What Are The Banks Really Looking For?

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Last month we explored the world of SBA guarantees and how this program works with banks to provide commercial loans to small businesses. But what if you are “bankable”? Can you go it alone with your bank?

One of the most consistent threads that runs through the world of restaurant financing is that in the vast majority of cases, banks have very little interest in financing independent operators in our industry. In most cases it is because restaurants are highly volatile, risky and most do not have adequate financial statements or collateral to get them through the process. The other key consideration for most banks is that they do not want to provide loans of less than $250,000 because it is just not profitable for them to do smaller loans.

Someone recently asked me, if they were bankable, were there simple guidelines for what a banker is looking for in a qualified applicant? The simple answer is yes. Uniformly, almost every banker I have spoken with talks about the “Five C’s of Credit”.  These are a basic set of criteria that they use when evaluating a company for a loan – they are:

1. Capital

Lenders want to see that you have skin in the game. How much hard capital have you put into the business?  They don’t care about sweat equity – they want to see the cash.  Most lenders want to see between 10 – 40% of the total capital in the business coming from the owners. They want to see that there are hard and soft assets from machinery, equipment, real estate and will even consider proprietary IT technology. They want to share the risk with you and your investment insures you will suffer too if the business fails.

2. Collateral

These lenders are “risk averse”. They want to know that if for some reason your business fails to pay back the loan that they can attach assets and liquidate them to offset the debt.  This is one of the reasons that they want to see meaningful assets in your company before lending to you. Not all loans require collateral, but if you want favorable terms you should expect it.  In the case of SBA Guarantees, you will be required to pledge not only the business assets, but all owners holding 20% or more of the business must pledge their personal assets as well.  Homes, cars, cash, jewelry – everything. If you can’t pay back the loan, you could lose everything.

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3. Capacity

This is a measure of your ability to repay the loan. A lender must have a realistic expectation that the borrower does indeed have the capability to repay. Lenders rely on numerous metrics and factors in determining your “capacity”. First among these is your personal credit score. Even though this would be a business loan, the main driver of an SMBs success is the owner. If you don’t pay your creditors for personal debt, it is a reasonable conclusion that you won’t pay your business debt.  To get to the next step with a bank you will need a strong FICO of over 700 with no liens or judgments. This is very rare among newer or struggling entrepreneurs.  The bank will also look to your current vendors for your payment history. A prime factor is the Debt Coverage Ratio demonstrating you generate more income than necessary to pay off your debt. Most lenders look for 1.25x or higher which relates to the big driver, which is cash flow of the business. They will look at average daily balances, number of NSFs and general liquidity. If you have cash then they know you can pay back the loan.

4. Conditions

This looks at the reason for the loan. What will the money be used for and do the banks feel you will be successful in reaching your goals. The bankers will look at everything from the economic conditions in general to those in your local area. The industry you are in is a strong indicator of success. The “SIC code” of your business provides risk assessments for your business and it can work with you or against you. Most importantly, the bank wants to understand the purpose of the loan and if the proceeds will help you grow the business as opposed to adding to your debt load. You will need to provide explanation and back up for the amount you need, why you needed it, details on what you are spending it for and the benefits you expect to gain from the loan.

5. Character

This is a difficult factor to evaluate, but the banks are basically trying to determine if you are of good character and can be trusted to perform. This can be very subjective and often determined by the bankers that you speak with in preparing your application.  They want to know as much as possible about the person behind the business. Are you a novice or a seasoned professional in your field? What is your background and did you have prior achievements they should know about? Do you have strong professional references from vendors, customers or credit providers? Do you have any blemishes that would influence the decision-making process like arrests, DWI or old tax problems?

While each bank, financial institution or alternative lender assesses applications differently there are numerous reasons why an application is rejected. Below are a few key reasons:

  • Poor Credit Quality of the Owners and/or Business
  • Poorly Prepared or Inaccurate Financial Statements
  • Industry is a Poor Credit Risk
  • Geography / Region has Economic Challenges
  • Insufficient or Inconsistent Documentation
  • Negative Cash Flow / Insufficient Sales
  • Tax Liens and Judgments
  • Undisclosed Negative Information
  • Seasonality of Business / Sales Instability

In conclusion, do your homework and be realistic in your evaluation of your creditworthiness and expectations with banks. If you have any questions or just want to discuss your business, please contact me at dsederholt@ragnarpartners.com

David Sederholt
David Sederholt is a multi-discipline entrepreneur who has launched and built numerous companies in specialty finance, foodservice and commercial real estate over 40 years. After owning, financing and operating over a dozen restaurants in his career he found a niche in serving small businesses seeking financing and strategic advice. For 10 years he served as Chief Operating Office of Strategic Funding Source, Inc., (now called Kapitus). David has also been a Managing Partner at a boutique investment bank and a specialty commercial real estate firm. He is a regular guest lecturer and contributor to business and industry publications as well as serving as a Board member and advisor to numerous companies and non-profit organizations. He is currently owner of Ragnar Partners, LLC, a private investment and advisory firm.