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Before The Loan Decision

Choosing a bank and, more specifically, a banker is one of the more important decisions a new or young business will make. A good lender relationship can sometimes mean the difference between the life and death of business during difficult times. There have been cases where one bank has called its loans to a struggling business, causing it to go under, and another bank stayed with its loans and helped the business to survive and prosper.


Those banks that will not make loans to start-ups and early-stage ventures generally cite the lack of operating track record as the primary reason for turning down a loan. Lenders that make such loans usually do so for previously successful entrepreneurs of means or for firms backed by investors with whom they have had prior relationships and whose judgement they trust (i.e., established venture capital firms when they believe that the venture capital company will invest in the next round).


In centres of high technology and venture capital, the main officers of the major banks will have one or more high-technology lending officers who specialize in making loans to early-stage, high-technology ventures. Through many experiences, these lenders have come to understand the market and operating idiosyncrasies, problems, and opportunities of such ventures. They generally have close ties to venture capital firms and will refer entrepreneurs to such firms for possible equity financing. The venture capital firms, in turn, will refer their portfolio ventures to the bankers for debt financing.


What should an entrepreneur consider in choosing a lender? What is important in a lending decision? How should entrepreneurs relate to their lenders on an ongoing basis? In many ways, the lender’s decision is similar to that of the venture capitalist. The goal is to make money for his or her company, through interest earned on good loans. The lender fears losing money by making bad loans to companies that default on their loans. To this end, he or she avoids risk by building in every conceivable safeguard.


The lender is concerned with the client company’s loan coverage, its ability to repay, and the collateral it can offer. Finally, but most importantly, he or she must judge the character and quality of the key managers of the company to whom the loan is being made.

Because of the importance of a banking relationship, an entrepreneur should shop around before making a choice. The criteria for selecting a bank should be based on more than just loan interest rates. Equally important, entrepreneurs should not wait until they have a dire need for funds to try to establish a banking relationship.


The choice of a bank and the development of a banking relationship should begin when you do not urgently need the money. When an entrepreneur faces a near-term financial crisis, the venture’s financial statements are at their worst and the banker has good cause to wonder about management’s financial and planning skills – all to the detriment of the entrepreneur’s chances of getting a loan.


The bank selected should be big enough to service a venture’s foreseeable loans but not so large as to be relatively indifferent to your business. Banks differ greatly in their desire and capacity to work with small firms. Some banks have small business loan officers and regard new and early-stage ventures as the seeds of very large future accounts. Other banks see such new ventures loans as merely bad risks.


Steps In Obtaining A Loan

Before choosing and approaching a banker or other lender, the entrepreneur and his or her management team should prepare by taking the following steps:

Decide how much growth they want, and how fast they want to grow, observing the dictum that financing follows strategy.

Determine how much money they require, when they need to have it, and when they can pay it back. To this end, they must”

-Develop a schedule of operating and asset needs;

-Prepare a real-time cash flow projection.

-Decide how much capital they need.

-Specify how they will use the funds they borrow.

Revise and update the “corporate profile” in their business plan. This should consist of:

-The core ingredients of the plan in the form of an executive summary.

-A history of the firm (as appropriate).

– Summaries of the financial results of the past three years.

-A succinct description of their markets and products.

-A description of their operations.

-Statements of cash flow and financial requirements.

-Description of the key managers, owners, and directors.

-A rundown of key strategies, facts, and logic that guide them  I     growing the corporation.

Identify potential sources for the type of debt they seek, and the amount, rate, terms, and conditions they seek.

Select a bank or other lending institution, solicit interest, and prepare a presentation.

Prepare a written loan request.

Present their case, negotiate, and then close the deal.

After the loan is granted, borrowers should maintain an effective relationship with the lending officer.


Approaching and meeting the banker

Obtaining a loan is, among other things, a sales job. Many borrowers tend to forget this. An entrepreneur with an early-stage venture must sell himself or herself as well as the viability and potential of the business to the banker. This is much the same situation that the early-stage entrepreneur faces with a venture capitalist.


The initial contact with a lender will likely be by telephone. The entrepreneur should be prepared to describe quickly the nature, age, and prospects of the venture; the amount of equity financing and who provided it; the prior financial performance of the business; the entrepreneur’s experience and background; and the sort of bank financing desired. A referral from a venture capital firm, a lawyer or accountant,  or another business associate who knows the banker can be very helpful.


If the loan officer agrees to a meeting, he or she may ask that a summary loan proposal, description of the business, and financial statement be sent ahead of time. A well-prepared proposal and a request for a reasonable amount of equity financing should pique a banker’s interest.


The first meeting with a loan officer will likely be at the venture’s place of business. The banker will be interested in meeting the management team, seeing how team members relate to the entrepreneur, and getting a sense of the financial controls and reporting used and how well things seem to be run. The banker may also want to meet one or more of the venture’s equity investors. Most of all, the banker is using this meeting to evaluate the integrity and business acumen of those who will ultimately be responsible for the repayment of the loan.


Throughout meetings with potential bankers, the entrepreneur must convey an air of self-confidence and knowledge. If the banker is favourably impressed by what has been seen and read, he or she will ask for further documents and references and begin to discuss the amount and timing of funds that the bank might lend to the business.


What the Banker Wants to Know

You first need to describe the business and its industry. What are you going to do with the money? Does the use of money make business sense? Should some or all of the money required by equity capital rather than debt? For new and young businesses, lenders do not like to see total debt-to-equity ratios greater than one. The answers to these questions will also determine the type of loan (e.g., line of credit or term).


How much do you need? You must be prepared to justify the amount requested and describe how it fits into an overall plan for financing and developing the business. Further, the amount of the loan should have enough cushion to allow for unexpected developments.


When and how will you pay it back? This is an important question. Short-term loans for seasonal inventory buildups or for financing receivables are easier to obtain than long-term loans, especially for early-stage businesses. How the loan will be repaid is the bottom-line question. Presumably, you are borrowing money to finance activity that will generate enough cash to repay the loan. What is your contingency plan if things go wrong? Can you describe such risks and indicate how you will deal with them?


What is the secondary source of repayment? Are there assets or a guarantor of means?


When do you need the money? If you need the money tomorrow, forget it. You are a poor planner and manager. On the other hand, if you need the money next month or the month after, you have demonstrated an ability to plan ahead, and you have given the banker time to investigate and process a loan. Typically, it is difficult to get a lending decision in less than three weeks (some smaller banks still have once-a-month credit meetings).


One of the best ways for all entrepreneurs to answer these questions is from a well-prepared business plan. This plan should contain projections of cash flow, profit and loss, and balance sheets that will demonstrate the need for a loan and how it can be repaid. Particular attention will be given by the lender to the value of the assets and the cash flow of the business, and to such financial ratios as current assets to current liabilities, gross margins, net worth to debt, accounts receivable and payable periods, inventory turns, and net profit of sales. The ratios for the borrower’s venture will be compared to averages for competing firms to see how the potential borrower measures up to them.


For an existing business, the borrower will want to review financial statements from prior years prepared or audited by a CPA, a list of aged receivables and payables, the turnover of inventory, and lists of key customers and creditors. The lender will also want to know that all tax payments are current. Finally, he or she will want to know details of fixed assets and any liens on receivables, inventory, or fixed assets.


The entrepreneur-borrower should regard his or her contacts with the bank as a sales mission and provide data that are required promptly and in a form that can be really understood. The better the entrepreneur can supply to demonstrate their business credibility, the easier and faster it will be to obtain a positive lending decision. The entrepreneur should also ask, early on, to meet with the banker’s boss. This can go a long way to help obtain financing. Remember you need to build a relationship with a bank and not just a banker.


Covenants to Look For

Before borrowing money, an entrepreneur should decide what sorts of restrictions or covenants are acceptable. Attorneys and accountants of the company should be consulted before any loan papers are signed. Some covenants are negotiable (this changes with the overall credit economy), and an entrepreneur should negotiate to get terms that the venture can live with next year as well as today. Once loan terms are agreed upon and the loan is made, the entrepreneur and the venture will be bound by them. If the bank says, “Yes, but…”

Wants to put constraints on your permissible financial ratios.

Stops any new borrowing.

Wants to veto on any new management.

Disallows new products or new directions.

Prevents acquiring or selling any assets.

Forbids any nee investment or new equipment.


What follows are some practical guidelines about personal guarantees: when to expect them, how to avoid them, and how to eliminate them.


Personal Guarantees and the Loan

When to Expect Them

If you are under collateralized

If there are shareholder loans or lots of “due to” and “due from” officer accounts.

If you have had a poor or erratic performance.

If you have management problems.

If your relationship with your banker is strained.

If you have a new loan officer.

If there is turbulence in the credit markets.

If there has been a wave of bad loans made by the lending institution, and a crackdown is in force.

If there is less understanding of your market.


How to Avoid Them

Good to a spectacular performance.

Conservative financial management.

Positive cash flow over a substantial period.

Adequate collateral.

Careful management of the balance sheet.


How to Eliminate Them (if you already have them)

See “How to Avoid Them”

Develop a financial plan with performance targets and a timetable.

Negotiate elimination upfront when you have some bargaining chips, based on certain performance criteria.

Stay active in the search for backup sources of funds.


What to Do When the Bank Says No

What do you do if the bank turns you down for a loan? Regroup, and review the following questions.

Does the company really need to borrow now? Can cash be generated elsewhere? Tighten the belt. Are some expenditures unnecessary? Sharpen the financial pencil: be lean and mean.


What does the balance sheet say” Are you growing too fast? Compare yourself to published industry rations to see if you are on target.


Does the bank have a clear and comprehensive understanding of your needs? Did you really get to know your loan officer? Did you do enough homework on the bank’s criteria and their likes and dislikes? Was your loan officer too busy to give your borrowing package proper consideration? A loan officer may have 50 to as much as 200 accounts. Is your relationship with the bank on a proper track?


Was your written loan proposal realistic? Was it a normal request, or something that differed from the types of proposals the bank usually sees? Did you make a verbal request for a loan, without presenting any written backups?


Do you need a new loan officer or a new bank? If your answers to the above questions put you in the clear, and your written proposal was realistic, call the head of the commercial loan department and arrange a meeting. Sit down and discuss the history of your loan effort, the facts, and the bank’s reasons for turning you down.


What else might provide this financing (ask the banker who turned you down)?


You should be seeing multiple lenders at the same time so you don’t run out of time or money.