Equity Investment

Business loan applicants must have a reasonable amount of capital invested in their business. This ensures that, when combined with borrowed funds, the business can operate on a sound basis. Lenders will expect you to contribute your own assets and to undertake personal financial risk to establish the business before asking them to commit any funding. If you have a significant personal investment in the business, you are more likely to do everything in your power to make the business successful.

A lender will make a careful examination of the debt-to-worth ratio of the applicant to determine how much money it is being asked to loan (debt) in relation to how much the owner(s) have invested (worth). Owners invest either assets that are applicable to the operation of the business and/or cash that can be used to acquire such assets. The value of your invested assets should be substantiated by either invoices or appraisals (for start-up businesses) or current financial statements (for existing businesses).

Positive equity with a manageable level of debt provide financial resilience to help a firm weather periods of operational adversity. Positive equity also ensures that the owner(s) remains committed to the business. Minimal or non-existent equity makes a business susceptible to miscalculation, and increases the risk of default (failing to repay) on borrowed funds.

Sufficient equity is particularly important for new businesses. Weak equity makes a lender more hesitant to provide any financial assistance. However, low (but not non-existent) equity in relation to existing and projected debt—the loan—can be overcome with a strong showing in all the other credit factors.

Determining whether a company's level of debt is appropriate in relation to its equity requires analysis of the company's expected earnings and the viability and variability of these earnings. The stronger the support for projected profits, the greater the likelihood the loan will be approved. Applications with high debt, low equity, and unsupported projections are prime candidates for loan denial.