In the past few years of the recession and business downturn, our local SCORE chapter here in Southwest Florida recognized that there was a lot of confusion between the commercial borrower and the banks. We formed a bank loan committee in our chapter and sent each committee member to a bank to have them show us their requirements for obtaining a commercial bank loan. The banks’ responses were overwhelmingly positive and that started close relationships that continue today. In this post, I’ll share with you what we have learned and tips you can use to secure a loan for your small business.
It is important to recognize that commercial bank loans are very labor intensive, especially when the loan value is from $10,000-$50,000. To mitigate this effort and cost, the borrower should prepare all of the information that will be requested by the bank prior to making the application. This information will be reviewed by the loan officer, and then, depending on the lending authority, presented to the bank loan committee for approval.
The purpose of the small business owner preparing and collecting this information is to familiarize themselves with many of the aspects of their business, to determine if the loan is affordable, and to give the borrower a perspective from the lender’s view. This can become an important factor in making changes to the business, or the loan application.
The Loan Application
In developing the loan application, start with a cover page that:
- The specific purpose of the loan
- The itemized amount of the loan
- The time duration of the loan
- The type of collateral you can offer
- Demonstrates that the borrower has the capacity to meet the level of monthly payment given
- Shows adjustments to the margins that will show that this loan is affordable
The importance of the above information is to provide the loan officer with information that demonstrates the lender can readily afford this loan.
The next item in the loan application is a 2 to 3 page business model, which is a very condensed version of a business plan. This model should contain:
- A brief history of the company, including the events impacting development/performance
- A summary of market, seasonal cycles, competition, estimated market share, etc.
- A graph of the projected sales forecast
- A brief summary of the company’s strategic five-year plan, etc.
- A statement of the list of major stockholders greater than 5% and their percentage of ownership
- A background summary of stockholders/the management (education, employment history, etc.), an organizational chart, if available
- Product or company literature
- Three years of business federal tax returns, signed by borrower
- Projected financial statements, by month for the remainder of the current fiscal year and subsequent fiscal year
- Most recent year to date balance sheet, income statement and (cash flow statement if available)
- Three years of balance sheet, income statement and (cash flow statement if available)
- Schedule of existing debt collateral pledged, rate and payment schedule as of the most recent month-end available
- Schedule of company owned real estate (with most recent appraisal)
- Accounts Receivable aging as of the most recent month-end available
- Accounts Payable aging as of the most recent month-end available
- Inventory listing as of the most recent month-end available
- Fixed asset listing as of the most recent month-end available, including any appraisals. Highlight any significant encumbered assets.
- Breakdown of historical, non-reoccurring expenses
- Credit reports – supplied by the borrower
- Last three years of complete personal tax returns for any owners of 20% or more of the business
- Current personal finance statement
During the submission of this material in the portfolio, the loan officer will ask various questions about the business. It is important that as a small business owner you are able to answer them in a knowledgeable and positive manner. Such typical questions might be:
- How does the business control its expenses?
- Are the officers of the company committed to the business?
- Does the business have a profitable operating history?
- Are sales growing?
- Are profits increasing as a percentage of sales?
- Is there any discretionary cash flow?
- What is the future of the industry or business?
- Who is your competition and what are their strengths and weaknesses?
Risk and Regulation
There has been a significant increase in the amount of regulation that the banks have had to comply with since the financial crisis. It can be noted that the banks are using the guidelines set up by the SBA, which assures them that they meet the regulatory confines of the loan. It must be noted that it is the bank’s decision to either assume all of the risk of the loan, or apply to the SBA to reduce their risk to 20%. The 80% risk is then assumed by the government. As to bank regulations, it should be realized that the United States Congress has an additional 250 regulations that will become effective for banks as soon as they sign them into law.
Owners of 20% or more of the business should be prepared to sign personal loan guarantees. Interestingly, some borrowers balk at this requirement, but doing so can send a message that the borrower is not committed to the business. Banks want their borrowers to have “skin in the game” just as they do.
Getting to “Approved”
It should be noted that the commercial bank loan application's chances of success are greatest when the purpose of the loan is to enhance the business’s assets. Examples of this would be the purchasing of new capital equipment, expanding the business premises or increasing inventory to enhance customer service.