As an early-stage startup seeking funding, one of the most important financial metrics you will encounter is loan-to-value ratio, commonly abbreviated as LTV. Especially when raising debt financing, lenders will scrutinize your company’s LTV to determine the risks of providing capital and the terms they are willing to offer.
In this post, we will explain how LTV applies to startups, discuss best practices for calculating and optimizing LTV for your company, and provide actionable tips for putting your best foot forward when interfacing with lenders and investors on this critical metric.
What is Loan-to-Value Ratio?
Loan-to-value ratio measures the size of a loan compared to the value of the asset or assets securing that loan. Expressed as a percentage, LTV shows the maximum amount a lender is willing to lend against an asset. The higher the LTV, the riskier the loan is for a lender.
For startups seeking secured debt financing, assets pledged as collateral often include equipment, accounts receivable, inventory, or other balance sheet items. The lender will assign a specific value to these assets, and will lend up to a certain percentage of that total value. This percentage is the LTV.
For example:
- Equipment worth $100,000
- Potential loan amount: $80,000
- Loan-to-Value Ratio = Potential Loan Amount / Value of Collateral Assets = $80,000 / $100,000 = 80%
In this scenario, the lender is willing to lend up to 80% of the value of the equipment – so they view an 80% LTV as their maximum acceptable risk level.
Why LTV Matters for Fundraising
For lenders, a company’s LTV determines the risk level they are taking on with a loan. A higher LTV means a riskier investment for them. For startups, your business’ LTV also indicates how much funding you can raise through debt financing.
Since most early-stage startups have limited assets to use as collateral, your LTV also essentially measures how “risky” lenders will perceive your business to be. The higher your company’s LTV, the harder it may be to secure attractive debt financing terms like lower interest rates and fewer restrictions.
As such, understanding and optimizing LTV is crucial when developing your fundraising strategy. The math behind calculating the ratio itself is simple, but presenting your LTV in the most favorable (yet ethical) light takes some finesse.
How Startups Should Calculate Loan-to-Value Ratio
When interfacing with lenders about raising a secured loan facility, they will ask you to present a schedule of potential assets to serve as collateral, including their current fair market values. With this information, lenders will evaluate the loan-to-value ratio based on this basic formula:
LTV = Potential Loan Amount / Total Fair Market Value of Assets Provided for Collateral
Potential Loan Amount
This is the amount of capital you wish to raise from the lender through the debt financing facility. Be sure the amount aligns logically with your stated funding needs and planned use of proceeds. Asking for too little can prompt questions about why you don’t need more funding, while asking for unreasonable amounts can cause the lender to doubt your business strategy and financial planning capabilities.
Fair Market Value of Collateral Assets
You should provide the lender documentation to support the fair market value estimates for assets you wish to pledge for collateral. This could include:
- Account statements for cash accounts
- Financial statements showing accounts receivable balances
- Appraisals or market data on equipment values
- Inventory valuation schedules and accounting methodologies used
Provide as much credible evidence as possible to substantiate your fair value assessments. Undervaluing these assets can get your loan application denied for trying to misrepresent LTV, while inflating valuations excessively will strain credulity.
Maximizing Fair Value of Collateral
Without straying into unethical territory, some legitimate steps startups can take to maximize the fair value calculation of your collateral assets include:
- Choosing higher-value equipment, inventory items, IP etc. to pledge while keeping lower-value items protected/unpledged.
- Getting updated appraisals of tangible assets like properties or equipment to reflect appreciation.
- Accelerating collection of accounts receivable prior to valuation date.
- Postponing planned write-downs of assets until after loan closes.
- Structuring inventory purchases, production plans etc. to maximize balances pledged right before valuation timing.
Each approach above aims to legitimately increase the fair market value of what you pledge against the loan, allowing you to achieve a lower (better) LTV.
What is a “Good” LTV for Startups?
Typical acceptable LTV standards depend heavily on asset class and perceived risk levels of the startup:
- Equipment Loans: Up to 80-85% LTV
- Inventory Loans: 50-75% LTV
- Accounts Receivable Loans: 80-90% LTV
- IP-backed Loans: 30-50% LTV
As a very general guideline, most lenders prefer to see LTVs at 65% or lower for early-stage companies. More mature firms with longer operating histories can qualify for higher LTVs.
Is There a Maximum LTV for Startups?
While 100%+ LTV secured loans aren’t completely unheard of, securing attractive terms at those levels is very rare for startups. And most prudent lenders will not exceed 100% LTVs except perhaps against extremely liquid assets like cash or marketable securities.
Elevated LTVs getting close to 100% essentially provide no collateral protection to the lender. And there is greater risk of falling into technical default if collateral asset values decline even slightly.
Startups proposing exceptionally high LTVs should expect to be met with skepticism, scrutiny about your methodologies and assumptions, and less favorable loan terms requiring more frequent collateral monitoring and reporting.
That said, don’t be afraid to push for the highest feasible LTV your particular assets can stand behind ethically. Even seemingly small LTV improvements of 5, 10 or 15 percentage points can allow raising substantially more debt financing.
What if LTV is Greater Than 100%?
On occasion young startups may find themselves needing to raise secured debt but only having very limited collateral assets on-hand to support the borrowing request.
In such “under-collateralized” scenarios, is it still possible to obtain financing?
Potentially, yes. A lender may remain open to providing funding if the excess amount above a 100% LTV position can become “credit-supported” based on the startup’s equity investors guaranteeing repayment, or collateralizing some of their equity ownership positions.
This backstops the uncollateralized piece of the loan to the satisfaction of the lender. So for example on a $100K loan request:
- Used equipment worth $60K pledged
- $60K piece = 100% LTV ($60K/$60K)
- Remaining $40K supported by investors personally guaranteeing repayment or posting some equity as collateral
Due to the lack of assets securing the full loan amount in these high LTV cases, startups should expect to pay significantly higher interest rates, face tighter restrictions on use of funds, and provide much more frequent financial reporting.
Tips on Presenting LTV Data to Lenders
As a key indicator of risk, LTV plays a pivotal role in a lender’s secured loan underwriting process. Optimizing how you calculate and frame your company’s LTV can improve your chances of getting approved and securing better terms.
Here are some final tips:
- Be conservative on asset valuations, but highlight legitimate upside potential. An unrealistically high appraisal screams desperation and raises eyebrows.
- Use an asset-based lending valuation firm to assess collateral if possible. This instills more confidence than a management team’s internally-generated numbers.
- Provide abundant documentation to support the asset valuations, borrowing bases, and methodologies used to calculate LTV. The more granularity and transparency you offer, the more credible the overall analysis will be.
- Along with the LTV metrics focus the story on the viability of the business itself beyond just assets. At the end of the day, the strength of the startup as an operating company is equally if not more important.
- Shop financing proposals around with multiple lenders and emphasize any strong LTVs in negotiations to press for better rate and term concessions.
LTV is pretty straightforward. Just make sure to use the right fair value of the products against which you are borrowing. Lenders will be conservative to protect their interests and they may ask for additional guarantees to reduce their risk.