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Securing a Small Business Loan – Part III: The Application

Posted on March 19th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

In Part II of this series I talked about the things a small business should do to prepare for applying for a loan. Now let’s get down to the specifics of the application itself.

Lending is the essence of the banking business and making mutually beneficial loans is as important to the success of the bank as it is to the small business. This means that understanding what information a loan officer seeks–and providing the evidence required to ease normal banking concerns–is the most effective approach to getting what is needed by the lender.

  1. Should you write a business plan?

In today’s banking industry, whether or not your bank requires a business plan depends on the size of your business and the loan amount, which in turn, determines the area of the bank that handles your loan request.  For smaller business loans, banks today may only require copies of your business and personal tax returns.

For larger loans, and/or certain types of lenders such as the SBA and private equity investors, a business plan is also advisable if not required. This document is the single most important planning activity that you can perform, and is advisable to do even if not required for your loan application.

A business plan is more than a device for getting financing; it is the vehicle that makes you examine, evaluate, and plan for all aspects of your business. A business plan’s existence proves to your banker that you are doing all the right activities. Once you’ve put the plan together, write a two-page executive summary. You’ll need it if you are asked to send “a quick write-up.”

The good news is, there are business plan software programs available on the market that will guide you through the whole process. But you may also wish to obtain the assistance with parts of it from an outside professional.

  1. Understanding the Lender’s Underwriting Criteria

The degree of analysis performed by the lender will vary based on the size of the bank and its lending culture, the size of the business, and the amount of the loan request.  In the larger banks today, the lending function is divided between “Business Banking” for smaller businesses, and “Corporate (or Commercial) Lending” for larger companies.  Exactly where this line is drawn is defined by each bank, and is largely a function of how much time they want to spend analyzing a business loan.  For smaller companies the approach may be to rely on tax returns, from which they compute what’s called a “Global Debt Service Coverage” ratio, and that you have an acceptable personal credit score and personal assets (such as your home), the concept being to treat the loan essentially as a consumer loan. For larger companies, banks will delve into much more detail on the business itself.

For purposes of this discussion, I will focus on what is required for larger companies, as the same principles apply to small businesses – regardless of whether the lender asks the questions.  (If you doubt this statement, or choose to ignore these principles, read here to see what the likely outcome will be: “Larry’s Fairy Godmother Strategies, Inc.”)

In general, a sound loan proposal or business plan should contain information that expands on the following points:

  • What is the specific purpose of the loan?
  • Exactly how much money is required? (“Larry’s Funding Strategies, Inc.”)
  • What is the exact source of repayment for the loan? (“Larry’s Debt Repayment Strategies, Inc.”)
  • What evidence is available to substantiate the assumptions that the expected source of repayment is reliable?
  • What alternative source of repayment is available if management’s plans fail?
  • What business or personal assets, or both, are available to collateralize the loan?
  • What evidence is available to substantiate the competence and ability of the management team?

Even a brief examination of these points suggests the need for you to do your homework before making a loan request, because an experienced loan officer will ask probing questions about each of them. Failure to anticipate these questions or providing unacceptable answers is damaging evidence that you may not completely understand the business and/or are incapable of planning for your firm’s needs. (“Financial Planning, or Business Turnaround – Your Choice”).

  1. Next Step: The Lender’s Analysis

This is where Part II and Part III of this series come together.  As I have often said, the real value of accounting lies in the interpretation of the numbers. “Financial analysis” is a whole new academic subject, and I won’t attempt to cover it here.  But one ratio I consider to be the most meaningful when evaluating a business’ ability to repay a loan is Debt Service Coverage. There are several methods of computing this, but one ratio I feel is the most meaningful is:

Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”)
Total Principal + Interest Payments

 A ratio of less than 1 to 1 here is an indication that the business does not generate sufficient profit and cash flow to stand on its own and repay its debt. So regardless of what ratios the lender uses (which you may never know), you should compute this one yourself, as again, the alternative source of repayment (above) is this: “Larry’s Fairy Godmother Strategies, Inc.” (or in short, from your pocket, or worse, your home).

Most small business owners I’ve met know about their own business, but lack the financial expertise to explain their financials to lenders. If this describes you, don’t be shy about requesting assistance from a financial professional, including perhaps, an introduction to a lender that is best suited for your particular situation.



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