PERFORMANCE BASED LENDING HOW MUCH MONEY IS THE BORROWER GOING TO NEED? TRY NOT TO GET INTO A POSITION WHERE ADDITIONAL MONEY IS NEEDED BEYOND THE ORIGINAL ESTIMATE TO SEE THE SITUATION THROUGH TO COMPLETION.

WHAT IS THE MONEY GOING TO BE USED FOR? BE SPECIFIC. TOO MANY OPERATING LOANS HAVE BEEN USED TO SUBSIDIZE LIFESTYLES, REFINANCE CARRYOVER DEBT, AND FINANCE CAPITAL PURCHASES.

HOW WILL THE LOAN AFFECT THE BORROWERS FINANCIAL POSITION? NOT ONLY ANALYZE THE BORROWERS SITUATION BEFORE THE LOAN IS MADE, BUT ALSO LOOK AT THE SITUATION AFTER THE LOAN IS MADE.

HOW WILL THE LOAN BE SECURED? COLLATERAL IS ADEQUATE ONLY IF UNDER THE WORST CONDITIONS, ENOUGH COULD BE SOLD FOR SUFFICIENT CASH TO REPAY THE LOAN IN FULL AND COVER THE COST INVOLVED. COLLATERAL’S PRIMARY PURPOSE IS TO PROVIDE INSURANCE IN THE EVENT OF DEFAULT, NOT AS THE PRIMARY MEANS OF REPAYMENT.

AN IMPORTANT LENDING CONSIDERATION IS THE EXPECTED VALUE OF THE COLLATERAL AT THE DUE DATE OF THE NOTE. CONSIDER POTENTIAL CHANGES IN COLLATERAL VALUE AND CONDITION, LEGAL AND SELLING COST, AND THE FACT THAT A DISTRESSED SALE WILL BRING LESS THAN MIGHT BE EXPECTED UNDER NORMAL MARKET CONDITIONS.

HOW WILL THE LOAN BE REPAID? WILL IT BE FROM OPERATING PROFITS, OFF-FARM INCOME, THE SALE OF THE ASSET BEING FINANCED, REFINANCING, OR THE LIQUIDATION OF OTHER ASSETS?

WHEN WILL THE MONEY BE NEEDED AND WHEN WILL IT BE REPAID? PROJECTED CASH FLOW SHOULD ANSWER THESE QUESTIONS. THE BORROWER AND THE LENDER SHOULD BOTH AGREE ON THIS POINT. MISUNDERSTANDINGS CAN OCCUR, THEREFORE, A SPECIFIC REPAYMENT PLAN SHOULD BE AGREED UPON.

ARE THE BORROWER’S PROJECTIONS REASONABLE AND SUPPORTED BY DOCUMENTED HISTORICAL INFORMATION? A LENDER SHOULD EXPECT THE BORROWER TO PROVIDE PRODUCTION, MARKETING, AND FINANCIAL RECORDS. TO THE EXTENT A BORROWER’S PROJECTIONS EXCEED PAST PERFORMANCE, THE MORE THE ESTIMATES SHOULD BE QUESTIONED.

HOW WILL ALTERNATIVE POSSIBLE OUTCOMES AFFECT THE BORROWER’S REPAYMENT ABILITY? AN EVALUATION OF REALISTIC ADVERSE OUTCOMES SHOULD BE MADE.

HOW WILL THE LOAN BE REPAID IF THE FIRST REPAYMENT PLAN FAILS? IF AT ALL POSSIBLE, IT’S BEST TO AVOID THE SITUATION WHERE FORECLOSURE IS THE ONLY ALTERNATIVE IF THINGS DON’T GO AS PLANNED. HAVE A BACKUP PLAN.

HOW MUCH CAN THE BORROWER AFFORD TO LOSE AND STILL MAINTAIN A VIABLE OPERATION? FIRST, A VIABLE NET WORTH IS NOT ANYTHING ABOVE ZERO. MOST COMMERCIAL LENDERS SHOULD HAVE SOME MINIMAL EQUITY POSITION (i.e. 30%) BELOW WHICH THEY WOULD NOT CONTINUE FINANCING WITHOUT AN EXTERNAL GUARANTEE.

THE ANSWER TO THIS QUESTION SHOULD CONSIDER THE IMPACT OF COMBINATIONS OF BOTH POTENTIAL OPERATING LOSSES AND DECLINES IN ASSET VALUES. HOW LIKELY IS THE POSSIBILITY THAT EVENTS WILL OCCUR WHERE EQUITY WILL FALL BELOW THE MINIMAL EQUITY POSITION?

WHAT RISK MANAGEMENT MEASURES HAVE BEEN OR ARE TO BE IMPLEMENTED, BOTH BY THE BORROWER AND THE LENDER? IF COMMODITY FUTURES OR OPTIONS ARE BEING USED, THE BORROWER AND LENDER SHOULD UNDERSTAND THE POTENTIAL FINANCIAL REQUIREMENTS.

OTHER POSSIBLE RISK MANAGEMENT MIGHT INCLUDE: LOAN AGREEMENT COVENANTS MONITORING AND REPORTING FREQUENCY INSURANCE REQUIREMENTS

WHAT HAVE BEEN THE TRENDS IN THE BUSINESS’S KEY FINANCIAL POSITION AND PERFORMANCE INDICATORS? THIS WILL REQUIRE SOME HISTORICAL FINANCIAL INFORMATION ABOUT THE BUSINESS. IF THE TRENDS ARE ADVERSE, WHAT ARE THE BORROWER’S SHORT AND LONG TERM PLANS TO TURN THE TREND AROUND?

PERFORMANCE BASED LENDING IS MORE THAN CASH FLOW LENDING. WHILE CASH FLOW PROJECTIONS ARE AN IMPORTANT PART OF PERFORMANCE BASED LENDING, A MORE IN DEPTH ANALYSIS IS NECESSARY TO ASSES THE RISK INVOLVED IN MAKING A LOAN.