The loan you think you need may not be what you need

When business owners approach a bank for a loan, most are not exactly sure what they’re asking for.

“They might say they need a line of credit to grow the business, or a loan to buy equipment and raw materials, but those may or may not be the best options for their needs,” says Rick Hull, Executive Vice President and Regional President at Home Savings Bank.

These business owners know their industry well, but often aren’t familiar with the financial products available to support specific initiatives. A good banker will take the time to help them determine the best way forward. But before a banker can help make that decision, they need to have the full background, which means asking the right questions to make sure they have all the information they need.

Smart Business spoke with Hull to explore the difference between assumptions and reality in lending.

How often is it that what business owners ask for in the initial bank meeting is what fits their needs?

Business owners typically come to a bank and say they want a term loan, perhaps to increase inventory. That would give them all the money they want immediately, but it comes at a cost they often don’t realize.

For instance, a customer who owned an ancillary business to the oil and gas sector recently wanted to borrow money in a term facility to buy raw materials. The owner was expecting a significant increase in business. Borrowing on a term facility would mean paying interest on the entirety of the loan when all that money wasn’t immediately needed. Rather, the business would be better off drawing as needed on a line of credit financed by receivables, saving the company a considerable amount of money in interest.

How is it that a business could end up with the wrong financing?

Some bankers are intent on making a loan, or may only have one product available, something seen more frequently in really small banks. They might not be capable of doing receivable financing or financing based on inventory or cash flow because they’re incapable of monitoring receivables, aging and monthly reports. So they might shoehorn the customer into the wrong product.

What should business owners expect when they first talk to a bank about financing?

Customers should expect a conversation. A bank wants to get to know both the person and the business. Collateral and cash flows are obviously a major factor, but character is a big deal.
Banks tend not to be interested in purely transactional situations. They want to build a relationship with their customer. History is also important. Reviewing the historical performance of the company may highlight some cyclicality or other repeating aspect of the business that wasn’t previously recognized. Banks will also look at a business’s client base, as well as its processes and procedures. Banks want to know if they are maximizing their position, ramping up, or if they can survive a drop in revenue or income if there were a downturn in the industry.

What is it that most commonly holds up a transaction between a bank and a business?

Typically, the holdup is a lack of comprehensive financial information — many small business owners don’t have their last three years of tax returns, current profit and loss, or interim financial statements. The bank needs all of this information to understand the business’s financial situation and to underwrite it appropriately.

Come prepared to answer questions regarding how well equipped the business is to handle events that might compromise an ability to repay. Be open and honest about what’s going on in the business. If things aren’t going well, what evidence is there that it will be better? Transparency builds trust, and increases the chances that a bank will be there to support the business through all its ups and downs.

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