Comparing Lender Term Sheets
If you’ve been comparing term sheets from development finance lenders for any length of time, you will notice that there is zero in the way of standard practice across the lending community when it comes to development finance.
As a result, one of the unfortunate facts of the development finance marketplace is as the borrower you are hardly ever comparing ‘apples with apples’.
The knock-on effect it is really easy to select a more expensive lender, and cost yourself thousands in the process.
Why is it so difficult in a little more detail?
Lenders do not present their information in the same way, they do not include the same set of costs in their offer, they use different methods to calculate the costs, and some do not use your cash flow projections to boot when doing so.
The three main issues are as follows:
1. No standard practice by lenders for assessing all costs
Some of the more common dangers to be aware of are:
- Some lenders don’t include exit fees in the total costs, stating they are technically outside the loan.
- Some lenders cover QS and/or legal costs in the loan, and some lenders do not.
- Some lenders require a % of the arrangement fee to be paid upfront, whilst some don’t.
- Some lenders retain interest and pay back what isn’t used pro-rata, some lenders take interest at the end out of sales
- Lenders use a variety of non-comparable models when projecting the interest amount.
- Competing termsheets can often have different lengths of loan, which affects the costs.
- If you want an 18 month term, ensure all terms are for 18 months. Compare apples with apples.
2. Not comparing interest, nor the interest rate, at a deep enough level
This is extremely important:
The Termsheet does not provide enough depth to accurately compare lenders.
Is the interest rate calculated on the drawn balance or the facility, or a private equity based IRR model? Is the interest compounding, or non-compounding?
If the lenders you are comparing are using different models to calculate interest (and the chances of that are very high), then it is impossible to compare the interest element correctly.
The borrower, therefore, needs to be very careful that they do not miss out of lenders who appear expensive that aren’t, and vice versa.
3. Missing the lack of constant in cashflow projections, and it's effects
On top of the varying interest rate models, lenders are also using different cashflow projections too!
There are a number of models here, from the S-Curve Development model to equal drawdowns to your own actual cashflow. Most lenders aren't using your cashflow model, and are therefore unintentionally predicting interest incorrectly.
The consequence, if you're unaware of this, is a further lack of ability to compare lenders correctly.
Getting this wrong can make the projected interest unrealistically low or high, and can unintentionally affect your decision making when it comes to selecting a lender.
Ultimately you need a constant on cashflow, even if it is projected and in reality will change somewhat during the build. The only way to do this properly is to make sure every lender is putting in your likely cashflow projections, and providing you with their calculation model as evidence. You may be surprised to see how much the interest projection changes, for good or bad!
What you need to do to compare termsheets properly
- Use your own template to compare terms
- Make sure you have accounted for all costs; is there anything missing?
- Make sure the term length is the same on all offers
- Put together your own cashflow and supply it to all lenders
- Ensure they have used your supplied cashflow!
- Ask them to supply their costing calculator so you can double-check against your numbers
- Ensure you are dealing with the right lenders in the first place
When comparing Termsheets, know the beast you are dealing with
In summary then, the development finance marketplace continues to be a minefield to explore and understand, so ultimately you are able to ensure that you’re choosing the right finance partners.
If you are to truly compare the 50+ lending options correctly, and the final 3 or 4 in particular, make sure you understand the dangers that lie in wait, and that you are prepared for them. Your ability to select the right lender afterwards will be greatly enhanced!
If you would like help comparing term sheets, or putting together your cashflow schedules, we have free templates available that can help make the process much quicker and much easier. If you would like the templates, please send us an enquiry.
Chris Davidson is Managing Director of Discover & Invest Ltd, a specialist development finance brokerage and operator of the Discover Development Finance website.
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