Banks Are Ready To Lend But Is Your Business Ready to Borrow

The end of 2007 marked a historic period in our nation's history.  For most, the next few years would become the worst financial disaster any of us had ever witnessed.

For Wall Street, the period between 2008 and 2009 would forever change the financial landscape.  Pillars of strength such as Lehman Brothers and Bear Stearns seemed to fail overnight.  Like a house of cards the corporate world seemed to be falling all around us as one firm after another either failed or was left kneeling at the feet of congress asking for mercy, or better yet, a bailout.

Perhaps most impactful was what was happening on Main Street.  Due to many of the mistakes made on Wall Street many Main Street businesses would now suffer as their local banking institutions panicked and ceased to extend credit.  Further exacerbating the issue was the fact that many small community banks relied on larger regional or national banks for liquidity as their correspondent bank.  Nervous from their own internal issues, many of these banks cut off liquidity to the smaller banks to let them fend for themselves.

Today, the dust has settled, TARP money has been all but repaid, GM has risen from the ashes, and the economy continues to slowly recover.  With that being said, most commercial banks are starting to open up the coffers once again.  What does this imply for the small and medium sized business owner?  Do they need to simply show up to the door with hands open?  It is important for the business owner to realize that while banks are seeking to increase their lending activity over the foreseeable future, they are undoubtedly going to be more conservative and cautious given recent experiences.  Businesses need to be prepared to secure the capital their business needs, and they need to be aware of what will be required of them that may not have been historically.  All business owners can benefit from taking 5 simple steps before approaching any bank with a lending request.

1)  Be Profitable or Have a Really Good Story:
It is important for many banks to work with companies who have a strong earnings history.  Does your business demonstrate a net profit?  If so, how many years has it been profitable?  If you haven't demonstrated at least 3 years of consecutive net profit, you may want to consider formulating your story as to why, and back that up with forward-looking projections demonstrating a return to profitability in the near future.  Net losses over the past couple years is not necessarily the kiss of death, but without a plan for the future or an explanation for the past, many lender's will find it hard to get comfortable with lending money at any dollar amount.  Most commercial banks are cash-flow lenders and don't care so much as to how much collateral you have.  Some do, and those would be asset based lenders, but conventionally speaking, just like cash is king, to the commercial banker cash-flow is king. 

It is important to note, however, that positive net income does not always translate into sufficient cash flow to service new or proposed debt.  An easy formula that most banks use to calculate cash flow to service debt is EBITDA (Earnings before Interest Taxes Depreciation and Amortization) divided by principal payments plus interest expense.  Stated in mathematical terms:

Net Income (Net Loss)
+  Interest Expense
+  Amortization Expense
+  Tax Expense/Provision for Income Tax (C-Corp)
+  Depreciation Expense
=EBITDA divided by Annual Principal Payments plus Interest Expense

Most commercial banks will look for this ratio to equal 1.00 or greater, but be ready to expect a requirement of more like 1.25 versus 1.00, which gives banks additional comfort by adding in a small cushion.


2)  Don't Ignore the Balance Sheet:
Most businesses simply focus on the income statement when asking their banker for a loan.  Don't ignore the importance of a strong balance sheet.  It is important that the balance sheet represent ample liquidity and reasonable financial leverage.  In a previous blog I wrote about the importance of financial ratio analysis for the small business owner and covered some common ratios used in financial analysis.  The most common ratios banks will look at is the current ratio (current assets divided by current liabilities) and the debt/equity ratio (total liabilities divided by total equity).  Generally, banks want the current ratio to be at least or greater than 1.00 and the debt to equity ratio to be less than 4.00 or 5.00 at the most.  If your business has negative retained earnings, as many do after the past couple of years, you may want to focus on whether assets on the balance sheet have more value than what is actually being reflected.  Many assets that have been on the balance sheet for a number of years are probably full depreciated and may understate the market value of the company's equity account.  In this case, it may be beneficial to determine the market value through an outside appraisal.  Some banks may require an appraisal as a condition of loan closing, so when working with your bank make sure they are comfortable with you ordering it on your own so you aren't required to pay for more than one. 

3)  Is Your Personal Financial House In Order:
While much of the focus in commercial lending is concentrated on whether the business can support the loan request, there is a considerable amount of focus placed on the owners of the business.  If you haven't checked your personal credit report in some time, make sure you know your score and be able to explain any derogatory items.  Most commercial banks will find it hard to consider a loan for a business owner who does not have a strong personal credit score, generally 620 or above, and in recent years this score has been as high as 670.

Additionally, make sure you have at least 2-3 years of personal federal income tax returns available as well as a current personal financial statement (listing of personal assets and liabilities).  Most banks will require you to use their form, but it is always a good exercise to figure out net worth on an annual basis on your own prior to approaching a lending institution.  Generally speaking, an individual's net worth should increase at a rate greater than the rate of inflation, but of course, extenuating circumstances such as purchasing a home or some other life event may cause large fluctuations (positive or negative) in one's individual net worth.  There is no magic number with regards to net worth, but getting back to negative retained earnings mentioned in the section above, adding your personal net worth and the company net worth together should result in a global debt/equity ratio that is less than the 4.00 or 5.00 mentioned above. 

4)  Be Organized:
Nothing can turn a lender off more than having to sift through piles of financial reports that are unorganized, incomplete, or just plain messy.  Lenders are busy and generally have multiple transactions to manage at one time. Being organized and presenting your information in a clear and concise manner can save a substantial amount of time and effort on both sides of the table.  As a general rule, a business should be able to present the following information in any loan plackage:

• Brief overview of the business
• Brief bio of the key executive officers
• Brief explanation of what the credit will be used for and how it will be repaid
• 3 Years most recent company financial statements (i.e tax returns, compiled, reviewed, audited stmts)
• 2-3 Years most recent owner federal income tax returns
• Recent personal financial statement for the owner(s)
• Most recent interim balance sheet and income statement with comparable prior year period
• Current A/R and A/P agings

Work with your CPA to make sure all documents are readily available and complete.  Review the statements prior to giving them to your lender to make sure everything makes sense and that everything can be explained if questions arise.  If there are issues, make your lender aware of them during our initial discussions.


5)  Be Educated on Your Options:
Before meeting with your lender, make it a point to talk with your CPA or do research on the internet about some non-conventional lending programs.  The US Government has now more than ever put programs in place to help spur small business growth.  Organizations such as the USDA and the Small Business Administration (SBA) have partnered with banks to offer enhancements to conventional credit structures to make it easier for business owners to obtain necessary capital.  The SBA, for example, partners with lending institutions to offer the SBA Express, 7(a), and 504 loan programs.  While each of the programs have differing characteristics, generally speaking, they all help to mitigate some weaknesses in credit structure such as a lack of start-up capital, higher financial leverage, or marginal cash-flow coverage.

There are a variety of websites available that speak to the programs mentioned above:
SBA:  http://www.sba.gov/
SCORE:  http://www.score.org/ (small business mentoring and training)
USDA:  http://www.usda.gov/ (USDA lending programs)

Partnering with a knowledgeable and respected lender can be extremely beneficial in helping business owners navigate through the complex world of government lending programs.  Furthermore, when interviewing banks, ask if the bank is a "preferred SBA lender."  This status means that the bank is allowed to approve SBA requests on behalf of the SBA, or more simply, has the resources and expertise necessary to make decisions without having to go directly to the SBA.  The advantage in working with a preferred SBA lender is the process moves much more quickly since it doesn't have to be packaged and sent directly to the SBA offices for decision.

By following the 5 steps outlined in this article, business owners can ensure they give themselves the best possible chance of securing a commercial loan.  While not all loan transactions or banks are the same, the 5 steps outlined in this article attempt to address the commonalities that all lenders are seeking when considering any loan transaction.