Is there a credit crunch? Based on the formal definition there is, because lenders are exercising much greater caution before granting business loans. However, banks actually have plenty of money to lend to qualified and well-prepared borrowers. While there’s definitely been a trickle-down effect from the mortgage industry, causing lending institutions to scrutinize business loan requests more carefully, CEOs can still secure funding by understanding the tighter requirements and using a more pragmatic approach to the market.
“It’s not that banks aren’t lending money,” says Jim Paul, senior vice president for retail administration at Fifth Third Bank (Tampa Bay). “CEOs need to have a better understanding of what banks are looking for and what’s behind their lending decisions because there’s more need for due diligence and preparation when applying for a loan.”
Smart Business spoke with Paul about the current lending criteria and how CEOs can successfully secure business loans.
What are banks looking for when evaluating loan requests?
Out of all the criteria, the most important is cash flow. If the banker doesn’t think the borrower has enough cash to service the debt, the request stops right there. They will also factor in the debt service costs when evaluating the company’s cash flow requirements and project whether the business will produce enough cash to make the payments over time. Many borrowers think that collateral can overcome cash flow shortfalls, but collateral doesn’t make up for shortfalls in cash. Banks are really not interested in taking over assets if a business fails to make its payments, so right now cash is king.
What else are lenders reviewing?
Lenders will review credit scores and how the borrower has historically used credit facilities. In privately held companies or partnerships, the personal credit scores of the owners will be reviewed, but the lenders will also be looking to see if the borrower has been using funding vehicles appropriately. For example, a line of credit is designed to meet short-term needs, such as paying bills or meeting payroll to bridge gaps in receivables. These funding vehicles were never designed for business expansion. So if the owners have been using credit lines for expansion purposes that will be a red flag to the lender.
Are intangibles reviewed?
Character is definitely the third thing lenders will review. It helps if you have a relationship with a bank, but if that’s not the case, the lender will look at the industry, the owner’s history, experience and reputation and how you approach the institution when requesting a loan as a gauge of your character and professionalism.
How can CEOs prepare before approaching a bank?
First, you’ll want to meet with several bankers to gauge the market and understand what lenders are looking for because having greater knowledge of the lending side will help you tailor your presentation and business plan to meet the requirements. The discovery process will also help you estimate both the type of loan and the loan amount your business will qualify for. Rates are still at an all-time low, but lenders are charging more for increased risk, and they are looking at worst-case scenarios to see how the borrower and the business might fare under a variety of conditions.
For example, if you’re applying for a loan to purchase property, you might need to secure key person life insurance to secure the loan or present your collateral and cash flow in a way that’s on target with what the lender is seeking. Let the lenders know exactly what you’ll be using the funds for and allow them to get to know you and your business, so they’ll be comfortable lending you the money.
What’s the best way to approach the lending institution?
The most successful strategy I’ve seen is where business owners approach a lending institution in partnership with an attorney and an accountant. You’ll also need a customized business plan tailored toward the lender’s requirements. It adds a great deal of credibility when a team of professionals collaborates in authoring and presenting the business plan, and a joint presentation makes lenders more comfortable because accountants can often address questions about cash flow and how the funds will be used. Borrowers can tap local resources, such as the business department at local universities or the Small Business Administration to help author a business plan if they can’t afford to partner with a local accountant and attorney. In today’s environment, success is commensurate with taking the time to understand the market from the lender’s perspective and then crafting your approach in such a way that it addresses all the lender’s concerns.
JIM PAUL is senior vice president for retail administration at Fifth Third Bank (Tampa Bay). Reach him at (813) 306-2511 or email@example.com.