In tough economic times, small-business owners find it more difficult to access loans for their businesses. But there are still funds available, and banks still want to make loans – they make their money from lending money. The key is how much risk the banker sees when evaluating you and your business.
If you are seeking a bank loan for your small business, there are two important steps you can take to improve your chances for success: Learn what bankers are looking for so you are prepared before you approach the bank, and learn more about funding assistance available through the U.S. Small Business Administration.
Bankers want to make loans to businesses they think will have future success, enabling the small-business owner to pay back the loan. One major indication of how likely that would be is the owner’s management experience and track record.
A small-business owner who has several years of experience running the business and can show profitability through past financial statements presents a lower risk in the eyes of the banker. This is one reason why it is more difficult to obtain a loan to start a business, particularly when the economy is hurting and bankers are being more cautious.
Another indication of future success is a well-researched business plan with realistic financial projections. The narrative portion of the business plan discusses the business’ products and services, target market, competition, marketing plan, operations, management and personnel needs.
For the financial portion of the business plan, there should be at least two years of income statement projections and cash-flow projections, laid out by month to show the monthly cash position and ability to repay the loan.
The business owner’s loan repayment history is a leading indicator of the owner’s ability and willingness to repay the loan. A good credit score reduces the risk to the banker that the borrower will not pay the loan back. This credit score has become even more important in today’s financial climate.
“Bankers are being more cautious now. One major difference we are seeing is that banks want to see higher credit scores for small-business owners. Whereas they once looked favorably at scores of around 650 and above, now we see that they like to have scores of 700 or more,” said Tony O’Reilly, president of the Small Business Assistance Corp., a local nonprofit Certified Development Company licensed by the SBA to handle SBA loans.
“There is still money available for small-business owners to borrow, especially with SBA involvement, but they need to be prepared to show credit worthiness. And, as in the past, bankers still look for solid management experience and an excellent business plan,” he added.
Bankers do not like to take on the entire risk of a project through 100 percent financing. For example, if you are planning to expand your business by purchasing additional equipment or buying a building, the bank would require you to come up with a portion of the money needed. This requirement is typically anywhere from 10 percent to 25 percent.
While the banker’s first concern is to make a solid loan that is very likely to be paid back, the possibility of nonpayment must be considered. This is why bankers require small-business owners to pledge collateral as security for the loan.
The reality is that collateral answers the question, “What can the bank take from you and sell if you don’t pay the loan back?” Bankers don’t want to have to do that; they want you to be successful and therefore be able to pay back the loan. But they need to reduce their risk by having access to assets they can use to recover their loss if you don’t pay.
Therefore you must be prepared to offer collateral to the banker, and often this will involve risking your home, which many people are not willing to do. But if you are not confident enough and willing to risk your home, why should the banker take a risk on you and your business?
Sometimes when a banker evaluates a small-business loan, it is determined that the loan is just too risky to proceed, and this is especially true in the current lending environment. However, the banker’s risk can be greatly reduced if the SBA becomes involved, making the loan much more attractive to the banker.
But be aware that while the SBA exists to help small businesses, it does have its own standards and requirements by which it evaluates risk, including credit score and collateral. It doesn’t want to make bad loans that waste taxpayer money.
You will greatly improve your chances of success if you make sure you are thoroughly prepared to meet with your banker, including educating yourself concerning SBA loan programs and requirements so you can consider the SBA as part of your overall funding strategy.
“We have noticed that bankers in all of our markets are more cautious than in years past and that no deal is a ‘sure thing’ anymore,” said Wendy Jeffers, loan officer with the Coastal Area District Development Authority, another local nonprofit Certified Development Company also licensed by the SBA to handle SBA loans.
“Cash flow is still king, but the borrower must also offer equity in properly margined collateral, an excellent credit repayment history, and a sound business plan going forward in order for most lenders to commit to new funding,” she said.
“With that in mind, CADDA (through the SBA) offers excellent financing alternatives for banks and borrowers seeking ways to fund new projects. We suggest that small-business owners research alternative financing like CADDA/SBA with their banker before making long-term decisions.”
Connie Edwards is a business consultant with the University of Georgia’s Small Business Development Center. Contact her at 651-3200.