Breaking the Million-dollar Barrier
Many of my clients are racing toward, or have recently broken through, the million-dollar sales barrier. With such growth comes the need for capital and, often, for the owner to make his or her first ask for a “big” bank loan. Because commercial bankers are generally far more risk-averse than small business owners, knowing how to make the ask is vitally important.
Be Prepared
Fundamentally, large loan requests are sales pitches: You have to sell your banker on your ability to repay the loan, and your banker has to sell the same thing to the bank’s loan committee. The key, then, is preparation: You need to be able to demonstrate that you’ve thoroughly analyzed all aspects of the project you’re trying to get financed.
Generally, this means developing a detailed set of financial projections, accompanied by some verbiage which convincingly describes why your project is going to be successful. I’m not talking about a 20-30 page business plan but, rather, a concise summary of 1) the details of the project you plan to pursue, 2) the reason you’re confident the project will go as planned (your company’s strengths) and 3) the assumptions underlying your projections. If the thought of preparing detailed projections gives you the willies, don’t sweat: that’s something the SBDC excels at.
The Five C’s
The traditional framework for judging credit-worthiness is known as “The Five C’s of Credit”. You’ll want to make sure that your loan request package addresses them all:
Character: Character is mostly about your credit score. Bankers want to know that you have a strong history of paying your bills in a timely manner. If you have a credit score in the low 600’s, you’re probably going to have a very difficult time borrowing from a traditional lender.
Capacity: Capacity reflects your company’s ability to generate enough cash flow to pay back the loan. Most banks measure this with something called a “Debt Service Ratio (DSR)”. The DSR is calculated by dividing EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization – by your annual Loan Payments. Depending on the bank, and assuming the SBA isn’t involved (see below), you’ll need a DSR of 1.20 or 1.25. In other words, the bank will want a 20% – 25% cash flow cushion above-and-beyond what’s needed to repay the loan. Also note that, in most cases, the bank will be looking at a “global” DSR. A global DSR captures all your sources of cash flow, and all your debt payments, both personal and business.
Capital: Capital represents the amount of skin you have in the game – your “down payment” on the project under consideration. Most banks will want to see a cash down payment of at least 20% of the project’s costs.
Conditions: Conditions encompass several factors. The first is the state of your business – whether it’s faltering or thriving. The second is the state of the economy, including industry trends. The third is the planned use of the requested funds, and how well those plans integrate with the other factors.
Collateral: Banks want to know that if, for some reason, your project doesn’t go as planned, they’ll still get repaid. As such, they are likely going to require collateral above and beyond the assets that you’re using the loan to purchase. Most often, this collateral will consist of a mortgage on your personal residence, as well as a personal guarantee.
Know Your Options
Oftentimes, it’s impossible for a business to meet all of a commercial bank’s credit requirements. They may not, for example, meet the debt coverage or capital requirements. That’s where the Small Business Administration (SBA) comes into play. Given the right set of circumstances, the SBA’s loan guarantee program can help borrowers obtain loans with somewhat less-restrictive requirements (e.g., capital requirements as low as 10% and/or DCR requirements as low as 1.15). In addition, if real estate is involved, the SBA offers a program that allows borrowers to lock in below-market interest rates for 10 to 25 years.
Be Patient
Despite your best efforts, your banker probably is going to end up asking a lot of questions. Be patient and do your best to provide as much information as s/he needs. Remember, your banker wants to get the deal done almost as badly as you do, but s/he needs to be able to answer the gazillion-and-one questions that s/he’s going to get from the bank’s loan committee.