Obtaining A Small Business Loan
Getting a bank to finance your newly acquired business isn’t as easy as it should be. The news states that banks aren’t lending to small businesses these days following the great recession. The truth is, they never did.  In the sale of a home, there are hundreds of lenders that will lend 90% on a house.  Why?  They have comparables on every house in a particular area and the banks know if they have to foreclose on it, they can let the house sit for 6 months with minimal oversight, and still get most of their money back when it sells again. That is not the case with small businesses. 

Banks don’t have any real security in a business loan. No two businesses are alike, so there are no common comparables.    A business also requires management and oversight. If a bank takes the business over, how do they get their money back? The hard assets would be auctioned, which has very little value, sometimes 10 cents on the dollar.  The bank will also have to pay the landlord and other creditors that may have liens on the assets. 

Yes, banks do lend to small businesses, but usually after the business has established a track record and comfort level within the industry. Even then, the loans are made on a very conservative basis.

The Five C's...
Bank loans for new acquisitions are possible, but the bank looks at certain criteria before making their decision. In the world of lending, the criteria is known as the Five C’s. Capacity, Capital, Collateral, Credit and Character. Let’s look at each of the five C’s.
The lender tries to determine if you have the qualifications, wherewithal or “capacity” to borrow the sum you requested. Are you capable of operating this business or are you pushing your limits? Does your experience in the market and industry, along with your track record in business make the lender confident that you will use the loan proceeds to produce the projected results? The lender will carefully consider if you can demonstrate sufficient effort, resolve, ingenuity and perseverance to manage and coordinate the tasks necessary to generate sufficient profits to repay the loan.  Sometimes borrowers fail to pass this test because they have more ambition than talent. The lender draws a conclusion, for better or worse, on limited information they have from the application and a few meetings. Therefore, a borrower’s resume, past accomplishments, references and ability to communicate a credible strategy, as well as demonstration of prior financial successes, can contribute significantly to establish the capacity to obtain a business loan.
Capital is defined as the portion of the total business investment that you, the borrower, contribute.  When you ask a lender for a business loan, they must quantify the adequacy of your investment. The lender will always limit their leverage or the amount of their funding as a percentage of the total loan and require you to have a meaningful amount of capital at risk. This will ensure that you are committed to the venture, while reducing the lenders exposure to loss.   

This criteria quantifies your ability to support the loan with tangible assets that will guarantee the loan by providing the lender with a secondary source of repayment. Lenders usually require that the loan be supported with assets valued on a discounted basis. This discounted value provides the lender with a safe margin to cover the time and costs of converting depreciated assets into cash, should that ever be necessary.  At a minimum, the lender will secure the loan with your assets being financed. Sometimes, the lender is requested to finance a sum reflecting a higher amount than the discounted value of the financed assets.  This precaution ensures that the lender has a comfortable margin of value from which to be repaid if the business operations do not provide sufficient profits. The lender will discount the market value of the collateral assets so as to maintain and adequate excess margin to cover the loan balance.   The excess margin is required to ensure that asset values always equal or exceed the balance of the loan. As a borrower, you will generally be required to provide a minimum 100 percent collateral coverage over the entire term of the loan.
The lender will always review your previous experience as a borrower. Studying your credit history discloses whether you or your business have or have not paid your previous loans as agreed. The credit report also discloses whether the business or you have (or have had) civil judgments awarded against you; unpaid tax liabilities, liens against your assets, or ever sought protection under bankruptcy proceedings.  While clearly not an absolute indicator of how well a business will perform in the future, this information tells the lender how you have performed in the past. If the information is negative, they may assume that you’re unsuitable for an extension of credit. The report may also reveal that you have not overcome earlier difficulties. Poor performance with previous lenders may indicate that you don’t take the responsibility of repayment seriously.
Character may be the most important assessment the lender can make about you, the loan applicant. Regardless of your positive attributes of your capacity, capital, collateral, and credit; if you don’t demonstrate integrity and appear trustworthy to the lender, they’ll refuse any proposal you make.  Character is the most subjective criteria. Not only is it difficult to define, it is difficult to assess. There is no checklist available to guide the lender’s sensitivity to quantify someone’s good character, particularly when the other party is a new acquaintance. The lender will watch for potential flaws in your attitude, conversation, perspective or opinion about business ethics, responsibilities and commitment.

Your character is important because it reveals your intent. If the loan officer senses that you are ambivalent toward fulfilling responsibilities under the proposal of the business deal, there is a character problem. The loan officer must embrace your moral obligation to repay the loan, superseding even the legal agreement to do so. When the lender does not feel comfortable with your character as a borrower, this information generally will not be directly communicated to you. The loan request will often be denied for different reasons, because the loan officer will have a difficulty defending a subjective decision without definitive proof. This ambiguity is part of the intangible matrix of underwriting commercial loans.
Things To Keep In Mind

  • The committee process can be somewhat political. Failure to support loan proposals introduced by other committee members can cost the reciprocal support for one’s own loan proposals. This system can be flawed with personalities, instructional hierarchies, and the dynamic of corporate ambitions. 
  • There may be many levels of credit authority through which a loan must be approved, depending on the amount of money involved. Persons vested with credit authority are usually isolated from direct contact with borrowers and depend entirely on information filtered through the loan or business development officer.
  • In too many lending institutions, the chances of deal success can be negatively affected by poor communication skills of the individual sponsoring the loan request. Loan request stand a better chance of success if the business development person can effectively articulate the positive attributes of the loan to the credit authority. Often ineffective translation of a loan proposal slows down or eliminates viable opportunities in the loan approval process. 
  • Defining the exact reason your business requires a loan is the first step toward the application process. Qualified borrowers lose precious time and credibility by not establishing a succinct financing proposition to explain how much funding is needed and how it will be used. Unfocused borrowers make lenders nervous. Failure to articulate this information reflects either unprepared or inadequate management, or the existence of another agenda in which the lender should not participate.