What is Loan-to-Value Ratio in a Business Loan?

The Loan-to-Value ratio (LTV) calculates the maximum amount of a secured loan offered by a lender to a borrower based on the market value of collateral offered by the borrower to the lender to secure the business loan.

For example, let’s assume that some equipment that is needed for a business factory is worth $100,000 on the open market, and a lender is willing to lend up to $80,000 in order for a business to purchase this equipment. This would mean that the LTV is 80%, which means that the business will receive up to 80% of the value of the equipment in the business loan.

Market Value of the Collateral

Note that the market value of an asset is the price that would be paid for the asset on the open market between two unrelated parties. Unrelated parties in this case means two parties that are involved in the transaction at arm’s length.

Liquidity of the Collateral

If the asset offered as collateral is easy to convert into cash, such as Stocks of a publicly-listed company, the borrower will likely be able to receive a bigger loan and LTV from the lender.

lf the asset offered as collateral is difficult to convert into Cash, such as Real Estate, the borrower will likely receive a smaller loan and LTV from the lender.

Who Determines the Market Value of the Collateral?

Ultimately, the lender must feel comfortable with the appraised market value of the collateral. Generally, a lender will play it safe and appraise the collateral asset conservatively.

Often a lender may even add a discount to the publicly-available market value information about the asset in order to protect its loan.

Loan-to-Value Ratio (LTV) = Secured Loan Amount / Market Value of Collateral

In addition to the Loan-to-Value ratio, a lender will also analyze the business cash flows to ensure that the business can afford to repay the loan.

Furthermore, a lender will also look at other business operating metrics such as profits on the Income Statement statement and the strength of the Balance Sheet, which is assessed by comparing the Debts and Assets on the company’s books. For instance, a lender will be reticent to extend further loans to a heavily-indebted business.

What is the Best Loan-to-Value Ratio?

Given that different asset classes have different levels of liquidity, the LTV ratio for each asset will vary.

For example, here are some common LTV ratios for different assets:

  • Marketable securities such as publicly-listed stocks can have an LTV ratio of as high as 90% since stocks are highly liquid, that is, they are easy to sell.
  • Accounts Receivable can have an LTV ratio of as high as 75%
  • Commercial and industrial real estate can have an LTV ratio of as high as 65% to 100%
  • Business inventory can have an LTV ratio of as high as 50% since it can be challenging to sell
  • Residential real estate can have an LTV ratio of as high as 80% and sometimes higher

How to Obtain the Best Loan-to-Value Ratio?

Given that a lender will analyze other metrics such as the strength of the business balance sheet as well as the business profitability, it is best to have a strong Income Statement and Balance Sheet in order to obtain the best LTV ratio from a lender.

For example, if the business already has significant current or long-term debt on its Balance Sheet, it may be best to pay down some of this debt before seeking additional secured loans.

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