Think Like a Banker: 5 Things Banks Consider When Evaluating Your Loan Request
If you are in the market for a business loan, being prepared will give you the best possible chance at success. When you’re getting ready to negotiate with a bank for business financing, it always helps to put yourself in their shoes: what will they want to see and hear from you? What will draw red flags? What, ultimately, will land you the money you need at the rate you want?
1. If the deal goes bad, how will the bank get repaid?
One of the first things a lender will look at is what collateral you bring to the table. Do you own your building, and if so, do you have enough equity in it to leverage towards paying your loan back should anything happen? Look at your assets. Determine whether there is enough value there to support the amount you are asking for. In general, the bank will look for assets in the realm of 120% of the loan amount you are asking for.
2. Do you have a good history of paying your bills?
Your character figures highly in the decision-making process; never discount your past performance with regard to decisions made on your behalf in the present. An exceptional personal credit score, good credit history, and evidence of your personal, as well as financial responsibility, is key.
The scrutiny you are under is akin to a background check that an employer might conduct. Your banker wants to know what kind of a person you are. If you have liens, litigation, or ethical issues coloring your past, it may prevent you from obtaining the financing you are after. If you haven’t looked at your credit report lately, be sure you do so in order to be prepared to answer questions about what’s in it.
3. Does your business make enough money to make the minimum payments on the proposed debt?
In any business, in any industry, cash flow is king. If your business is not making enough money to make your loan payments in addition to floating your day-to-day operating and fixed costs, it’s not likely you will be approved. Your prospective lender will look at both past and projected performance, and will also consider the business history of all major stakeholders, including upper management.
They will look at issues such as whether you have had past success in your industry, and what the potential is for you to be successful again in the current market. This aspect may disqualify many new businesses seeking to finance, though if you have a proven track record of success and sufficient collateral, you may still have a chance.
4. Will the business be around long enough to repay the loan?
Are there any industry risks, regulatory, or environmental risks that could put the business in danger of closure or failure? Many industries are seen as high-risk. Restaurants, for example, historically fail within one year of opening, so are seen as inherently volatile even with a proven track record.
Technology also contributes to obsolescence within some industries. Changing regulations, competition, exchange rates, and inflation are all mitigating factors that may affect how a lender views risk. Know your challenges. Be realistic, be pragmatic, and anticipate this conversation.
5. Why do you need the money? How are you going to use of funds?
It should go without saying, but here it is: you should be able to articulate what you need the financing to pay for. Be as specific and as detailed as you can. Is it to purchase new equipment? To service payroll and expand your staff? Are you buying a building, planning to scale, buying out a partner, or buying another company to add value to yours?
Some of the things you can’t use your financing for are paying yourself, or floating your day-to-day expenses. It may seem at odds with the concept of seeking a small business loan to say that you need to be successful in order to qualify, but it all comes back to risk. If you are being unrealistic about your future, you shouldn’t expect anybody else to get on board.
6. Bonus “think like a banker” tip: Do you have any skin in the game?
How much cash do you have to allocate towards the project? How much have you already invested? How much do you have to gain, and how much do you have to lose? If you, yourself, haven’t invested a dime into your business, why should you expect a lender to take a chance on it?
The Bottom Line
Your lender wants to see commitment. They want to know that you have the vision and the fortitude to see this through to completion. They want to know that you are doing everything you possibly can to make your business a viable entity. The greater your net worth, the more capital you have invested in your business, the lower the potential risk—and that (risk) is truly the bottom line.
If you are seeking financing for your small business, these are all important points to consider. If you are able to anticipate any question that may arise, if you are able to answer any challenge or explain any negative factors that may influence the decision, you stand a better chance of getting what you need.
Even when working with the Small Business Administration, you will need to fulfill some of these conditions. It is in your best interests to have your ducks in a row, so to speak, prior to initiating the application process. Working with an experienced CFO advisor is always a good idea, and may give you the edge you need to succeed.
Bob Doyle is Managing Partner at Gold Leaf Capital Partners, a financial services firm providing access to capital and CFO advisory to business owners and commercial real estate investors. Follow @goldleafcapital or visit www.goldleafcp.com for more information.