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Small Business Management Article
The Bank Won't Lend to My Business-Why?
Raymond D. Matkowsky
Several years ago I was a member of a group holding regular discussions about business situations our members would run up against. One member was upset that his bank turned him down for a loan even though his small business was flourishing.
Diverging Point of Views
Before one proceeds too far, remember, how you and the bank view a loan is different. Like most business people, you view a loan as a way to grow your business. The bank looks at the loan as a potential liability. The larger the loan you ask for, the greater the risk. Although credit rating is a factor, it has less weight than other factors. The bank wants next to an iron clad guarantee that the loan will be paid back.
Too Much of a Risk
It is unfortunate, but most small businesses are considered poor credit risks. They just don’t have the large customer list that billion dollar players have. This is where the problem begins. Even though his business was booming, 80% of his business was from one large international retailer. This retailer had a reputation for dropping vendors over small differences in costs between suppliers. Banks saw this as a red flag.
What Do Banks Want?
Banks want to see many small accounts. If a business losses a customer that represents 5% of their business, that is survivable and not that unusual. However, if a business loses a customer that represents 80% of their cash flow, they may not be able to pay their utility bills let alone a bank loan.
Most banks evaluate loan requests against a so called “Five Cs.” If any of these are missing or a poor bet a loan will be very difficult to get. They are:
Capacity to Repay
I have already discussed that banks need to be convinced that they will be repaid. But, how do they measure this. Having a handful of customers presents a huge risk regardless to profit a business may have. Besides the number of customers, banks want to see each dollar of loan bring in 1.2 to 1.5 times in cash flow to insure that debt can be serviced. Included in this calculation is any debt you already have.
Banks want their loans to be backed up by collateral. Be aware that banks will only consider 80% of value in determining sufficient collateral. Banks will hold a lien on the collateral until the loan is paid off.
There is only one question to be answered when it comes to capital holdings. Do you have enough money to operate? The answer is a simple yes or no.
When it comes to character or reputation in the business world, again, the answer is simple. Would you receive solid recommendations? Do you offer inferior service? Do you have what many would consider a disreputable name? This is an intangible that is considered but one that can be answered with a simple yes or no.
Finally, we come to conditions in the marketplace. Even a strong organization can be blindsided and go bankrupt in the marketplace. Covid-19 is a great example. Few saw the pandemic coming. In the United States at least 150,000 businesses have closed. The number is much greater when you take the whole world into consideration. Many businesses went bankrupt through no fault of their own. I was recently in a shopping center that had over 300 feet (91.5 meters) of adjacent businesses closed. I regularly patronized many of these for years. Banks want to be assured that if things go south you can withstand it.
“Five Cs” and a Business Plan
Depending on how much risk an individual bank is willing to take, a strong business plan that addresses the “Five Cs” and explains how each fits into the plan may trump an individual weak factor. Don’t discount the value of a strongly written and explained business plan.
There is one further option. However, whether or not to take it has to be a personal choice since you would be giving up any personal protection that incorporation gives. I am referring to a “Personal Guarantee.” This is only a possibility if your personal financial strength is greater than that of your business. You would be personally responsible for the repayment of the business loan.
In order to get a bank loan you must look at your business through the lens that banks use. Also keep in mind how banks rate each risk. One bank may turn you down because of a weak C, whereas another bank’s standards may weigh that weakness differently based on your overall business plan.
Getting a small business loan is tricky and difficult but doable. However, you have to honestly evaluate your strengths and weakness. These have to be presented to a bank honestly. You will have to show contingency plans for how these weakness will be overcome should the need arise.
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