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What Is Equity Investment?
Business loan applicants must have a reasonable amount invested in their business. This ensures that, when combined with borrowed funds, the business can operate on a sound basis. There will be a careful examination of your business' debt-to-worth ratio to help all parties understand how much money the lender is being asked to lend (debt) in relation to how much you have invested (worth). Owners invest either assets that are applicable to the operation of the business and/or cash which can be used to acquire such assets. The value of invested assets should be substantiated by invoices or appraisals for start-up businesses, or current financial statements for existing businesses. This value is also known as equity investment.
How the Debt-to-Worth Ratio Affects Your Loan Application
Strong equity with a manageable debt level provides financial resiliency to help your business maintain viability during tough times. In contrast, if your business has minimal or non-existent equity, the risk of default (failure to pay) your debts is increased.
- Strong equity investment shows a lender that you are fully committed to the business.
- Sufficient equity is particularly important for new businesses, to convince the lender that you are serious.
- Weak equity will make a lender more hesitant to provide any financial assistance. However, low equity in relation to existing and projected debt (your current obligations plus the new loan) can be overcome with a strong showing in all the other credit factors.
- Non-existent equity can make obtaining a loan almost impossible, as you have not shown commitment to your business by investing your own money or assets in it.
Assessing Your Company's Suitability for a Loan
Determining whether your 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 that your loan will be approved. Applications with high debt, low equity, and unsupported projections are prime candidates for loan denial.