10 Ways to Strengthen Your Next Loan Application

Demystifying decision-making — and 10 ‘red flags’ to avoid

by Julie Fletcher

What business owner hasn’t dreamed about what could be done for the business with more capital. Buy new equipment? Hire more staff? Expand into a new market? When it’s time to explore putting dreams into motion, seeking financing is often the next step.

Banks typically have well-documented criteria business owners must meet to qualify for a business loan. But what they may not realize is that there are additional, more subjective measures that many banks use when evaluating a request.

With a better understanding and preparation, business owners can address the full range of qualifications to maximize their chances of getting that coveted “yes” on their business loan application.

Understanding How Banks Assess Businesses

To begin, let’s take a moment to consider the difference between how entrepreneurs and bankers view a business. Entrepreneurs are, by nature, visionaries and risk takers, seeing the possibilities, eager to grow and constantly seeking out partners who share and support their dream. Bankers, however, are risk averse — seeking to minimize potential for losses by identifying threats that may hamper the ability to repay a loan. Banks must always consider the worst-case scenarios. Remember, the business owners share most of the upside advantages of getting a loan, while the bank shoulders a large portion of the downside risk.

Along with being risk averse, banks are also highly regulated, which can set the stage for disconnect when business owners bring innovative new ideas to the table.

Understanding these differences helps business owners to be better prepared when submitting a loan application and minimize miscommunications in the lending process.

Asking Questions and Preparing Answers

With an understanding of the bank’s approach in mind, business owners should conduct their own due diligence and ask their bank:

  1. What is the bank’s experience with my industry?
  2. What is the bank’s overall outlook toward risk?
  3. How are loan decisions made and what is the process?
  4. Will I get to know all the decision-makers?
  5. What is the bank’s upper limit of credit?
  6. How does my loan amount compare with the bank’s average credit request?
  7. What will happen if I face a business setback?

Next, business owners should be prepared to discuss in detail the following questions the bank will have for them:

  1. What is the big picture of your company? (Your industry designation, competitive landscape, value proposition, and the general reputation of your company).
  2. How are financial decisions made within your company?
  3. Who is involved (CEO, COO, CFO, controller; an advisory or legal board; or active shareholders)?
  4. Do you have partners who advise you, such as a CPA, attorney, or board of directors?
  5. How is your financial information managed? Do you prepare annual budgets, monthly/quarterly statements and annual tax returns? Does a CPA prepare your financial statements?
  6. How is the ownership of your business structured? Is your business an LLC, Corporation, and are there related companies or subsidiaries?
  7. What does your internal financial management system include? (Systems could include sales pipeline and backlog reports, production and administrative expenses, accounts receivable and inventory management, and cash management systems.)

The Personal Side of Business Loans

The way business owners manage personal finances can be a window into how they’ll handle their business affairs, so they should not be surprised when a banker views personal finances while they are seeking funding for a business idea. Business owners should be ready for these questions:

  1. Do you pay your bills on time?
  2. Do you forecast your expenses?
  3. Do you have reserves and liquidity?

Applicants may also be asked to describe some subjective things about themselves: the character and reputation they’ve created through things like how their bills are paid, how any problem situations were handled (i.e., any litigation) and the tenure of their business/professional relationships. Being engaged in community philanthropy, active in trade associations and other examples of “being a good corporate citizen” are also windows into an applicant’s character.

For those who don’t already have a strong banking relationship, seeking one out and getting to know their banker before they urgently need financing will help build a solid foundation. Since bankers are fiscally conservative, rushed decisions are less likely to go in the applicant’s favor.

Red Flags to Avoid on a Loan Application

While some criteria weigh heavier than others, ensuring that crucial aspects of their financial picture are in good shape will help business owners into a better position when it is time for a loan decision to be made. Here are the ten most common loan stumbling blocks to avoid:

  1. No budget – A surprising number of small businesses do not have a set budget, meaning the bank can’t forecast growth. It’s also a sign that it may be too early in the life cycle for a bank to take the risk.
  2. Minimal understanding of the business’s numbers – If business owners have a hard time explaining their finances, or if relatively simple questions are hard to answer, it leaves the owners – and their banks – vulnerable should any financial challenges arise.
  3. Interest rate is the applicant’s primary concern – Everyone wants the lowest possible interest rate, but if a business owner is talking with five to six prospective banks, the bank may see it as “rate shopping” rather than seeking a business partnership. Switching banks frequently also leads to questions about the business owner’s commitment.
  4. Excessive dependencies – There is risk in being overly reliant on things like a key raw material, one or two huge customers, a labor contract or a patent. High dependence on one or more components of the business puts its owner at greater risk for sudden failure. A business’s banking advisor should seek to understand these dependencies and, ideally, help identify ways to minimize that risk.
  5. Instability, Variability – For businesses than operate in an unstable business environment (for example, sporadic access to raw materials), or are in an industry has frequent highs and lows (i.e., housing construction), business owners should discuss this with their banker to see if there are ways to mitigate this concern.
  6. Turnover ratios lengthening – Slow-selling inventory, too much product, delays in paying suppliers or collecting payments can worry a banker. There are many good explanations that will help overcome this hurdle and ensure the banker understands the situation.
  7. No skin in the game – If an entrepreneur or small business owner hasn’t put their money where their mouth is, why should the bank?
  8. Growth and expansion that is too fast – This may seem counterintuitive, but rapid expansion can mean management may not be able to sustain that growth, or may not have grown its infrastructure or capital base to keep up.
  9. Overall cash flow – Business owners should be able to provide their banker global cash flow information, including relevant personal and affiliate financial and debt records that can help banks calculate total cash available to pay for potential loans. While focused on capital for financing, overall marginal or negative cash flow must be addressed.
  10. No estate plan – Particularly for mid-size or larger businesses, having no estate plan puts the business – and therefore financial performance – at risk. What happens to the business if the owner is no longer around?

The Benefits of Explaining the Business

Addressing the red flags has benefits beyond increasing business owners’ chances of a positive outcome, such as improving their operational processes and efficiencies and developing a trusted relationship with their banker.

Evaluating a business’s loan readiness may even shed some light on a gap in the owner’s business strategy that needs to be addressed. No estate plan? The bank knows some great estate planners. Need a deeper bench of talent? The bank may have suggestions.

The most important takeaway is that business loan decisions are both objective and subjective. Basic financial criteria must be met, but overall impressions, work style and the ability for the bank and business owner to develop a deeper, trust-based relationship matters.

Julie Fletcher, MBA, is a vice president and business banker team lead at Enterprise Bank & Trust. She has spent more than 28 years as a business leader and entrepreneur, working with both domestic and international clients assisting with the startup and development of their businesses. Fletcher has served on the board of the Arizona Council for International Visitors, The Fabric Foundation and ASBA’s Public Policy Committee.

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