In order to negotiate a small business loan, successfully, entrepreneurs must be able to think like the banker. The small business owner must provide information in a coherent, logical manner that answers questions, even before they are asked.
If you are interested in getting a small business loan, it's useful to have a good understanding of the four distinct phases of analysis in the Loan Request process:
Loan Purpose Analysis
One of the first questions the banker has when you approach with a loan request is: "What is the specific request? Is it legal, reasonable and consistent with bank policies and guidelines?" Once the specific request is determined, the banker looks closely at what really caused the need to borrow. For example, the entrepreneur's need to meet payroll or to pay accounts payable, are not underlying problems. What events led to the situation? Was this cash shortage a surprise or was it predicted with careful cash flow analysis? Was it poor cash management that created the shortfall? Often, the entrepreneur does not have a clear understanding of what has caused the need to borrow and the ambiguity this creates does not give the banker the necessary confidence that the entrepreneur will know how to avoid the situation in the future.
Repayment Source Analysis
The banker analyzes many factors when considering the repayment sources available. Typically this phase of the loan request process requires the most documentation and includes a:
- Business Review
- Management Review
- Analysis of Financial Statements
- Cash Flow Analysis
- Summary of strengths and weaknesses of the request
The banker will perform a thorough business review, primarily by reading the business plan- which intends to answer the question - "Does the business have a well conceived strategy?" The management review determines whether or not management has the skills, information and experience to implement the strategy.
To answer the question "Does the company have a balanced financial position?" the banker will analyze the financial information of the company, including:
- Personal financial statements
- Personal Tax returns
- Annual company financial statement
- Interim company financial statements
- Cash Flow and assumptions
- Certain support documentation such as accounts receivable or payable aging reports
The banker not only considers the ability to repay the loan using ratios and trend analysis, but also takes a careful look a the cash flow within the company, to begin to match the repayment source(s) with the need to borrow and the loan structure. With all of this in mind, the banker drafts a summary of the strengths and weaknesses of the credit request.
Only after the business and management review phases of the process are complete does the banker begin to consider loan structure. Ironically, this is the part most entrepreneurs want to know first: "How long do I get the money for?" "What is the interest rate?". It is important to understand the logic behind the bankers' rationale, only after he or she has determined the request is justified and can be repaid, can they comment on what the terms and conditions will be!
Entrepreneurs should be cautioned not to focus only on the interest rate as the cost of the loan. Banks can include fees, deposit requirements and other elements in the pricing scenario. Furthermore, banks can require certain performance conditions tied to financial covenants, which may be included in the loan agreement. These terms and conditions, which may include guarantees or subordination agreements, are often much more binding on company growth than the interest rate and should be negotiated carefully. Finally, the bank will typically require the borrower to provide financial information on a regular basis as a condition of the loan. A knowledgeable entrepreneur can negotiate certain elements of the loan structure
Once the loan has been funded, the banker relies on three sources of information to track the loan performance. Information internal to the bank systems is the most obvious, i.e. your deposit relationship and other accounts you have at that bank, and of course their records of your payments on the loan. Another source of information is the data the bank requires from the small business, such as the quarterly financial statements or any other insight provided to the banker during visits. Lastly, the bank will utilize other "outside" information such as reports from vendors, suppliers or your key customers. A savvy entrepreneur also manages these sources of information and uses them to initiate communication with the banker, thus creating a positive banking relationship.