5 Step Business Loan Process: A banker's prospective
by Joseph Lizio - August 11, 2009
One of the best ways to get something for your business is to understand the process. If you know the process, you as a business owner, can better plan to achieve that what you want.
The same is true for small business lending! If you understand the process, then you will better understand the requirements and be better positioned to secure the funding your business needs.
Most lending follows a pretty defined process. When you sit down with a lender, they will politely listen to your story about why you are seeking funding. But, what they are really listening for is what you will use that funding for.
Most lenders will only match loans to the need. If you need commercial property for your business - the lender will not consider an unsecured 60 month term loan. That would not be good for the business or the lender as the payment would be extremely high. However, a 15 or 20 year loan would lower the monthly payment making it more affordable for the business owners and lowing the risk of default for the bank.
Or, if you are seeking to purchase equipment that has a useful life of 5 years, the bank or lender will not consider a long term loan of 15 or 20 years. The loan amortization would go way out past the useful life of the assets used as collateral.
Once the purpose of the loan is determined the real process begins.
Credit. Lenders pull credit first. It does not matter what the rest of your deal looks like or how much money you make or the value of your collateral. If you have shown that you have not honored your obligations in the past, the lender will never take a chance on you. Plus, if your credit is bad, the banker or lender does not want to waste any more time with you as they know your loan request will never be approved. If you find yourself in this position, your only option is to work to fix or improve your credit score.
Cash flow. If your business does not have positive cash flow, a banker or lender will determine that you or your business will never be able to make the monthly loan payments. It does not matter what you think you will make in the future with the loan proceeds or how good you think the opportunity is, if you cannot demonstrate that you can service the loan (make the payments) at the time of application, the banker will not take a chance on some unknown future event.
Moreover, bankers tend to want to see more than just your ability to meet the minimum monthly payment. Lenders also want to ensure that your business's cash flow could withstand a slow month or two. Thus, if business slips, you can still pay the bank each month.
Collateral. The next step is to evaluation the collateral. This process could be expensive for both the borrower and the lender as it may require extensive valuation, assessments and appraisals from third parties. When banks evaluate collateral, they not only look at the value to ensure the value covers the loan amount but also how quickly and cheaply the lender can sell the collateral should they have to take it. Banks do not really want your collateral. It is expensive to hold and to sell. Thus, they want collateral that can be easily sold in the market to many different buyers. Therefore, if you are seeking a loan against unique or single purpose property (like a car wash that can only be used as a car wash or a specialty piece of equipment that only your business will use) your chances of using that as collateral or getting a fair valuation for it is very small.
Additionally, collateral values change over time. Meaning that the value of the assets at time of the loan may not hold up over the life of the loan. Markets change, economies change and technology can easily make existing products obsolete. Therefore, many lenders, specifically banks, will try to impose a UCC-1 filing on all business assets - this is just to protect themselves as they want and need to be repaid.
Supplementary Repayment. In addition to cash flow and collateral, many lenders, especially banks, want, at the least, one more form of repayment should the borrower not be able to make payments and the collateral value does not hold up. Here, many lenders look for co-signers or personal guarantees. Thus, if the business's assets do not cover the outstanding balances and costs of selling the collateral (including legal fees), the lender also wants to come after personal assets for payment. This protects the banks in several ways. First, borrowers who have "skin in the game" (meaning have a personal stake in ensuring repayment) are less likely to just walk away - like many borrowers do with unsecured loans like credit cards. Second, having a co-signer or guarantor means one more person keeping an eye on the business; someone else who will keep pressure on the business owner or offer advice to help them succeed. If the business succeeds, there is a better chance of the borrower repaying the loan in full. Lastly, as stated above, it is one more option that the bank can go after to ensure that it receives all its loan proceeds, interest and other costs.
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Covenants. Once everything is said and done, bankers want to ensure that everything in the business says that way. Once funded, it is nearly impossible for a lender to take the loan proceeds back. But, if your business begins to struggle, they do want to be the first to know. Thus, they require covenants. Covenant can come in many forms but are usually based on the criteria of the underwriting and approval. If your business is making an operating profit of say 10% of gross sales (giving your business the ability to service the loan) then lenders will set that as a requirement and want you to provide them monthly financial statements showing that your business is maintaining that ratio. If your loan is based on the conversion of assets like accounts receivables or inventory then the lender will want to see that your business is turning those assets over in a manner that further facilitates the loan servicing.
By understanding the process - the bank's or lender's process - your business will be better able to secure the funding needed to grow and succeed. Further, it will save time away from the business through understanding what is required before walking in the door to speak with your lender.
The bottom line is that banks and other lenders do want to make loans - that is their business. But, they also have to protect themselves against undue risk. They want to get repaid just like you want to get paid for your work and efforts. Going in understanding and seeing things from a lender's prospective will make the entire loan procedure easier and quicker. Wouldn't it be better to know you will be approved before you even start the process?
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5 Step Business Loan Process: A banker's prospective - Business Money Today