Written By: Mark Ellis
Getting a small business loan from a bank can be difficult and time consuming. Each bank has its own criteria for loan approvals and can change its criteria depending on both internal and external events. The best chance you have for getting approved is to present the bank with the information they need, how they need it, and in a professional and concise but complete manner. To that end, here are the major criteria used by most banks in approving loans.
1. Business Plan
A well thought out business plan provides the business owner and the bank with a road map for the success of the business. It introduces the business in a clear and thorough but concise manner. It describes the business, the potential for the products or services offered, the competitive situation, the experience of the management/owners, and the organization of the business.
The plan should include historical and year to date financials as well as estimated financials for the business for two years. It should clearly show how the borrowed funds will be used. Financials presented should include and Income Statement, Balance Sheet and Cash Flow statement. Often banks look for a new business to be cash flow positive after the first 6 months of operations. For existing businesses, increased margins to more than cover the interest of the loan are expected. If your financials show margins outside of the usual margins in this business, a detailed explanation will be required.
Also included in the business plan are documents which support the estimates made in the business plan (competitive situation, market trends, etc.) . In addition, resumes of the key management personnel as well as a personal financial statement of net worth will likely be required for anybody with a significant (>20%) ownership position.
The business plan should give the bank confidence that the business will generate at least 110% of the required cash flow to fund debt service and all other expenses. Newer businesses might be required to show coverage of 150%.
SCORE has many document with will guide you in the preparation of your business plan and you are advised to take advantage of those resources.
A lender will need to be assured that the loan will be paid back. The bank will be looking to see if the management of the company has the experience and expertise to run the business so that it generates sufficient gross margins to pay back the loan. While this criterion varies by bank, many look for three years of experience as an owner or in management of a similar type business. Additional management people and their experience and expertise will also help satisfy this expectation.
From a bank’s perspective, it wants to make sure that the owner is also at risk with this company to make sure they put their best efforts forward. Sometimes that is called skin in the game. Many banks require 10 to 20% if it’s an SBA backed loan or 10- 30% if it is a conventional loan of the value of the loan to be put into the company by management.
When evaluating business loans, banks will turn to any of the owner’s personal credit rating to see what history they have had in paying back their bills. This is a very important criterion for any business loan. Banks will look for good or even outstanding credit when evaluating your loan request. In a recent meeting with an SBA preferred lender, the loan officer told the SCORE group that a minimum credit score of 650 was needed. Other banks have said a FICA score of 700 is needed. If the loan is for an existing business, a SBSS score of 175 is needed
One would think that if you had good credit, a sound business plan and financials, plus a healthy equity infusion into the company that the bank would approve the loan. Collateral is the last criteria as it backstops the risk of the loan. Collateral is any asset of value that can be pledged by the borrower(s) as collateral to make sure the bank gets paid back its loan with interest. The collateral requirements vary by bank and can range up to and above the 100% of the loan value. The percentage will depend upon the calculation of risk for this loan by the bank as well as the banks situation with regards other loans it has in its portfolio.
Collateral can take the form of securities inventory of the business, equipment, real estate, and other assets as well as deposits, home equity, home equipment, etc. Note that in determining the collateral value, only a percent of the cost of the item is considered in the collateral determination. Inventory that is easily sellable might have a value of 80% while perishable inventory might not have any value at all.
The five major criteria used by banks for a business loan are:
Business Plan Clear, complete and shows positive cash flow in 6 months including debt service
Includes: financial projections, relevant experience of the management, description of the industry, competition and positioning of the business in the industry, the use of borrowed funds, and the types of collateral available and how accessible is that collateral to being sold.
Experience 3 years
Equity 10 – 20% SBA loans or 10%– 30% conventional
Credit 650 to 700 minimum FICA and, if applicable, SBSS of >175
Collateral up to 100%+ in discounted value of collateral assets
Mark Ellis is a former SCORE Mentor. If you would like to meet with any of our SCORE Mentors to assist and help your business grow, CLICK HERE!