Board Topic: Tangible net worth clause question
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Tangible net worth clause question

Posted by: Shawn Feb 23 2004, 06:11 PM
I applyed for a business loan but the Bank told me that they needed a tangile net worth clause in the loan. Why do you need clasue in the loan? The company is worth a lot of money. My accountant prepared my taxes and he said that the capital account is at $250,000. I only need $100,000 for the business loan. please help

Posted by: loanuniverse Feb 23 2004, 08:32 PM

The reason why the lender is requiring that covenant is probably due to some weakness detected in your balance sheet. Specifically a problem with the amount of leverage that you are carrying as compared with the equity invested.

A good lender will look behind the net worth line shown in the balance sheet to determine how much of it can really be counted on in case something goes bad, and to assess the "real" level of investment by the owners. There are several accounting entries that can make a balance sheet look stronger than it really is.

For example:

I could borrow a lot of money from my company, call it a "note receivable from shareholder" leave the note as an asset and reflect a healthy net worth. Nevertheless, this would be a little misleading as to the condition of the company so these types of entries have to be adjusted out.

Normally lenders use the following to compute tangible net worth:

Start with Book Net Worth
Add Subordinated Debts
Substract Assets/Receivables due from Affiliates/Shareholders
Substract Intangibles
The result is Tangible Net Worth

The formula is pretty simple to follow. I guess the most complicated part is the determination of what these "intangibles" are. Goodwill is the easiest to determine, but others that are missed even by credit analysts with little experience are "organizational costs" and "borrowing costs", which are sometimes carried as an asset in some balance sheets.

Hope this helps.

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