Many entrepreneurs turn to their bank for a loan when starting a small business. On the latest podcast episode, Chris Ward, Small Business Credit Executive from Bank of America, explains what banks are looking for when making loan decisions.
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Chris Ward: If you have an accountant, that's your business partner. If you have an attorney to help represent you, that's your business partner. Think of your banker the same way, one of the three trusted business partners for you to be successful as a small business, because every small business owner wants to grow their business over time and wants to have a positive impact on the community. So how can your banker help you with that?
Gregg Stebben: I'm here with Chris Ward, he’s the Small Business Credit Executive at Bank of America. We're going to talk about something, Chris, I know all small business owners think to themselves and always wonder who I can ask? Here's the question. When it comes to a bank like Bank of America making business loans, what is the bank looking for?
Chris Ward: Good question Gregg. It's hard for small businesses, because there's not a lot of information out there to help them like there is on the consumer lending side. What are banks looking for? They're primarily looking for the five C’s of small business credit. What are those five C’s of small business credit?
It's about capacity, collateral, capital, conditions and character, and if I could throw in one more, it's also about communication, so let's just call it the six C’s of small business lending credit.
Gregg Stebben: Okay. I'm game to call it the six C’s of small business credit. Let's take them one at a time. You said the first one is capacity. What do you mean by that?
Chris Ward: Capacity really is about whether the revenues, the income that your business generates, is enough to cover your debts, so your business debts and also your personal debts. Because if you're a small business owner, your business is your personal income as well. So, it's about the cash flow that your business generates and is that cash flow getting better, is it getting worse, is it stable, is it unstable, is it volatile? It’s things like that we’re looking for to determine the capacity that a business has for handling its expenses and its liabilities.
Gregg Stebben: Do you find that many people who are looking for a small business loan are surprised that their personal credit situation is also a factor?
Chris Ward: A lot are. A lot don't realize that. But if you think about it, if you're a sole proprietor, it makes all the sense in the world, because on your tax returns on your personal side you're going to have your business. But when you're a Subchapter S or LLC, a lot of those businesses—because of the way they're structured—they have to pass through the retained earnings back to the personal side.
Because in a small business loan, as owners, you're going to be personally guaranteeing that loan, we have to look at both sides, both the business side and the personal side to see how you're managing your entire financial well-being.
Gregg Stebben: Are there certain benchmarks or rules of thumb that I, as a small business owner, should be looking at to recognize whether I'm in a good situation to be going to a bank for a small business loan?
Chris Ward: Yeah. There's a general rule of thumb, and it's really about the income divided by your total debt. We call it debt coverage ratio. In general, in the industry you're looking for about $1.25 to cover at least every dollar of liabilities out there. That way you have a little bit of buffer, a little bit of wiggle room, if you will, on your cash flow to manage your debt and provide some working capital for the business so it can keep on growing. [GK4]
Gregg Stebben: Then the next C of the six C’s of small business credit is capital, so talk about that.
Chris Ward: Capital is really about your business assets, what the business owns, what the business has generated. Is it greater than the total liabilities the business has out there? Think of your business assets. Think of what the business owns. Think of inventory. Think of real estate. Think of retained earnings, the cash, the checking account balances. Is that more than what the business owes to others? So, whether that's an actual loan or maybe it's just your accounts payable, and does that capital also have enough to show how much you as a business owner have invested in that company that you own?
Gregg Stebben: Which I think would tie into the next C, which is collateral.
Chris Ward: Collateral, right. Capital helps to generate collateral, at least generate the means to grow your collateral. It's accounts receivable for a business. It's inventory. It's cash. It's equipment. It's real estate if the business actually owns its property instead of leases. It's an automobile that might be in the business name or a truck, depending on the type of business.
Gregg Stebben: I'm talking with Chris Ward. He's the small business credit executive at Bank of America. We're talking about ... I think classically they're called the five C’s of small business credit. We've talked about capital, we've talked about capacity, we've talked about collateral. There's also a C, which is the fourth C, which is conditions. What does that refer to?
Chris Ward: That's really about the economy and the type of industry that you are. A lot of industries could be very seasonal. You think of industries that rely upon tourism, very, very seasonal. So that means the cash flow, the revenues, could be somewhat volatile if we look at the entire year.
It also could be about the type of industry such as a gas station or a convenience store. You might be handling very dangerous liquids—obviously a gas station would—so there's legislation, there's regulations involved. So, it's really understanding not only the business itself, but also the type of business it is and how it impacts our local communities.
Gregg Stebben: It's interesting, when you talk about something like seasonal industries, are you suggesting that there's a best time of year for me to be applying for a loan, or just that I am addressing it well when talking about the need for the loan or in the written materials I might submit to the bank?
Chris Ward: It's more about addressing it well with your banker, making sure they understand the type of business you are, when your revenues come in if they don't come in as a straight line. And no business has revenues coming in in a straight line every month, month over month. You think about it, just the American economy. People spend a whole lot of money in the fourth quarter for the holidays and then they turn around and they have to pay all their bills in Q1, and the tax time comes, so that also relates to small businesses in general from my opinion.
Help your banker understand how your revenues come in, how your expenses go out, and how does time and the time of year impact how your business runs.
Gregg Stebben: Chris, as I'm listening to you, I'm thinking that you're suggesting that I be prepared to answer the same questions a rich uncle would ask if I went to my rich uncle for a loan.
Chris Ward: Yeah. Exactly.
Gregg Stebben: Is that actually ... Could that be a good way to approach this? Just imagine that I'm making a case for a loan for my business to another person versus a bank? Because everything you've said so far is really common sense.
Chris Ward: It is common sense, but you're dealing with your banker, and so how you have that relationship with your banker, how you build that partnership with your banker, is really important. Getting them to understand how your business runs, because every business is different. There's over 28 million small businesses in America today. They're all different. Some are businesses at home. Some are businesses with an actual storefront. Some are businesses where the owner is more of a consultant and traveling all the time.
So, help that the banker understand how your business runs, how it operates, how it generates cashflow, and what is the ultimate goal and purpose of your business.
Gregg Stebben: Okay. Let's move on to the fifth C of the six C’s of small business credit. It's character. That's got to be a big one.
Chris Ward: It is. It's probably one of the most important, if not the most important. It's all about you as a business owner and your history. It's tied so closely to the success of your business. It's actually critically important.
It's factors such as your personal integrity, your industry experience, your good-standing. It's about your credit history, both your personal and your business credit history, and the factors that impact your credit score, because there are small business credit scores out there as well as the credit bureau agencies.
Gregg Stebben: And the sixth C you have said is communication, and I would think that that fits in with character as well. Talk about why that's so important.
Chris Ward: Well, it's a little bit different, and here's how it's different. Communication is first you have a business plan. It's significant if you have a business plan where you've been, where you are today, and where you're going, and how are you going to continue the success of your business, and then can you communicate and share that business plan with your small business banker? Because your small business banker is your business partner in many, many senses. They're there to represent you with the bank and to cut through the red tape of banking, because banking is not easy nowadays.
It's gotten a lot better because of mobile technology and mobile banking or remote deposit capture and things like that, but it's still complicated, especially for a small business owner, because there are so many factors that impact you as a business owner. So that communication, that relationship, that give and take that you have with your small business banker to help you get the proper products, to make sure that you're lining up the right type of lending products to the needs that you have, that's what communication is all about.
Gregg Stebben: Chris, I want to ask you two more questions. I'm talking with Chris Ward. He's the small business credit executive at Bank of America. I want to ask you two other questions. One is what is the best way for me to begin building a relationship with my local bankers now, so that when I'm ready to ask for a loan I'm not walking in for the first time, so that I know them and they know me?
Chris Ward: That's a great question. So here's my suggestion. Where you have your business checking account today, get to know that bank, the bankers there that represent you at that local branch, and get to know their products and services. Then ask them questions about how to run your business better, how to have a better business banking relationship.
So think of things like merchant services. If you accept credit cards from your customers, are your merchant services to accept those credit cards with the bank that provides your checking account? Do you have a business credit card? Business credit cards are a very popular way of helping to finance small dollar expenses for a business. If you don't have a business credit card with your bank today, why not? Look into it.
Does the relationship you have with your bank reward you, so the more that you have at that bank, does it give you discounts and fee waivers? The larger the relationship with your bank, the better that you get from that bank, the better the relationship, but also the more that you know about that banker and how they can help you.
Gregg Stebben: It sounds to me like I should really be thinking about the bankers in my local branch almost as consultants when it comes to managing the money of my business. There are ways they can help me that I might not know unless I made the effort to ask them.
Chris Ward: I totally agree. I actually think they're your business partner. If you have an accountant, that's your business partner. If you have an attorney to help represent you, that's your business partner. Think of your banker the same way, one of the three trusted business partners for you to be successful as a small business, because every small business owner wants to grow their business over time and wants to have a positive impact on the community. So how can your banker help you with that?
If you have a banker that can help you with that, it's going to help your business. It's going to help make your life easier as a small business owner. So making sure that you have a banker who's competent and knowledgeable and dedicated to small businesses I think is super important.
Gregg Stebben: The last thing I want to ask you, Chris ... Chris Ward, he's the Small Business credit executive at Bank of America. The last thing I want to ask you is this. I'm sure many people listening have never applied for a business loan before from a bank. What is that process like? Can you give us a brief overview?
Chris Ward: Every bank is a little bit different. It's not as common and streamlined as it is in consumer lending, say as an auto loan. But a lot of banks are dedicating a lot of time, money and technology to improve in the small business credit application process.
So the first thing I would ask that you all do is that you go to the bank's website and see what their capabilities are and are not. For example, go check out Bank of America and compare it to the competition. Do they have an easy way to apply for credit? Do they have a learning section with really good general industry information that helps you understand how to establish and maintain your business credit? How to apply for business credit
Then does it also list out all the different types of small business credit products that are out there, from a small business credit card, to a real estate loan, to a business auto loan, up to an SBA, a Small Business Administration loan? Do they have those capabilities? That's a great place to go and to start the process, to educate yourself and making sure that you're dealing with a bank that is full-service and has industry experts to help you with your small business.
Gregg Stebben: That's really great advice. I've been talking with Chris Ward. He's the small business credit executive at Bank of America. Chris, thanks so much for joining us.
Chris Ward: Thank you.