Today we are going to specifically discuss Commercial Lending. I will share with you 5 steps entrepreneurs need to do before approaching banks for a business loan.
Did you know…. “Nearly 89% of business owners report having the enthusiasm to execute growth strategies, yet just 46% report having the necessary financial resources to successfully execute growth strategies,” wrote Craig Everett, director of the Pepperdine Private Capital Markets Project.
With over two decades of experience, I have some positive and also some negative experience when dealing with banks. Bottom line from my experience is, when you need cash banks are reluctant to lend it but and I stress, the time when you have positive cash flow is when you should be asking for more! Running a business is challenging in itself however, if you are experiencing negative cash flow, well it then takes you to a whole new level of obscene stress. Sadly, I have coached and witnessed many colleagues and business owners that have their current loans pulled from underneath them, and in some instances the reasons were completely out of their control. Like Ken Lee story earlier on episode 005 when he explained the impact the Global Financial Crises had on the health care industry in Australia back in 2008.
Here are five steps to successfully prepare your next business loan or increase your existing lending facility.
Step 1 - Prepare a “Loan Package” that includes all the documents and details the lender generally will be seeking, such as, but not limited to:
A business plan including summary of your companies, product, market, team members and past financials statements and business owners’ resumes. Also, include Future Financial Projections Profit & Loss, Balance Sheet and Cash Flow Statements. Lastly, they will want to see your personal financial information including three years of personal tax returns.
Step 2 – Have specifics on what you need the money for. Here are some good reasons for a loan; financing a piece of equipment, real estate, long term software development or large seasonal sales variances. Do not ask for a loan to finance ongoing losses, office/warehouse build outs, or acquiring non-essential business assets.
Step 3 - Find a lender that is the best fit for your business’ loan needs.
Step 4 - This one is important… Most commercial lenders look at key ratios bench marking by industry. Although ratios don’t make sense to the average entrepreneur, the bank will rely heavily on just 3 ratios to get a good picture of your business, and importantly your serviceability to repay, so it is important for you to understand how to calculate them and more importantly what they mean and how you can improve. It is also very important that you explain how you will be able to service the loan each month. Example repayment - is this from personal funding, your lines of credit, residual income, dividends paid etc.
There are the 3 important ratios that you must understand:
Once you completed your pro forma financial statements based on your proposed loan, go through and calculate these ratios.
If you have a good handle and understanding of these three ratios, you will be able to go into the bank with confidence that your loan request is reasonable based on industry standard ratios. Plus, you can leverage your numbers if favourable to request lower interest rate or better terms and conditions.
Step 5 – Make a list of lenders you will approach starting with the most favourable. Keep in mind it can sometimes take 2 to 4 months to get an answer. If you get a yes on the first one that’s awesome but make sure you still go to the others on your list so you can then compare terms and negotiate a better deal. If you are turned down, ask them why so you can improve your situation for the next institution you approach.
Now onto Ken’s Lee story and what inspired me to talk about the topic, is when I asked Ken what was his worst Entrepreneurial moment.
Ken’s story provides us with an essential life lesson, “Never assume anything.” Ken assumed that the Global Financial Crisis wouldn’t and to some degree couldn’t effect the pharmaceutical sector. He learnt the hard way and realised that even some of the most abstract scenarios, can still be obstacles for you and your business. This story encourages the notion mentioned in this episode, “loan money while you still can, and while you’re still ahead.”
“Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed.”
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More… Some suggest that a leverage ratio over 4 to 1 would significantly reduce your chances of securing a traditional bank loan. The basic idea is that your lender doesn’t want you to simply borrow in order to grow the business. You need to put something in as well. So how do you improve your leverage ratio? Pay off your debts and your leverage ratio will come down, or simply increase your cash balance without borrowing.
More… Most lenders will require the appraised value of your collateral to be higher than the loan amount. The lender is looking at this ratio to see how much breathing room they have. If the business is to default on the loan and the bank ends up with the collateral, the bank wants to make sure they can sell the collateral for a value high enough to recover the entire balance of the loan. You should simply provide the bank with collateral that is appraised for more than the amount of the loan.
More… You can calculate your debt service coverage ratio by dividing your annual net income by your annual debt service. Debt service is a fancy way of saying your loan payments. Again this is simply a way for the bank to determine how much breathing room they have. This ratio tells the lender how many times you could make the loan payment with your net income. If you could make the loan payment 10 times with your net income each year, you have plenty of breathing room. If you can only make the loan payments 1.25 times per year, the bank is going to be nervous that if there is any negative downtrend with your business, you won’t be able to make your loan payment. This is simply a ratio that you should be aware of, so that you don’t request a loan that is larger than you can handle.
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