Vinu: Manu, there’s a business that was originally a proprietorship, but it has recently transformed into a partnership. The new firm is seeking a loan, and the new partner is offering his own asset as collateral. They’ve also submitted the old proprietor's financials. How should I consider this situation when reviewing their loan request?

Manu: That’s an interesting case, Vinu! Since the business has transitioned from a proprietorship to a partnership, the first thing you need to understand is that the legal entity has changed. You’ll need to evaluate the partnership deed to get a clear picture of how the new firm operates. This will tell you about the partners' roles, their capital contributions, and how they share profits and liabilities.

Vinu: So, I should treat the new partnership as a separate entity from the old proprietorship?

Manu: Exactly! Even though the proprietorship and partnership might seem like a continuation of the same business, legally, they’re different. You need to review both the old proprietorship's financials and the new partnership's financials to make a proper assessment.

Vinu: But the new partnership might not have a financial history yet. How should I handle that?

Manu: You’re right. The partnership may not have a financial history. So, the old financial statements of the proprietorship will still be valuable. These records will show you how the business was performing before the transformation. Look at its revenue, profitability, and any existing liabilities to gauge the health of the business.

Vinu: Got it. What about the new partner who’s offering his asset as collateral? How should I evaluate that?

Manu: Good question. First, ensure the asset is properly valued and that there are no existing liens or disputes on it. You should get a certified valuation report to assess its market value. Also, do a title search to verify ownership and confirm there are no other claims on the property.

Vinu: Should I be concerned about the financial strength of the new partner as well?

Manu: Absolutely! You’ll need to evaluate the financial strength of each partner, not just the new one providing collateral. Collect their personal financial statements, income proofs, and tax returns. This will help you assess whether they have enough personal financial stability to support the business, especially since they’re taking on joint liability in the partnership.

Vinu: That makes sense. So, I need to look at both the business’s past performance and the partners’ individual financial health?

Manu: Exactly. But don’t stop there. Also, consider the business continuity under the new partnership. How do they plan to keep the business going or growing? You should ask for a business plan that shows their strategy, expected revenues, and how they intend to use the loan.

Also, ensure that the collateral provided covers the loan adequately, and it might be a good idea to ask for personal guarantees from both partners as extra security.

Vinu: And what about calculating their ability to repay the loan?

Manu: You’ll want to calculate the Debt Service Coverage Ratio (DSCR), which shows how well the firm can cover its loan payments with its income. A DSCR of at least 1.5 is ideal, meaning the business should generate at least 1.5 times the loan repayment amount. Use the old financials to help with this, but also consider future projections.

Vinu: That makes a lot of sense! So, in summary, I should:

Manu: Exactly, Vinu! If you follow these steps, you’ll be in a strong position to decide whether to approve the loan.