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Need-to-Know Tips for Getting a
The thought of seeking financing to help fuel business growth can give private business owners feelings of both excitement and apprehension. Many don’t know what the bank looks for in a business loan application. It’s fairly common for entrepreneurs to be unfamiliar with the complete workings of the loan process, notes Jim Lynch, President and CEO of Leaders Bank, which caters to privately-held businesses and entrepreneurs. But, he points out that while the lending process is different at each bank, there are basic qualities any bank seeks in a loan request. The first thing a bank looks at when weighing a credit application is the primary function of a business. What does it do? How does it support itself? A very critical question is “Does the business have the managerial expertise needed to help the business thrive?” Whether a business has a “defensible niche in the marketplace” is also a key consideration. In other words, Lynch says, “The business should be able to reliably provide products or services to its customers and potential customers in its market, giving it the ability to support itself and be profitable long-term, regardless of market conditions.” Commercial banks will also consider the business’ ability to “service” the debt, looking at expected cash flow to ensure the company will be able to pay its debt obligations. This includes an analysis of the borrower’s collateral – an asset the company may be expected to put up when it receives the loan as a kind of insurance policy against being unable to repay. If the cash flow isn't sufficient to retire the debt, the bank may have to produce cash by liquidating collateral. Bankers weigh all this information to analyze the risk they assume in approving a loan. The risk splits into three categories: business risk, or the risk of a business being successful in attracting customers; financial risk, the risk that sufficient profits will be earned to pay off the loan; and managerial risk, the risk that the business owner or management team will be capable of steering the company to long-term success. “Managerial risk is important, but often overlooked,” says John Prosia, Executive Vice President of Leaders Bank. “What many business owners don’t recognize, sometimes catastrophically, is that they need to build a team around them that will provide the skill sets that they themselves don’t have. “For example, there is a completely different managerial risk related to the size, scope and complexity of a $20 million business, compared to a $300,000 business. Aside from sales, there are accounting and human resources functions, and possibly regulatory functions. Managerial risk is a conversation that we as lenders have on a regular basis. Management needs to be capable of envisioning the business systems and personnel needed to sustain success,” Prosia says. One way business banks assess this capability is by looking at financial information, such as the prior year’s year-end financial statement, a current interim financial statement, and information on major assets and major liabilities on the balance sheet. The bank can see if sales volume is increasing, operating margins are stable or growing, and expenses are in check. When analyzing expenses, banks pay attention to both controllable and uncontrollable expenses, and what management does to keep expenses reigned in. For example, Prosia has worked with a plastic components manufacturer whose raw material costs were a major part of expenses. A major supplier to this manufacturer was notifying customers that based on its ability to produce material and acquire the petroleum needed for the production, that it was going to put all customers on allocation, meaning there was a cap on the weekly volume that could be ordered. ”Our customer, recognizing the changes in his market, had preordered a supply of plastic that insulated him for a period of time from that change with his vendor, protecting him from a product shortage. That’s an excellent example of taking something that’s out of the company’s control and mitigating that risk,” Prosia says. In addition to making sure their business, financial and management risk components are all solid, business owners can take further steps to enhance their chances of gaining financing. One is to make sure the business has a good accountant and good accounting systems. ”It’s hard for any entrepreneur to manage his or her business without reliable information,” Lynch says. “The accountant can set up an appropriate internal system that will allow the entrepreneur to make timely and informed decisions.” A business can also help demonstrate its creditworthiness to a banker by providing a list of its main five or ten customers, along with a well-conceived business plan, several references, and marketing information such as a leave-behind brochure or product information sheets. Unfortunately Prosia says, there is a common pitfall when it comes to businesses providing the necessary information. “Many business owners think that the bigger the package of information is that they provide, that the quantity itself demonstrates to the bank and banker that they’re a credit-worthy prospect. It’s not about how many pieces of paper may be in a nice binder, it’s about the quality of the information.“A 30-page marketing plan doesn’t prove that a business owner knows his market any better than the person who shows up with a 3- or 4-page presentation on whom his customers are and how the product will be marketed.” Finally, says Lynch, be honest in dealing with your business bank. “Most important is that we do business with good, honest people. They won’t hide the truth. Instead they come to you right away with any issues, allowing us time to work out solutions. Honest people view problem solving as a collaborative process.” Prosia agrees. “Open lines of communication are a necessity. Business owners that find a way to communicate really well with the important third party people in their lives – their accountant, their attorney and their banker – are more likely to realize long-term success. On the flipside, a lack of communication will end up being a detriment to their business. Especially in banking, nobody likes surprises.” Leaders Bank’s Jim Lynch and John Prosia have a combined 55+ years of experience in business banking. They have made determinations on countless loan applications, in the process becoming experts on the distinctive characteristics of a successful loan application. |
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