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Securing a Small Business Loan – Part II: Positioning

Posted on March 11th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

In P art I of this series, I talked about the importance of establishing a relationship with your bank long before you need a loan. In this article I will talk about selecting the right type of lender, and other things you should do in the years leading up to applying for a loan.

Which Type of Bank Or Other Lender is Suitable For My Situation?

Walking into a bank and talking to a loan officer will always be something of a stressful situation.  Preparation for and thorough understanding of their evaluation process is essential to minimize the stressful variables and optimize your potential to qualify for the funding you seek.

First, banks differ in the types of financing they make available, interest rates charged, willingness to accept risk, staff expertise, services offered, and in their attitude toward small business loans.  Selection of a bank is essentially limited to your choices from the local community. Typically, banks outside of your area of business are not as anxious to make loans to your firm because of the higher costs of checking credit and of collecting the loan in the event of default.  Furthermore, a bank will typically not make business loans to any size business unless a checking account or money market account is maintained at that institution. Ultimately your task is to find a business-oriented bank that will provide the financial assistance, expertise, and services your business requires now and is likely to require in the future.

But, also keep in mind that not all loan situations are even “bankable,” such as for instance if  your business is losing money, or growing too fast.  Or you may not have sufficient collateral to secure the loan with, such as in the case of rapid sales growth, where your only available collateral to secure the loan may be accounts receivable and inventory. These assets are not of much value to a bank unless they maintain absolute control over them, and most banks are not set up to manage this kind collateral.  Instead, a more specialized lender such as an “asset-based” (accounts receivable) lender or factor are more appropriate in these situations. Their rates are typically higher than bank rates, but if the loan enables your business to grow faster and do so profitably, the higher rate may be more than justified.

Finally, another source for very young businesses and /or which have insufficient collateral to secure a conventional bank loan, is the Small Business Administration (SBA).  Many banks offer this service wherein the SBA guarantees repayment of the bank’s loan in the event of default.

Before you apply for a loan here’s what you should do:

  1. Have an accountant prepare historical financial statements.

This is important. Many small businesses have only had their accountant prepare their tax returns every year, and their books are often maintained on that same tax basis, or worse hardly at all.  However, tax returns are not appropriate for measuring the true profitability of your business (see “The Difference Between your CPA and a Controller: M-1”). And by the time you are seeking a loan, the lender will most likely be looking for a historical (usually 3-year) trend of profitability, NOT tax losses (even though they are completely legitimate for tax purposes).

Also, internally generated statements are OK for interim monthly financial statements IF your books are maintained properly (“Small Businesses Need to Understand if They are Really Profitable“, “The Most Wonderful Time of the Year: Accounting Clean-Up Time,” and  “’Winging It’ in QuickBooks”).  But your bank will usually also want the comfort of knowing an independent CPA has verified the information at year-end, which, depending upon the size of the loan can take the form of “reviewed” or “audited” financial statements.  Compiled financial statements are NOT “verified” by your CPA, but are less expensive, better reflect your true profitability if based on accrual accounting, and often provide a comfort level to the lender almost as if they were verified, especially if they include footnotes.  Even though banks these days often only require tax returns, we always recommend to our clients that they also provide compiled financial statements based on Generally Accepted Accounting Principles (GAAP).  Then, you (or someone) must understand your financial statements, and be able to reconcile for the lender the differences between these statements and your tax return, and explain previous financial trends or hiccups.

  1. Line up references.

Your lender may want to talk to your suppliers, customers, potential partners or your team of professionals, among others. When a loan officer asks for permission to contact references, promptly answer with names and numbers; don’t leave him or her waiting for a week.

And it should be noted here that even if your bank ends up not being the appropriate lender for your loan situation, bankers often do maintain relationships with specialized lenders to whom they can refer you. So your banking relationship you’ve been building all of this time has not been in vain, as that level of trust is now transferable in the form of a reference.

In Part III of this series, I will talk about the specifics of what should go into a loan application.

 


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