What the Banker Sees
As the owner/operator of a small business wouldn’t you like to know what the banker is looking for when you go to apply for a loan? It is much better to have all of the answers ready before you approach the bank. As the saying goes, “the best offense is a good defense.”
During my 18 years as a commercial banker, the rules often changed for the banks but were almost never effectively communicated to the potential borrower.
Banks are often faced with pressures from auditors and new regulations that a small business is not aware of. First and foremost is that almost all business loans have to pass a global cash measurement. Basically a global cash flow is determined by all of the income from the borrower plus all the income from the business, divided by all debts of the borrower plus the debts of the businesses. This would include all other businesses where the owner had an interest of ownership.
These new requirements were a direct result of the series of events that happened during the recent recession (2006 through 2009). Many loans were charged off, not because of the underlying company’s cash flow but because of a borrower’s interest in other business that had a negative cash flow and values that were overinflated.
Generally speaking, in addition to the business being able to cash flow its debts, an addition hurdle was put in place called a Global Debt Service Coverage Requirement. This requirement takes into account all debts of the borrower both personally and business as well as all income sources. In my experience, most banks have had a minimum Global Debt Service Coverage Ratio of 1.25 times with most banks desiring 1.35 times or better. Business owners should be prepared for this additional requirement and realize that their personal credit dealings are included with the business’s ability to repay the debts.
Collateral values play an even more important part of today’s commercial lending than perhaps ever before. With the recent recession barely past, many properties are just now rebounding and growing in value. There are still several large areas in the Tampa Bay market that are still considered a stagnant depressed collateral market. It is more important than ever before for the small business owner to inspect the potential purchase and examine not only the price but also the area surrounding the property to determine any areas of depressed values.
A business owner can protect against this by adding contingencies to his contract to purchase. The owner can add a contingency that the property must appraise for the purchase price or greater, and they could also add a contingency that the buyer must be approved for financing at acceptable terms. Regardless of the value of the property, due diligence is not just a catch phrase but should be included in all purchase transactions including property and or equipment.
Another basic fact is that almost all banks require a personal guaranty from the business owner(s). A personal guaranty is basically a document signed at the loan closing that states that if the business is unable to make its payments, that the guarantor (owners) will personally make those payments. In fact, even an owner that holds a small portion of the business may be required to provide a personal guaranty. Most banks require anyone that owns 20 percent of the business or more will be required to sign a guaranty. A business owner should be prepared for this and include personal tax returns and a personal financial statement for all owners with a 20 percent ownership or greater, with the complete loan package.
While a business owner is often more concerned with the day to day running of his enterprise, expansion and growth of the business will often require purchases of property and or equipment. As long as the owner exercises proper due diligence, they should be able to navigate the banking requirements and feel comfortable with financing in today’s economy.