Applying for a bank loan can be a frustrating and mystifying experience for many business owners.
The main concern bankers have is protecting their capital, money with which their depositors have entrusted them. Their first priority is to recoup the principal of the loan, then earn a reasonable rate of interest on the loan, and finally have you prosper and open more accounts with them. Safety of principal is paramount. Bankers are not in the risk business.
Your job is to provide the banker with as many reasons to feel safe as you can. Start with a financing proposal – a statement of what you need, why you need it, when you need it, and how you plan to repay it. This should include a description of how much you need and what you’ll do with the loan, up-to-date balance sheets, cash-flow pro formas and projected income statements. All banks have forms to help you prepare these, but using your own business plan increases your credibility.
The six Cs of credit
What do bankers look for when considering a financing proposal? Here’s a start:
Personal character is important. The bank’s experience with you is critical. The judgement of the character of an individual is based on past performance. Personal and business credit histories will be reviewed.
This is figured on the amount of debt load your business can support. The debt-to-net-worth (debt/net worth) ratio is often used to justify a credit decision. A highly leveraged business with a high debt/net worth ratio is perceived as less creditworthy than a company with low leverage.
Your business plan can make a difference. Suppose it shows that the loan will increase earnings and lead to a swift reduction in the debt/net worth ratio. Your chances of a positive answer would increase. Keep in mind that a good banker is the ultimate realist. Don’t try to snow your banker with numbers.
Economic conditions have a profound effect on credit decisions. If the bank is persuaded that a depression is coming, it won’t extend credit easily.
Collateral is a secondary source of loan repayment. They want the loan repaid from operating profits and inventory so you become a bigger, better borrower and depositor. But just in case things go sour, a bit of collateral makes your banker sleep better at night.
Do you know your business? Can you be counted on to be level-headed? How credible are your plans? A business plan helps you answer the banker’s questions without hesitation, sending your credibility rating soaring.
6. Contingency plan
A contingency plan is a useful financing tool. Bankers like to see that you look ahead. A contingency plan is a short worst-case business plan that examines the options that would be open to the business and how those options would be treated. Decisions made in panic are poor decisions.
Bankers and risk
Bankers are risk-averse by training and temperament. They can’t take the kinds of risks a venture capitalist or private investor might; that isn’t their job. They tend to shun start-ups. They hate surprises. This leads to misunderstandings between business owners and bankers. Business owners, actual or prospective, have to learn that the relationship between them and their bankers should be businesslike.
Get to know your banker
Take your banker to lunch. Always be honest with him or her. It pays. Make appointments before dropping in. Bankers are businesspeople and appreciate ordinary business courtesy. Keep in mind that your relationship with your banker should be cooperative, not antagonistic, subservient, fawning, obsequious, mistrustful or fearful.
A good banker is a terrific asset, so shop around to find a banker you can work with. The role of your banker is to help you make your business successful. A good banker will sometimes do things that you don’t agree with, such as turn down a loan request or try to get you to maintain a cautious debt/net worth ratio. How do you find a good banker? Ask around.
Know the kind of credit you need
The basic rule is to fit the term of the loan to the purpose. Some loans call for term payments that include principal and interest, others for interest only with lump sum principal reductions. The package can become complex. If in doubt, ask your banker for advice: “I want to expand. Here’s the loan I think I need. What do you think?” That’s a lot better than asking for the wrong loan at the wrong time in the wrong way. Your banker wants you to succeed and knows that there’s a high correlation between asking for (and heeding) professional advice and making an SME grow profitably.
If you face a problem, let your banker know immediately. Don’t wait until it’s a Friday night “gimme a loan or I go broke“ issue. Let your banker work with you. Your banker’s job is lending money and protecting depositors’ assets. If your proposal is sound, you’ll get your loan. If it isn’t sound, you shouldn’t. And if you disagree with your banker, be prepared to back up your renewed application with facts.
Why do bankers turn down loan applications?
Except for bank credit policy reasons or banking law, applications are rejected for the following credit-related reasons:
- Too little owner’s equity
- Poor earnings record
- Questionable management
- Low-quality collateral
- Slow/past-due trade or loan payment record
- Inadequate accounting system
- Start-up or new company
- Poor moral risk
- Other (only 4% of rejections have other reasons)
Make sure you cultivate bankers for their advice and support, have more than one bank, and be prepared to ask why credit is denied before getting angry.