Do You Know How to Navigate The Canadian Commercial Finance Market?

When it comes to Commercial Finance in Canada, small and medium sized businesses (SME's) have a broad spectrum of lenders to choose from, each with their own approach to the Commercial Finance Market Place.

And having a continually growing number of options only improves the access to capital.

The challenge is understanding the various options available, and which ones are most appropriate for a particular business at a particular time.

Unlike the personal and residential financing markets, the commercial finance market place is much more diverse.

Small and medium sized businesses in Canada come in all sizes, shapes, and descriptions.

So, from a lending point of view, the process of assessing any one particular loan request is more complex due to the extreme variability of business types and needs.

From a borrowing point of view, the scope of the commercial finance landscape is mostly a large unknown, which can be extremely difficult to navigate without some sort of map.

While there is no official listing of privates and specialty lenders, the total number is estimated to be well into the hundreds.

According to Statistics Canada (CANSIM Table 176-0023; Bank of Canada), in 2004, Business Credit in the Canadian Commercial Finance Market (debt and equity) exceeded $940,000,000,000, of which $254,000,000,000 was categorized as short term business credit and $686,000,000,000 was categorized as long term business credit.

While approximately half of short term business credit was provided by Chartered banks, less than 35% of the long term business credit came from the Chartered banking group

Here are a few more points to consider:

* There are a very large number of lenders and lending outlets in Canada, many of them providing commercial finance programs to small and medium sized business.

* The Chartered banks, while by far the dominant lender category, still provide less than 40% of the commercial finance loans in Canada.

* While there are a multitude of potential lenders out there, most people's overall awareness of specific lenders is directly related to their knowledge of local loan providers and national branding campaigns.

* Lenders can work on both a wholesale and retail basis in that they may provide loan products directly to business owners or they may fund (underwrite) the retail programs provided by other lenders.

* Retail systems can vary considerably from bricks and mortar storefronts, to field area salaried staff, exclusive broker arrangements, non exclusive broker arrangements, and so on.

With all these available lenders, spread over the landscape, getting financing should be easy, right?

Answer: It depends.

Before we get into what it depends on, let’s look at this from the business perspective of the lender.

 Like any other business, lenders work to generate a margin from sales. They have loss provisions similar to bad debt expenses. And they have criteria to determine the relative risk of any one particular loan, any category of loans, and the collective risk of all loans combined.

Lenders target market segments they believe they understand and can make money from; no different from any other business. If their risk is too high, or their profits are lower than expected, they will make adjustments to their offering to improve their overall financial position. Basic business fundamentals.

Like any profitable business, a lender’s business model must have a focus that can be replicated over and over again to achieve efficiencies and has a competitive advantage over the rest of the market place.

For the chartered banks in Canada, their small to medium sized business focus is very broad based and they achieve a good portion of their profit margin from lending spreads between deposits and loans, and bank service charges.

Any time a business model is broad in scope, there needs to be offsetting factors to manage risk.

In the generic banking model, of which the Chartered banks are the key players, this is achieved by high reliance on personal net worth, credit history, and government support programs.

 Because the banking system provides loans to such a broad spectrum of business types, and because of the high propensity for small business failure, non business specific criteria are very important to lending decisions.

In many cases, they are more important that the business criteria.

Because of large investments in bricks and mortar, national brand campaigns, and other media exposures, you will likely look to the primary banking system first when applying for any commercial financing for your business.

And why not?

You have an existing relationship with your primary bank, credit union, or trust company, you may have a direct business relationship with one or more employees there, and it’s likely convenient for you to do business or you would be banking somewhere else.

As consumers, we are all branded to think of the primary banking system as the first option, and just like Coke and Pepsi, the majority will try the primary system before thinking about a different choice.

The impact of this broad scale, branded knowledge, is that the primary banking system in most cases does get the first look at most potential lending opportunities in both the commercial and non commercial finance markets.

This is an extremely powerful advantage to primary lenders and as a result they can be very selective with the loans they provide.

If a loan application is declined from someone in the primary banking category, there is some variability among the lenders for potentially placing the loan with another primary source, but in many cases this does not happen.

Now, returning to the question.

With all these available lenders, getting financing should be easy, right?

In many cases, the answer is that it is very easy, if the combination of your personal credit, net worth, use of borrowed funding, and other relevant criteria were collectively sufficient, at this particular point in time, for the bank, credit union, or trust company you are now working with.

Then, let's say you application was declined, and you decide to make a second application to another lender in the primary banking category.

At this point, you could still get a loan approval and the process might in fact still be relatively simple.

 But what if you are now declined a second time?

 Now what?

The process starts to become more complex.

There are still numerous lenders out there in the commercial finance market place, but which ones are likely to be more interested in your application than the two you have already applied to?

Can you name 5 lenders that are not a chartered bank or credit union?

In assessing your two failed attempts to this point:

1. Did you prepare well enough to answer any and all questions from the lenders? Did you adequately research your market, competitors, and revenue model before sitting down with a lender to discuss your application?

2. Did you do a thorough and appropriate job of presenting your business proposal, the opportunities and risks?

3. Did you properly explain and/or represent your financial information in the form required by the lender?

4. Did you understand all elements of your application before you applied including your credit history and credit score?

5. Do you know why your application was turned down? Were you given an explanation by the lender? If so, was the explanation satisfactory, or did it leave you wondering what went wrong?

In many cases, you would not know that the answers to some or all of these questions, which only complicates your continuing search for financing.

Should you go to a third bank?
Did the loan decline hinge on something that you said or did not say?
How will other lenders view the fact that you were turned down twice already? Does that matter?

If you are approved, remember that the primary banking group (banks, credit unions, and trust companies) are mostly broad based lenders in the small to medium sized business category, with risk of loan loss managed significantly by personal credit, personal net worth, and government guarantees.

As broad based lenders, they are set up to handle large volume both from a marketing and administration point of view.
Understanding the specific risk elements of each and every business in each and every region they cover, is not practical, so more generic criteria is utilized to approve and administer loans.

The more money they lend, the more security they will consider putting in place on business and personal assets, and the more restrictions they will likely require in terms of loan covenants.

When considering your overall finance strategy, make sure you understand all your obligations to the lender before accepting a financing offer.

Your commercial finance strategy has to not only take into account your cost of capital, but it also must continually assess the impact a new loan will have on your future borrowing power capacity.  The more restrictive any one lender is, the less likely you will be able to find a complementary lender, and the less likely you will be able to take advantage of future opportunities or react to unplanned cashflow issues.

Let’s get you back to the commercial finance landscape.

Once you move past the broad based lending strategies of the primary banking group, the lending spectrum becomes more specialized as each lender group carves out their unique position in the market place.

From a customer point of view, a specialty lender can still be a primary lender as their lending products are usually tailored to a certain group or certain lending application.

Or they can be a secondary lender, taking on borrowers that did not qualify for an additional loan from what I have referred to as the primary banking group.

Each lender category is geared to a profit and risk management model that allows them to create an expertise and efficiency level they can market.

The more narrow and unique the focus, the higher the cost of borrowing is likely to be.

 Like everything else in business, competition usually lowers the price and a lack of competition can create a pricing premium.

Similar to the broad based primary banking group, the specialty lender categories also focus their commercial finance criteria on business type, sector, geography, business net worth, personal net worth, cash flow, business experience, and credit history.

The main difference with more specialized lenders is that the business assets and cash flow have a greater emphasis.

This is due to the fact that risk is managed to a larger extent by the lenders ability to understand asset liquidation and cash flow management.

Instead of tying everything up with a first security position and having exclusive access to a personal guarantee, specialty lenders are more focused on a specific asset group and monitoring the cash flow in industries they are committed to doing business in.

But, again, there are great extremes to specialty lenders.

Some primarily focus on assets, with real estate assets being an exclusive focus in some lenders approach to commercial finance risk management.

Some lenders are primarily focused on cash flow and are not overly concerned with asset value as a way to protect against risk due to the fact that these lenders are usually in a second or third security position.

And as you may have guessed, some specialty lenders have a high concentration on both elements.

The asset based lender category and the cash flow, or subordinate debt based lender category, will be further explored in the links provided.

Go To Asset Based Financing

Go To Cash Flow Financing
 

The degrees of variation from one category to another can be considerable. Each category can also have a low, medium, and high risk position which is reflected in their offered rates and lending terms.

But from the outside looking in, it can be extremely difficult to tell one lender from another.

It can also be difficult to determine what risk position your business opportunity should occupy in any one commercial finance lending category.

 As an example, say you get a loan approval from a higher risk lender in a particular asset based category, but you're not sure if there are any lower risk lenders that could provide lower rates and better terms.

Part of the reason it's difficult to figure out which lenders are the most relevant to you is because virtually all lenders advertise that they can help every business with their commercial finance needs, regardless of your specific situation.

It goes without saying that no one lender can meet all the potential business needs of its applicants.

But because they don’t want to limit their market reach and do not have the resources to brand a specific niche, many lenders put out a more generic message to get your attention.

Then you are left going from place to place and self educating yourself as to which lenders can actually help you.

Even when you find one, you still can’t tell if it’s the best alternative, because you don’t likely know how to compare what you’ve found to everything else that's out there.

Add to all of this the fact that commercial finance programs are always in a state of flux.

Lenders come and go from the commercial finance market.

Lending programs are added, expanded, removed.

The competitive nature of the market is always trying new approaches. Competition can reduce costs, but can also increase them if larger players start to monopolize a certain niche.

Basically, a commercial finance road map is a key tool to help execute your financing strategy.

As a financing specialist, my role is to assist you in your development of a financing strategy and in your navigation of the commercial finance market.
 

Go Here To Contact Me About Business Financing

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