Consider these “5 C’s” before applying for a bank loan for your small business
A traditional bank loan remains a popular way to borrow because they are cheaper and come along with other helpful services like online banking and cash management. So if that’s your plan, how can you succeed?
If you think it may be a good time to get a loan from your bank, you’re probably right. Interest rates are still pretty low, the economy is strong, and bank profits are up.
This is why loan approval rates for small businesses are increasing. In fact, according to the Small Business Lending Index, a monthly barometer published by financing firm Biz2Credit, small-business loan approvals reached their highest level of all time in April.
Almost 28 percent of loan applications submitted by small companies and received by big banks with more than $10 billion assets were given the green light. Small bank lending approval rates reached close to 50 percent.
"The economy is still strong, and small-business optimism is high,” said Biz2Credit CEO Rohit Arora, who oversees the monthly research derived from more than 1,000 small-business credit applications on his company’s online lending platform. “Small-business lending is as strong as it has ever been in the 21st century’s post-recession era.”
But let’s not get too excited. Because when you look at those numbers the other way, 72 percent of small businesses are not getting loans approved from big banks and still half are being declined by smaller institutions. Why? It’s because most small businesses are just not ready to get a loan from a traditional bank.
If you’re in that boat, it doesn’t mean you can’t get other financing. You can borrow from a credit card or an online lender (if you don’t mind paying much higher interest rates). Or you can apply for a Small Business Administration guaranteed loan or funds through a Community Development Financial Institution (Bank of America, for example, has a $1.5 billion portfolio of loans and investments to 260 CDFI’s throughout the U.S. and Puerto Rico).
Some businesses take advantage of cash advances on their revenues such as those offered by payment service like PayPal and Square, or they negotiate longer payment terms with their suppliers or borrow money against other assets like insurance policies and real estate.
Or they simply assume the risk of an awkward Thanksgiving dinner by taking a loan from a family member.
Getting a loan from a traditional bank - big or small – still remains one of the more popular options because bank loans are cheaper and come along with other helpful services such as online banking and cash management. So if that’s your plan, how can you succeed?
The most important thing you can do is to make sure you’re addressing the “5 C’s.”
The first “C” is about capacity. Will your business be able to support the debt? Have you thought through your monthly payments and do you have enough cash flow to handle them? What if there are unexpected expenses or an economic downturn? Your job is to show your lender that you will be able to service the debt easily and that the risk of non-payment is low.
“The guidelines will vary but typically the balance sheet and income statement of the company will be thoroughly reviewed as it is the lead indicator on how the company has been performing,” says Jeffrey Donovan, a business development manager in Philadelphia for JPMorgan Chase. The New York-based lender last year announced a major expansion of more than 50 new branches and $3 billion in lending in the Delaware Valley.
Next, you have to take a hard look at your collateral. Bankers want protection and, unless you’re running a big corporation and have a long history of strong financial performance, the fact is that they’re going to demand collateral. Most of that time that means a personal guarantee. It will also mean pledging such assets as accounts receivables, inventory, cash, equipment, property and real estate. The more assets you’re willing to pledge, the better chance you’ll have of getting a loan.
Don’t believe me? Just ask Paul Ahlers, the president and owner of Triactive Media, a business consulting and technology company based in Mount Laurel. Ahlers considers his company financially healthy. Last year, for example, he generated more than $1 million in sales and cleared about $200,000 in profit.
Even so, “we still don’t see ourselves being able to get a loan without some sort of personal guarantee,” he told me. This hurdle has forced Ahlers to build his business without the aid of any bank financing.
Capital is very important. A banker will look at your balance sheet to determine how your assets compare to your liabilities. If you’ve got a significant excess of assets, that’s a good thing.
Some rules of thumb: Are your current assets (receivables, cash) at least more than one-and-a-half or twice your current payables? Does your existing equity (total assets less liabilities) significantly exceed any other debt you have outstanding?
These are critical metrics that every banker will look at when evaluating a new loan, which is why, according to JPMorgan Chase’s Donovan, "the business owner should count on their banker to discuss the liquidity and leverage position and get their feedback on how the business falls within or doesn’t meet the bank’s financial guidelines in these areas.”
Lenders also look closely at conditions. Oftentimes, these factors are out of your control. They include such things as the economy, industry trends, and pending legislation or political circumstances.
To win a bank loan, you’ll need to explain why your business is poised to grow, how the economic environment will impact you, why your industry is strong, and how you’ll be meeting the challenges of any potential legislation or political action that may be on the horizon. That means doing some economic research, perhaps investing in a few market analyses, and creating a business plan that shows how your company will continue to succeed in the years to come.
Finally, there’s character. Since the dawn of modern commerce, people like to do business with people they trust. Every good banker I know takes a hard look at the person they’re lending money to in order to determine if that person is hard-working, honest, and true to his or her word. Can you demonstrate your personal integrity? Do you have strong references from other business associations and members of your community? Is your credit history sound? Are you confident in your reputation? All of these factors will determine whether or not a lender would want to be in business with you.
Meeting the “5 C’s” isn’t something that’s going to happen overnight. It takes time to build up a financial history. It also takes time to put together your business plan that demonstrates all of the above. Most bankers I know say that business owners - particularly first-time borrowers - should be laying the groundwork for their financing pitch months, even years, in advance.
It takes a lot of effort to get a traditional bank loan, even in these times of higher-than-usual approval rates. Which is why you might decide - like Ahlers – to just spend your resources elsewhere.
“Unless you are financing to buy equipment (for example, a pizza shop),” he says. "The energy and risk spent to get a bank loan may be better put toward servicing customers and building the business organically.”
Gene Marks is a certified public accountant and the owner of Marks Group, a technology and financial management consulting firm in Bala Cynwyd.