CHAPTER 7 Documentation and Its Connection to the Interest Charged
This chapter will aim to bridge the divide between the lender’s perspective and the business owner’s perspective while seeking funding in regard to documentation. We will discuss both the connection between documentation and interest charge as well as all the risk-mitigating ways that documentation helps support the lending business. I do know that the first part of this chapter will be of greater interest to those who are trying to nail down the connection between interest and documentation, and the second part will be of greater interest to those who are engrossed in how all the documentation will help mitigate risk in the business of lending.
The Connection between the Amount of Documentation Required and Interest Charged
The loans that usually require less documentation are usually more expensive loans. Many business owners are busy running their businesses and do not want to take an exorbitant amount of time completing documentation. Documentation is what funders use to determine the risk level. The risk level is what is used to determine the interest charged. Whenever you can get a loan with less documentation, it also means that the lender involved is willing to take higher-risk clients. It also means they prefer higher risk, because they are going to be charging more interest on those particular loans. Many characterized these lenders as sharks or some form of predator. But in reality, in a capitalistic society, businesses have a choice, and they weigh the pros and cons of their time. Some entrepreneurs decide to go with the more expensive loan for the convenience of not having to invest a considerable amount of time dedicated to gathering documentation; although some may regret that decision when they are in the process of repaying back the loan, but it was still a decision that the business owner makes in consideration of their unique circumstance.
I do not believe one loan is better than the other in abstract. I do believe that a business owner must objectively review the pros and cons of each decision based upon their situation and make it so that way it is a win-win scenario, even if that involves the business owner paying higher interest. Because of the demand for these types of loans and the expediency of getting the funding in a matter of days, Doriscar Capital Group do have funders that meet this criterion within its portfolio of financial products.
Documentation in the loan business is what funders use to determine a client’s level of risk. The risk level is what is used to determine the interest charged (Berg, Saunders, and Steffen, 2016, pp. 1357–1392). The rest of this chapter will address documentation from a lender’s perspective so that one can understand the reasoning and some of the facets of mitigating risk through documentation.
Mitigating Risk through Documentation in the Lending Business
A registered funding entity should create a working framework of managing risks and periodically examine the usefulness of that framework. Inner audit functionality can help a certified company to achieve its aims by bringing a systematic, disciplined method for assessing and continually improving the efficiency of its management of risks and internal control procedure. If a registered corporation has an inner audit function, the senior auditor should suit qualifications and have a direct-access line to the board or the panel audit group to convey the essential level of ability, autonomy, and neutrality to the role (Ibtissem and Bouri, 2013, pp. 9–24). If a registered entity lacks an inner audit function, the panel or audit group should examine periodically whether that function is needed.
The risk management systems of lending institutions are developed in assessing potential financial and other risks to its assets and operations and plan for their resiliencies (Murfin and Petersen, 2016, pp. 300–326). While decisions and reviews of capital investments integrate possible range of risks, it will be hard to forecast with confidence the severity, timing, or frequency of such occurrences, any of which might have substantial material negative effects on the firm’s outcomes of financial conditions or operation without proper documentation. The supporting statements cited in the risk factor, the part that is related to financial and economic risks, should show that the company has been transparent in reporting its risks.
Risk management is the structure, culture, and procedures that are directed toward taking advantage of possible opportunities while monitoring potential harmful threats (Berg, Saunders, and Steffen, 2016, pp. 1357–1392). The management of risks starts with comprehending the appetite of the perils. When borrowers question the time-consuming process of providing documentation, many do not consider the financial risk involved with the lending institution in the event of default.
The lending entities will be able to create a sound framework for risk assessment and management processes and occasionally review the framework effectiveness when proper documentation is provided. The principles of corporate governance will enable the board to set organizational risk appetite and then ensure it create a framework of risk management to assess and manage risks on an ongoing basis, which is why documentation is so important to lending institutions. The recommendations and principles of the corporate governance offer the benchmarks against which entities should evaluate and measure risk. With proper documentations, certain particular types of risk such as fraud are minimized (Ibtissem and Bouri, 2013, pp. 9–24). This implies that a funding company will be able to fill the loopholes that would otherwise lead to loss of the funding company’s funds.
From internal documents to agreements with external parties, documentations touch all aspects of investing (Murfin and Petersen, 2016, pp. 300–326). Documentation also offers proof of how firms function and interact externally and internally to deliver their services. When processes, policies, and procedures are poorly documented or undocumented, there are rooms for doubts since the processes, policies, and procedures can be subject to undue influences or interpretations. Proper documentation is critical for investors because it eliminates ambiguity; They are important for investors because they enable the financers to understand whether the companies are operating according to corporate governance or not (Ibtissem and Bouri, 2013, pp. 9–24). Investors are ready to invest in firms with proper documentations because they feel that such businesses have less risks and it would be safe to invest in them.
Documentation shall minimize liabilities and mitigate risks from unforeseen events and lawsuits. It helps in resolving disputes within the organization (Berg, Saunders, and Steffen, 2016, pp. 1357–1392). Documentation outlines the wealth-distribution details and clearly describes the particular roles of company stakeholders such as the board of directors, the advisors, the employees, and the partners. Although the documentation that one is looking at is mainly for financial review, such as taxes, P and L Statements, and A and R statements. The documentation in this manner enables the investor or lender to make evidence-based investment decision.
Many businesses do not like to take away time from their core business to produce documentation when considering getting a loan. I just wanted to explain the importance of the documentation to the lender and inform borrowers that there is no right or wrong way in particular. But once you understand the importance of documentation to lenders, you will also understand why lenders that are willing to lend with less documentation has to charge (the responsible business decision) higher interest to compensate for missing out on the wealth of knowledge the documentation usually provides, in a way that would have limited the lending institution’s risk.
In conclusion, these seven things one should know is important in helping businesses to better understand the lender’s perspective. If one could understand how the lender is looking at a set of facts, it may be easier to predict how the lenders will act in certain situations. I believe there is enormous benefit for business owners and investors if they understand how lending institutions are likely to act in a given scenario. Being able to effectively anticipate how lending institutions may react with a given set of facts will empower businesses to employ effective strategies in their pursuit of reaching their lending needs. This book does not cover every facet of how a lender approaches a set of facts but aims to arm the reader with a perspective that I noticed wasn’t prevalent among many businesses. For example, if one understands that most lending institutions are niche in nature of their funding choices, one could understand the benefit of working with an organization that works with several lending institutions with a variety of lending preferences. Many businesses assume that because one lender said no, that even though they have a viable business, they will not be able to find financing for their funding needs. The reality is that if you could afford the loan you are requesting, backed up by your business cash flow numbers, you may be able to find another lender that has a preference that is closer to your business profile.
Reference List
Berg, T., Saunders, A., and Steffen, S., 2016, “The total cost of corporate borrowing in the loan market: Don’t ignore the fees,” The Journal of Finance, 71(3), pp. 1357–1392.
Ibtissem, B. and Bouri, A., 2013, “Credit risk management in microfinance: The conceptual framework,” ACRN Journal of Finance and Risk Perspectives, 2(1), pp. 9–24.
Murfin, J. and Petersen, M., 2016, “Loans on sale: Credit market seasonality, borrower need, and lender rents,” Journal of Financial Economics, 121(2), pp. 300–326.