the trend of the sales and expenses and look for improving or declining cash flow. He will also review the balance sheet for other sources and uses of cash. Other uses of cash include such items as capital expenditures, and growth of accounts receivable and inventory relative to trade payables and other financing.
The second significant loan underwriting concern is the amount of debt and equity. The loan officer will calculate a debt to equity ratio by looking at the company’s total debt divided by the amount of equity. The total debt should be less than 4 times the equity. In other words, the company should have at least 20% equity. Equity provides a cushion above the debt which allows the company to be sold or liquidated and still be able to repay the loan.
The company’s assets are usually pledged as collateral for the loan. Collateral is a specific asset (or assets) which is pledged to the bank to secure repayment of the debt. For financially strong companies and guarantors, banks will make unsecured loans. However, most small business loans are secured by the company’s assets, such as its inventory, receivables and other fixed assets. In the event of default, the bank will have the right to repossess and sell the assets or collect the receivables to repay the loan.
The final consideration is the principal owner’s financial strength. In almost all cases, small business loans made by financial institutions will require the personal guarantee of any principal owner with 20% or more ownership of the company. If the business defaults on the loan, the bank will have the right to pursue the owner of the company. Loan approval considers the liquid assets, personal cash flow and overall net worth of the principal owner, especially if the primary cash flow and collateral offered by the business are not sufficient. The bank may ask that the principal owner pledge additional collateral to support the loan if the company’s assets are not adequate collateral for the loan
What If The Loan Is Declined?
If your loan request is declined, you are entitled to be told specifically why you have been declined. The best strategy is to meet face-to-face with the loan officer and discuss the specific reasons for the decline. You should inquire about what changes or benchmark ratios need to be improved to obtain a loan.
If the loan officer is not an SBA loan specialist or the bank is not an active SBA lender, you should meet with the SBA officer or locate the most active SBA lender in the community. The SBA guarantees a significant portion of the loan principal (up to 90%) and many banks and other non-bank financial institutions will make loans declined by banks. You should also go back to some of the resources mentioned in this book and begin searching for alternative lending sources. There are many sources of financing available and strategies to become “bankable” if you search for them.
Thank you, Tom, for your valuable insights.
We will discuss SBA loans in the next chapter. But first, it is appropriate to provide several more tips for dealing with banks, or any lender for that matter.
Where Do I Stand?
If the numbers and formulas we’ve been describing in this chapter make your head spin or your eyes cross, you may check out a couple of simple tools that can help you (and lenders) handle your businesses’ overall financial health.
Sageworks is an internet company that develops products that can be used by small businesses, accountants and other financial advisors, as well as lenders, to evaluate the financial health of a business. According to Sageworks, there are five main financial statement ratios that creditors frequently use to evaluate the financial performance of a private company. They are:
• Cash to Assets
• EBITDA to Assets
• Debt Service Coverage Ratio
• Liabilities to Assets
• Net Income to Sales
With the Sagework platform, eight to ten pieces of information can be entered to produce a report that will help evaluate the businesses’ financial statements and analyze what they are doing well, as well as what areas may need improvement.
“Some businesses will run these reports to see where they stand before they talk to a banker. It’s a quick proxy for what will I hear from my bank?,” says analyst Libby Bierman. But a business owner can also use it, “for leverage or to negotiate for better payment terms,” she says, if the financial health of the business is strong. For more information, including free whitepapers on business credit topics, visit our Resource Section.
Dress for Success
It should almost go without saying that when you meet with a banker or other lender you should dress appropriately. We’ve added the word ‘almost’ to that last sentence in recognition of how informally people conduct themselves now. Most of you know how to dress. But clearly—the evidence is all around us—some people don’t. So while we don’t want to come across as a nag or a scold, if your idea of formal is a T-shirt without holes in it, we have some work to do. The point of this book is to get your business financed. You’ve got to use every strategy and tactic to get it done. Show the lender some respect by dressing appropriately. (For an entertaining and interesting perspective on this topic, read Crazy Egg founder Neil Patel’s post, “How Spending $162,301.42 on Clothes Made Me $692,500” on his website, Quicksprout.com.)
Avoid High Salaries and Entertainment Expenses
Lenders want their money to be applied to the business. They don’t want that money going to your salary and your enjoyment. They want you committed to the business by taking a low salary at the start and foregoing the perks of larger businesses.
A Winning Business Plan
There is considerable debate about whether a business plan is a necessity. Some entrepreneurs say they either never created a business plan, or if they did, never used it. And it’s true that in certain circles (especially those trying to raise money in Silicon Valley) a “pitch deck” is considered more appropriate than a formal business plan. (We will discuss the pitch deck in more detail in Chapter 14.)
But banks and other financial institutions tend to be traditionalists, and they often want to see a well thought out and well drafted business plan. (In certain countries, such as Germany and Peru, a business plan is an absolute necessity.) Not only does a business plan serve as a road map for where you are headed but for lenders it is the starting point of the journey. It also forces you to ask hard questions about your business and where you see it headed. Those are the same questions that a bank or other lender will ask. The proper drafting of a business plan is a book unto itself. Please consider reading Garrett Sutton’s Writing Winning Business Plans.
Even the SBA says a business plan is “an essential roadmap for business success.” SBA loans are up next…
Chapter 4
SBA Loans
For years, Leslie had dreamed of opening her own one-stop event shop that combined her exceptional baking skills, her background in design, and her experience as a florist. Having worked part-time for years for a well-established florist in Austin, Texas, Leslie had aspirations of taking over the shop when the owners retired, which they’d announced would be soon.
Leslie, was anxious to get started. But then, the flower shop owners told her that they had decided not to retire after all. It was time for Leslie to take matters into her own hands.
The business plan she’d been tinkering with for years became her sole focus. Despite being in the midst of the worst economic
