by David Tremblay.
There is no silver bullet when it comes to getting a loan to fund your business. With Small Business lending on the rise, knowing how to approach the process can help you secure a loan more quickly than others in your industry. When it comes down to it, it’s all about Ability, Stability, and Willingness to Pay, limiting uncertainty on the lender’s side by providing a very detailed plan.
Respondents were split when asked by our Fall Small Business Owners Report what they believe is the most important factor in receiving a loan.
The funny thing is that none of them are wrong. Most financial institutions look at ALL those things, but in reality, less-than-perfect credit scores or a lack of a previous business borrowing history won’t carry the same weight individually that cash flow does. It’s also important to have a good relationship with your banker, who can provide context if one of those factors comes up short. Figuring out how much to ask for when applying for a business loan is part and parcel of the factors above. Here are a few thoughts on how financial institutions look at those different factors:
Cash flow: Cash flow is typically considered the primary source of repayment for credit. It is important because that’s what repays the lines of credit and loans that banks extend to clients. Does your business have the financial capacity to support debt and expenses? Do your assets outweigh your liabilities? Typically a business needs to have between $1.15 and $1.35 of income to support every $1 of debt service, including the new debt being requested. The extra $0.15 to $0.35 provides a cushion for your business to absorb unexpected expenses or a downturn in the economy. It is important for the business to demonstrate more than one year of adequate cash flow history to show consistency in the ability to service debts. The ability to use projected cash flows as opposed to historical cash flows is uncommon. Inadequate cash flow is a frequent reason why banks are unable to extend new credit to businesses.
Credit score: Banks often look at multiple credit scores – business scores, consumer scores of the owners who will act as personal guarantors, and other internal scores based on bank risk factors and relationships. The credit scores of the business and individual owners in and of itself aren’t nearly as important as what is driving them, but the scores still play an important role in predicting creditworthiness. As Jeannie Kelly also notes in a post running today on the MasterCard Small Business site, important drivers of credit scores are payment history, amounts owed, length of credit history, types of credit used and new credit opened.
Track record of ability to repay previous loans: Relationships are important to banks, whether new or existing. An established borrowing and/or deposit relationship with their bank is often beneficial to the applicant requesting new credit. An existing borrowing and/or deposit relationship can offer immediate insight into the potential creditworthiness of the applicant based on the bank’s established risk guidelines. When applicants have a proven track record of adequate repayment of previous loans, the decision to extend new credit is often an easier or quicker one to make. The length of time for a bank to consider a small business to have a proven repayment track record can vary. Two years would be considered a minimum but 5+ years is preferred in order to establish trends that cross different economic cycles. Business borrowing history is less important than credit scores or cash flows but it brings an additional positive factor to the lending decision.
Annual revenues: The gross annual revenues of a business is one factor that helps banks size potential credit needs and guide applicants to the most appropriate products available. Annual revenue size is an indicator of how marketable the product or service is. After our established revenue minimum of $250,000 for lines/loans, revenue trends over several years become far more important than the number itself. Banks also care more about client base diversification to provide cushions in volatile markets.
Personal finances: Work experience, experience in your industry, and personal credit history are all “character traits” banks will consider. Your personal integrity and good standing—and the integrity and standing of those closely tied to the success of the business—are critically important. Business owners who have demonstrated challenges in managing their personal finances will have higher hurdles to obtaining new credit for their business. Related to this, many banks will ask how much stake the owners have in their business. If leadership is heavily invested monetarily in their own business, the bank sees this as a higher commitment to success, and therefore a higher chance of repaying the loan. To be further prepared for the loan application process, the Small Business Administration website has a Business Loan checklist that goes in more detail.
Again, it’s important to develop a strong relationship with your business banker – before you ever ask for credit. If that person understands the story behind the factors above, she can make the process much easier and help you get a yes to your loan request.
This month, I’ll be part of a Google Hangout on this very topic, so feel free to revisit this post for an updated start time. Top small business influencers from around the country will be discussing what drives credit decisions.