Over the years, I have received more than my share of denial letters from banks. I didn't understand. I was good with my money, so why wouldn't these banks let me borrow some of theirs?
Since those early days, I've learned a thing or two about how to take a business and make it appealing to banks. But before we dive too far into the nuts and bolts of the process, let's take a step back and look at what makes a business bankable.
For small businesses, banks are not just interested in the company financials – they want to know about the people running the show too. If your finances are in order, but your personal accounts are out of line, the chances that your application will be approved plummet.
Banks are highly motivated to lend to people who have the right goals. Loans are not meant to rescue companies with deeper problems than cash flow, like product-market fit. Instead, they're best suited for businesses that need more immediate capital to grow. This situation is quite common: According to federal statistics, 59 percent of business owners applied for funding to expand their companies in 2017.
Believe it or not, banks will sometimes deny a loan to a company that's growing too fast. I've seen some financial institutions deny loans to businesses growing faster than 25 percent per year. Other banks refuse to lend to companies in certain industries, like restaurants and construction companies.
Even considering these other factors, cash and collateral are king when applying for loans. The higher those numbers, the higher your bankability. Banks typically consider the past three years of cash flow, which means fledgling companies have an even harder time getting loans. Financial institutions also look at current financial statements, tax returns and debts.
Designing your debt schedule
A debt schedule refers to all the debts a company possesses. Loans, leases and accounts payable all qualify as debts of some form. Short-term accounts payable typically don't make a debt schedule, which is more about long-term viability. A company with heavy debts and limited income or assets will struggle to convince a bank to add more weight to the debt side of the equation.
Maintaining an established debt schedule isn't difficult. I recommend a spreadsheet with one row for each loan and columns with the following information:
- Creditor name
- Owner of property/equipment
- Original loan date
- Term or maturity
- Current fair market value
- Present balance
- Interest rate
- Monthly payment
By adding up your monthly payments and dividing that sum by your cash flow, you get your debt-service coverage ratio. This is one of the most useful numbers you can calculate for your banker. Typically, banks want to see a minimum DSCR of 1.25, but you should shoot for 1.75 or 2 to be safe. A DSCR of 1.75 would mean that you have $1.75 in income for every dollar of debt.
Putting all of this together takes time, but once you have the wheels in motion, keeping them well-oiled is a simple task.
How to make your business bankable
You've figured out your debt schedule and optimized your operations. You have cash flow and collateral. Your company is growing and could use extra cash to make the most of an opportunity.
Congratulations! You're ready to apply for a loan. Follow these three tips to ensure you get the right one for your business:
1. Enter the meeting with up-to-date information. Boost your chances of success by providing your banker with recent, accurate information. Certain items, such as your debt schedule and DSCR, help you stand out as a prepared and professional businessperson.
Come into the meeting with three years' worth of tax returns (personal and business), financial statements (no more than 90 days old) and all relevant account information (e.g., account numbers and balances).
2. Re-evaluate your needs and choose a bank that specializes. Are you asking the right bank for your loan? If you need an SBA loan, go to a bank that specializes in those. If you own a construction company, find a bank that works in your industry.
Don't assume your loan will work out. The National Small Business Association discovered that 69 percent of small businesses got adequate financing in 2016, while the other 31 percent didn't qualify. Do the legwork to find a partner that can help you grow. Alternative financing options might help owners who are in unusual situations.
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3. Create an ongoing relationship. Don't just work with your banker – talk to them. You, as the business owner who needs to borrow, should get to know the person on the other side of the table.
Ask about the ratios the bank likes to see for numbers like DSCR. Connect at the beginning of each year to share your plans. If you have a bad year, it's not the end of the world. Keep the lines of communication open. Connect your CPA to your banker to improve clarity and avoid miscommunications. Remember, banks hate surprises.
You can have a relationship with more than one banker too. Larger companies should use at least two banks to separate their interests. As your operation grows, consider diversifying your financial relationships.
At first glance, the amount of information required to apply for a business loan can be daunting. But once you've put the information together the first time, it's much easier to keep your information organized and up to date for future applications.
Whether your business is just starting out or looking to expand, these tips will improve your odds of securing financing and help you build the business of your dreams.