The environment for bank lending is improving, but it’s nowhere near what it was a few short years ago. For businesses in good shape there is money to be borrowed and you’ll need to be prepared to prove your case.
Banks are in the business to make a profit and that means they need to count on being paid back in full. Keep in mind that banks are in the business of reducing risk to the bare minimum, so here are five things they’ll look at in evaluating your request.
You Have Sufficient Cash Flow
If you’re borrowing money for a business purpose, your banker needs to know your business has the cash flow to make the scheduled payments. First and foremost, this means your business is profitable. Don’t expect the bank to lend to you to fund losses unless you have a history of profitability and you can show recent losses are temporary and you’ve already taken the steps to correct them.
Cash flow begins with profitability, but doesn’t end there. Your banker will also evaluate current debt service, investments in fixed assets, growth in accounts receivable, and other non-P&L items that require cash going out the door.
In addition to your cash flow, your banker will want to see…
You Have Sufficient Collateral
In case your business runs into trouble and can’t pay back the loan, your banker wants to see assets that can be sold to pay it off. For entrepreneurs this will be both business assets and personal assets – most importantly real estate (your home).
There’s some truth to the old adage that banks only want to lend money to those who don’t need it. They’re most comfortable lending to those who could fund themselves if they sold all their assets and want to borrow to avoid doing so.
Cash Flow and Collateral are not an either-or. Both must be sufficient for your banker to feel comfortable lending to you, but they are just the first steps. Your banker will also want to see…
You’re Asking For The Right Amount
Back in the good old days it was possible to ask for more than you needed “just in case”. That is no longer true. You will need to prove how much you need in specific detail.
However, if you’re looking to fund a long-term project in which cash will be used in increments over an extended period of time, you can get approved for the whole amount now (if you can justify it) and have the cash come to you in a series of draws timed with your need to spend it.
Not only do you need to ask for the right amount, but you need to demonstrate…
You’re Asking For The Right Type
A business can get itself into trouble by taking on the wrong kind of loan.
As a rule, lines of credit are used for short-term needs – the most common being to fund accounts receivable during seasonal highs.
Equipment is financed with term loans or equipment leases – usually with 5-7 year terms.
Long-term working capital needs are generally financed with term loans – often SBA guaranteed.
Real estate is financed with mortgages – usually with 10-20 year terms for commercial property.
Never, ever, buy equipment or other fixed assets with a short-term line of credit.
You Have A Strategic Plan
Bankers have always wanted to see historical results for the last few years as well as a business plan for the future, but more and more they are upping the ante by requesting a more strategic approach to your plan.
Instead of going along with your assumption that revenue is going to increase 10% a year for the next three years, they want to know how you’re going to do so. Which new customers are you going to acquire? How are you going to acquire them? What new capabilities do you need to build in your organization? Do you need to shore up weaknesses in your roster of key employees? What is your competition doing that will either hinder you, or assist you, in reaching your goals? Etc.
If you want your banker to say yes to your loan request you must: demonstrate the ability to pay back the loan, show it’s for the right amount and right type, have a plan for the future that makes sense. Of course, this is good business advice even if you’re not looking to borrow money.
And there’s no time like the present. You’ll earn bonus points from your banker if you already have these things in place before he or she asks for them.