Getting a business loan is as easy as
one-two-three. One, have good information. Two, be well prepared.
Three, make sure you understand exactly
what your credit request is.
But wait. It’s not that cut-and-dried.
Several subjective judgments factor into a
banking institution’s final loan decision.
“We don’t put the numbers into a black
box, turn the crank and spit out yes or no,”
says David Janus, president of FirstMerit
Bank’s Cleveland Region. “I can take three
bankers, put them in a room and give them
the same set of financial statements, and
they won’t identify exactly the same things.
So it is subject to interpretation.”
Smart Business asked Janus how our
readers can improve their chances of getting a bank loan.
What determines the fate of a typical loan
request?
The first thing the bank asks is what the
loan is for, and it’s not always crystal clear
or readily apparent. If somebody says they
need the money for a new machine, that’s
pretty obvious.
Where it gets tricky is when a company
says it’s growing rapidly and needs more
working capital or an increase in its line of
credit. The bank will study the balance
sheet to understand changes in the
accounts receivable, inventory and
accounts payable, because that’s really
what the line of credit is financing. The
bank also looks at sales, earnings and cash
flow. Are receivable turns slowing down?
Has the company had some credit losses?
Has a customer filed for bankruptcy? Are
collections poor?
I’ve seen instances where customers
wanted money because they were growing
fast, but they had too much money tied up
in receivables and inventory and were
starving for cash. Once the request is
understood, the financial analysis begins.
What are the important financial considerations?
Think of the basic approach as the sides
of a triangle where the sides are represented by cash flow, collateral and equity capital/leverage.
Cash flow is what repays the loan. Banks
have minimum policy guidelines for debt
service coverage ratio, and basic acceptance is often at least 1.2x coverage, as a
cushion provides for the unexpected. The
bank looks at the cash flow leverage, too,
using a measure of debt/cash flow.
Next is collateral, which generally means
receivables, inventory, machinery and
equipment, and real estate. The bank discounts the stated values of the collateral to
better align the total with what the bank
would realize in a default, and then makes
sure that amount would cover the loan.
This all gets tricky in the brave new world
of less manufacturing, because many companies — especially service businesses —
don’t have machinery and equipment, and
fewer have inventory.
Finally, there’s equity capital and leverage.
Bankers ask what the company’s net worth
is relative to debt. Is it well capitalized or
thinly capitalized? Does the company leave
money in the business or distribute it?
Capital structure dictates overall strength
of company and what kind of shock it can
take. If it has a couple quarters or years of
poor earnings, is the company strong
enough to weather the storm? Does it have enough borrowing capacity? Is it financially strong, or is it leveraged too high? If it’s
over-leveraged, it could collapse like a
house of cards.
What’s the subjective part of processing a
loan request?
It’s the interpretation of the numbers and
an assessment of what’s going on in the
business, the industry, management’s
skills, and other characteristics.
If somebody needs a very minor increase
in their line of credit and they’re doing well,
it’s a pretty easy loan request. If somebody’s buying another company and
they’re tripling the amount of the debt
while tripling the size of the company,
banks have to determine if management
has the skills to handle it as well as the viability of their business plan.
How can a loan be structured?
The output of the financial analysis determines how a bank structures a transaction
in regard to personal guarantee support,
pricing and fees, term of loan, repayment
schedule, reporting requirements, additional collateral needs and covenant structure — just to name a few components.
Are any other factors important in securing a
bank loan?
It helps to have a good relationship with
the banker.
Applicants should also have good quality
information, be knowledgeable about
what’s going on in the business and knowledgeable about the numbers. They should
have a financial plan, a projection for why
they need the money and supporting information. They need a good understanding
of what’s happened in the past, and be able
to clearly explain risks and how they mitigate those risks. We’re in the risk business,
and if the borrower can help us mitigate
the risks, so much the better.
DAVID JANUS is president of FirstMerit Bank’s Cleveland
Region. Reach him at [email protected] or (216) 694-5658.
