Now that the economy is showing some traction and the business environment is continuing to improve, business owners are looking at opportunities to expand their businesses, including hiring additional team members, purchasing new equipment and making acquisitions.
Such plans often require outside capital, and commercial banks can provide an affordable source of funds.
“The more that you know about your lender, the better your chances will be in securing business credit at favorable terms,” says Mark G. Metzler, CPA, CGMA, Director of Audit & Accounting at Kreischer Miller.
Smart Business spoke with Metzler on the three issues you need to know about lenders.
What are the key factors that lenders use in their decisions?
Lenders assess credit risk based upon factors including credit/payment history, income and overall financial situation. These are commonly referred to as the ‘5 C’s’:
1. Character. What kind of borrower will you be for the bank? Character is the general impression you make on the potential lender. It is a subjective opinion as to whether or not you are sufficiently trustworthy to repay the loan. Companies don’t repay loans, people do. Your educational background, experience in business and in your industry, the quality of your references, and the background and experience of your management team will all be considered in making this assessment.
2. Credit history. Qualifying for different types of credit hinges largely on your credit history. Many lenders use credit scores to help them in their lending decisions, and each lender has its own criteria, depending on the level of risk it finds acceptable for a given credit product.
3. Capacity. This is the monthly or annual revenues question. No lender is interested in providing a loan to someone who has no means to repay it. Lenders will consider cash flow available to service debt (EBITDA) and the company’s debt service coverage ratio.
4. Collateral. Lenders may make both secured and unsecured loans. Lenders may require you to pledge assets like real estate or capital equipment as collateral. Alternative lenders might consider your accounts receivable, inventory or monthly credit card receipts as collateral.
5. Capital. Capital is the money you personally have invested in the business and is an indication of how much you have at risk should the business fail. To your lender, capital represents your ‘skin in the game.’ Remember that bankers are highly risk-averse and want to ensure borrowers have some skin in the game. From their perspective, borrower’s capital will make it harder to walk away.
How have regulations impacted banks and their willingness to lend?
Historically, commercial lenders were not burdened by the same degree of regulations as consumer and mortgage lenders. It was not uncommon that a few notes on a napkin, or a handshake over drinks, were all that a lender needed to initiate a commercial loan request.
That changed with the enactment of the Dodd-Frank Act which has had a significant impact on the manner in which banks conduct business. Dodd-Frank increased the compliance stakes in the commercial application process through new data collection requirements.
Consequently, the timeline from initiation of a loan request to settlement has expanded. New regulations make it more advantageous for a borrower who may need to restructure a loan to find another bank rather than to stay with the current lender.
A loan restructured with an extended amortization with a current lender may be considered a troubled loan, whereas with a new lender it may not be.
Are there intangible factors that a business owner should consider?
Similar looking banks may have a different appetite for providing loans to certain industries. One lender may be interested in technology companies, while another may avoid them.
Additionally, depending upon the size of the bank, the bank may be near its lending capacity for a certain industry.
Business owners should speak with their financial advisers who can assist in matching the company with the right lender. It’s all about relationships, and working together to achieve a common goal. ●
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