Being a little paranoid is always a good thing for a banker. While looking on the negative side of life is not something I’d normally recommend, it can pay when you’re lending money to a business.
Why do I say that? Well, let’s say your business client needs a facility for a particular project, or perhaps an overdraft is needed to finance a large order from one of its customers. The source of repayment would then be a specific transaction such as the completion of the project or simply the collection of the outstanding debtor amount after delivery of the goods or services.
When you are making the decision to lend (or motivating it if you’re not actually the credit decision-maker) what you need to think about is what would happen if that source of repayment doesn’t materialise. Stuff happens from time to time and it might not be the fault of your client that repayment can’t happen as planned.
That’s when a touch of paranoia can be useful. Imagine that repayment can’t be made from the expected source, where else could repayment come from. In other words, what’s your plan B?
Every good credit decision includes an alternative (or secondary) source of repayment. If nothing else, having one also avoids your client getting into trouble as well. Does the business have a separate cash flow from this transaction? Does it have reasonably liquid assets that it could use to raise cash?
The alternative doesn’t have to involve the business itself, it might come from the owner’s personal funds – maybe a undrawn bond, a cash investment or whatever.
Sometimes, we might feel that we want to make sure that we have recourse to that alternative means of repayment, that’s when we’d take collateral for the facility.
Either way, always make sure that you identify that secondary source of repayment at the time of making the initial credit decision and keep it in view until the facility is settled.