Understanding a golden rule Featured

9:35am EDT July 22, 2002
The first step in the loan process is pretty simple to understand, according to Mark Mills, principal of Mills, Potoczak & Co., which offers accounting and consulting services for businesses.

"You have to think like the banker thinks. I call it the golden rule," he says. "He who has the gold makes the rules. Since the banks have the gold, they make the rules."

But turning that into ready cash to expand your business requires more than adjusting your mindset. Before you can delve into the mind of your lender, it's essential to be clear in your own.

Here are the questions you must be able to answer to before you're likely to get a banker to lend you money.

  • How much do you want to borrow?

  • Why and when do you want it?

  • Where and how do you plan to pay the money back?

Once you can answer those questions, it's time to start preparing for the lender. Here is Mills' checklist for every entrepreneur.

Item 1: The executive summary

This one- to three-page document answers the above questions and explains that you know why you are borrowing the money and when it will be paid back. The lender will want to know how you plan to pay the money back, whether it's from expected cash flow from the operations, collateral or personal assets of the owner.

"Have someone independent read your executive summary to determine whether it makes sense," Mills says.

Item 2: The list of risks

"You need to come up with reasons why you shouldn't get a loan, because that's what the banker is going to do," Mills says.

One question to ask is, "How timely are you paying your other creditors?" Mills says. "If you're way behind on your other payables, banks, all other things being equal, consider that a negative."

Another approach is to put yourself in the role of the banker. What would prevent you from loaning somebody else money? Determine what objections a lender has about your operation and make sure to explain how those risks can be mitigated.

Item 3: The necessary papers

Anyone willing to loan you money is going to want to know a little something about the history of your enterprise. You will need to provide historical financial data (balance sheets, profit and loss statements, cash flow), as well as projected financial statements (budgets).

You will also likely need to provide personal financial statements, along with corporate and personal tax returns.

Item 4: The collateral

In return for their money, lenders want to know what they can extract from your business, should the venture fail and their money disappear. These items can include accounts receivable listings, property and equipment, inventory or other assets that have a ready market value (patents, intellectual property).

A lender may also require some sort of "key man" insurance. At many companies, if the owner or some other vital member of the company were to get hit by a bus, the company would be lost. Insurance, with the lender as beneficiary, may ease this concern.

Whether it is a bank or a venture capitalist doesn't matter; the basics still need to be in place.

"The difference between a bank and a venture capitalist is their risk tolerance, because a venture capitalist expects such a high return," Mills says. "They look for 35 to 40 percent return. So, if one out of three or one out of five deals succeeds, they're happy.

"At a bank, 99 out of 100 have to go right. They charge prime plus a quarter (percent). Their risk tolerance is far less than a venture capitalist, so that's why they charge lower interest rates." How to reach: Mills, Potoczak & Co., (216) 464-7481

Daniel G. Jacobs (djacobs@sbnnet.com) is senior editor of SBN.