One of the toughest tasks any small business owner will face is getting a loan. And nearly three years after the recession struck and the credit markets froze, the current economic situation remains quite challenging.
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“Three years ago, lending froze up,” said Mike Lubansky, senior financial analyst with Raleigh-based Sageworks. “Certain banks are still not financially healthy, not able to do as much lending as they might like. Regulators require them to have higher levels of capital, more loan-loss reserves. And for the ones that are healthy, their standards are definitely a bit tighter.”
Lubansky spends much of his time helping small business owners better understand their current finances and future needs. Since he also works with financial institutions, he’s in a good situation to size up the lending problems that continue to plague small business.
The Small Business Administration SBA reported earlier this year the total value of small business loans was about $652 billion in 2010, down from $712 billion in 2008. But there is good news: A March Capital One Bank survey found 85% of small business owners reported they were able to get the financing they need this year.
Prior to 2008, Lubansky said certain lenders were more relationship based and perhaps not as stringent in paperwork requirements when deciding on loans. Now lenders are back to following standards they should have followed in the first place. “Some banks are still in a tight spot, but overall the atmosphere is much better for lending.”
Jay Davidson, chairman and CEO of First American Bancorp in suburban Denver said banks are very risk averse right now. “Small business owners should prepare for a very in-depth process that will help the borrower understand his own risk.”
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Lubansky offered the following tips for small business owners looking for a loan:
1. Find the right bank.
Business owners mistakenly think all banks are the same when it comes to getting a loan, Lubansky said. Wrong. Some specialize in loans for smaller businesses or startups, while others prefer to lend to more established firms.
Larger banks use “a more formulaic method” when reviewing loan applications, while smaller community banks tend to scrutinize each application on a case-by-case basis, he said.
For example, some banks specialize in construction lending. If you’re a software company, they won’t be as familiar with your business; a bank specializing in lending to manufacturers would be a better fit. Having a banker who is knowledgeable in your industry will come in handy when discussing your business needs.
Some big banks were heavily involved in credit default swaps and may still be recovering capital, which means they’ll have less to provide you.
Lubansky says one easy way to assess a bank’s capacity to loan is to check its “Texas Ratio,” which is one measure of a bank’s financial strength and sometimes is an indicator of banks that may fail. A Texas Ratio score above 150 is an indication of potential trouble, Lubansky said.
The SBA’s site, allows you to enter your zip code to begin searching for a potential lender nearby.
When considering a bank, The National Federation of Independent Business advises you to ask the following questions: Does it participate in Small Business Association loan programs or other government-guaranteed loans? What criteria does it hold for qualifying for loans? What is the minimum balance required and fees associated with a small business account? Does it offer night deposits and online banking? What are the interest rates on both credit cards and loans?
2. Create a relationship with a bank, or banks, before you need a loan.
Just as you would be more likely to lend money to a friend over a stranger, a bank will be more receptive to your loan request if they know you, Lubansky said.
Once you identify a bank that suites your business needs, open an account with them and use it to demonstrate your dependability. Establish a line of credit and demonstrate your reliability by paying it back consistently, Lubansky advised. “That will be a positive when you want a larger amount.”
For established businesses, small credit lines of $10,000 to $50,000 often require a simple one-page application with no financial statements or tax returns necessary.
Startups will need more documentation, usually a business plan and financial statements with a starting balance sheet and a projection of what it will look like in a year.
Lubansky also suggests “spreading around your relationships,” by establishing a business account with more than one bank. If one bank turns down your loan request, you’ll have a fallback banker who is familiar with your business needs.
3. Embrace risk.
There’s a good reason banks are often not eager to part with money when it comes to small businesses: they have a notoriously high failure rate. You need to prove your credit worthiness.
When discussing a potential loan, don’t be afraid to discuss the risk with your bank, Lubansky said. “Every business has risk, and if you do not talk about it, the bank will assume that you have not taken it into account.”
A bank wants to be assured that you know your business well enough to anticipate its upsides and downsides. Lubansky recommends accounting for both good and bad situations in your application. “While you may be pleasantly surprised when fortunes swing your way unexpectedly, a bank may be worried. Why? If you can’t predict a good surprise, why should they trust you to account for the bad surprises?”
Davidson said lenders will be impressed that you have anticipated negative events. “We can all make the numbers sing, but that is not the objective of the lender – he wants to see that the borrower will pay him back, even in difficult times. The borrow needs to be brutally honest, first with himself and then with others.”
Rehearse, rehearse, rehearse. When a banker asks a question about your business, it should not be the first time you’ve thought of the answer. “Having strong, well-rehearsed responses to questions demonstrates that you have done your homework and have a thorough understanding of the situation,” said Lubansky.
Be prepared to answer: How much money do you need? What are you going to do with it? When will you repay? What will you do if you don’t get the loan?
Need a practice partner? Try SCORE which has 11,500 volunteer business counselors that are trained to serve as counselors and mentors to business owners across the country. And it’s free. Find the one nearest you here.
Never underestimate the power of the personal relationship with a banker, the NFIB advises. After reviewing your plan with you, your banker will likely take the information to the bank's daily or weekly planning meeting and present it to the group. A good personal recommendation could tip the balance in your favor.
Banks value businesses that do their homework and take the loan review process seriously. Being prepared is the best way to ensure your bank that no matter what contingency arises, you have planned accordingly and will still be able to pay the loan.
If you are caught off guard with a question, don’t lie.
“Don't try to BS your way through a loan interview,” Davidson said. ”Where the borrower may go through this process once or twice in their life, bankers do it time and again. After years in the business, a good banker can see through any anomalies, and certainly any fabrications.”
5. Be prepared to apply to multiple banks.
No matter how much preparation you may do, sometimes things might not go your way.
It’s fairly common for businesses to apply to multiple banks before they get approved for a loan. “In our current economic state, persistence and perseverance are needed to successfully secure a bank loan,” said Lubansky.
Even if you’re turned down, thank the banker for the time spent reviewing your application, the NFIB advises. Never act resentful. The lender is likely to have considered the application in a highly professional, objective manner. Don’t take it personally. Remember that, if your business is a success, there’ll be future applications to consider. Don’t burn your bridges.
Most banks will prepare a detailed explanation for the loan rejection. Talk with the lender about the points mentioned, asking how you can address each to improve future applications.
Remember that you have other options. There are plenty of banks, and sometimes credit unions offer better deals than commercial banks.