Getting a bank loan approved is not an easy process. It can take quite some time and the outcome is unpredictable. After losing a lot of money from the economic recession a few years ago, banks have become more strict with small business lending. Also, new regulations from banking regulators have had their impact on the internal processes of banks. Nevertheless, it’s worth talking with banks as they often are the lowest cost option for financing. Moreover, the recent upturn in the economy has made most banks somewhat more open to small business lending.
Before going to the bank you need to do some homework and know exactly what it is that you want and what terms you can afford. For small business lending most banks ask for a personal guarantee, so it is important to know your credit score. A low credit score is one of the main reasons for banks to decline a credit request. Review this credit score before you visit the bank and make sure it is accurate. In case of an error, give yourself time to correct it.
For your first bank visit, they will ask you to provide documentation needed for the bank’s loan approval process. These are mainly documents which prove that you are not too risky for the bank, but also include information such as the Articles of Organization and the operating agreement of your company.
So what are the five determining factors for a bank to provide a loan?
1. The bank will look at the credit history of your company and of the owner(s). As I mentioned before, check your credit score before you visit the bank. With a low credit score, it will be very difficult to get credit from a bank.
2. The bank will look at the cash flow history of the business. How has the business been doing over the past 2-3 years? Given past performance, would the business have been able to pay down the requested loan within the requested term? It is important to understand your past financial performance and be able to explain what is behind the numbers. Please note that, most likely, the banker will not be familiar with your business or the industry it operates in. Thus, you will have to educate the banker on why your business is successful and better than the business of your competitors.
3. The projections of the business. Given your past performance, how does the future look for the business? If possible, prepare a realistic forecast for your business and, based upon the forecasted cash flow, it should be clear that you will be able to afford the interest and debt repayment. You should be ready to explain this with good arguments, especially if the forecast looks much better than your historical performance.
4. Collateral which you are able and willing to provide for the loan. Many assets can be used as collateral. The most common ones are real estate, car, receivables, inventory, equipment and marketable securities. The bank usually wants to match the term of the loan with the useful life of the collateral. Real estate is the best collateral for a long term loan, whereas inventory and receivables are commonly used for short term loans. Banks do not provide a loan for 100% of the collateral value. Instead, they use a discount, the so-called loan-to-value ratio. The discount depends on the kind and quality of the collateral.
5. Finally, the banks will look at character, that is, they will look at YOU. Whereas all other criteria can more or less objectively be analyzed by the bank, character is highly subjective. The banker you speak to will make the judgement call so it is very important that you prepare well for the meeting and that you are able to convince the banker that you are the right person to make your plans work and will be able to repay the bank.
It helps if you have had successful prior dealings with the bank, but it also helps if you have some referrals from respected persons. In particular, (small) community banks put great emphasis on referrals from professionals in the local community or, even better, one of their board members. Banks will consider it a “sign of good character” if you yourself invest in your company prior to going to the bank. In general, banks do not invest in companies without any financial involvement of the owner. The more you finance yourself, the easier it gets for a bank to provide a loan.
The banker with whom you have your meeting becomes your ambassador within the bank. The banker has to “sell” your credit to the people who have the authority to approve the credit. It is therefore your task to give the banker all the right arguments for why the bank should give you credit. The banker needs to be convinced that you and your business are a good risk for the bank, so it is important to build a good relationship with your banker.
Finally, don’t get upset if a bank declines your loan. Every bank has its own rules on what kind of loans they like to fund. In order to increase your chances for getting your loan approved, it is always good to meet with several banks.
About the Author — Ronald Blok was the CEO of RaboBank N.A. from 2006-2013 and has worked in the banking industry for over 20 years.
This article was originally written on June 2, 2014 and updated on November 1, 2016.