn out that way, and it’s not necessarily better.

Evon G. Rosen is senior vice president and director of marketing for Celtic Capital Corp. She can be reached at erosen@celticcapital.com.

Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.

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