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UpFront THE TROUBLE WITH BUSINESS
Approved! If you’re thinking about applying for a business loan, your chances for approval are better if you avoid these common pitfalls. By Mike Phillips
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usiness owners seek financing from banks for a variety of reasons, including purchasing equipment, expanding inventory, and acquiring an office facility. The owner applies to a financial institution for a loan, providing fairly lengthy documentation in order for the loan request to be evaluated by a lender. Despite all that work and preparation, the loan may be refused. Why? Here are the most common reasons a business owner’s request for funding is turned down. Inadequate Cash Flow Loans are repaid either from future cash generated by the business or by liquidation of assets. The lender will typically review cash generated from historical reports, such as tax returns or financial statements, as well as from financial projections normally
provided by the applicant. This is especially true for a new business, or one that is doing a major expansion, such as adding an office or increasing the size of a manufacturing facility. The lender needs to be comfortable that future cash flows generated by the business will exceed the scheduled loan payments by 15-25 percent, providing some cushion for adverse changes in cash flow, such as loss of a key customer or large, unanticipated repairs. Projections are scrutinized carefully as borrowers frequently overestimate revenues and understate expenses. A comparison to industry or historical databases will help a lender identify potential erroneous assumptions or flaws in the projections.
contributor Michael A. Phillips is vice president and a commercial loan officer at BankVista, Sartell. He can be reached at (320) 257-1986 or mphillips@bankvista.com.
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Business Central Magazine // J U LY/A U G U S T 2 0 1 8
Lack of Cash Equity In most financing transactions, the borrower will be asked to provide a down payment of 15-30 percent of the purchase price of the asset or business to be acquired. In addition, the lender will want to see what other sources of cash or access to cash might be available to help avoid situations where a temporary cash shortfall results in late payments. In some cases a smaller down payment might be available if the financial institution partners with a third-party lender, such as the U.S. Small Business Administration, and the loan request meets the eligibility rules for their program. It can’t hurt to ask! Lack of Sufficient or Tangible Collateral Although most financial institutions are “cash flow” lenders, they will still try to help shore up credit risk by seeking assets from the borrower to be pledged in the event a loan can’t be repaid. The most common collateral is real estate, such as land or buildings, followed by equipment. Each bank develops its own lending policies to determine how much collateral is needed in order to approve a loan. Inadequate Industry Experience or Planning Businesses fail for a wide variety of reasons. Historically, the
most common reason is due to poor management. Financial institutions will review the experience and education of the borrower’s management team as part of the underwriting process. A loan request from a borrower who lacks adequate experience can be a factor in not approving a loan request. Likewise, if a lender is uncomfortable with the effort and quality of the business plan and related financial projections, a loan request may be denied. Poor Credit History For closely held businesses (four or fewer people own the business), most financial institutions will require the owners to personally guarantee business loans. Over time, lenders have observed a correlation between how a business owner handles personal credit and how the related business credit is handled as well. Often, if the owner has a history of late payments, the owner’s business will exhibit a similar payment behavior. Financial institutions consider many factors when reviewing a business loan request. When possible, the financial institution will try to approve the loan…as successful lending is profitable for the bank and for the customer. If a loan is not approved, the applicant should talk to the lender so they understand why the loan was refused.