David R. Evanson
Where’s the Money?, Fall, 1999
ADDRESSING A LENDERzzS NEEDS
Imagine yourself as a commercial lending officer. You have limited funds, unlimited discretion as to where the funds go and, letzzs not forget, ultimate accountability to a bank executive who holds your livelihood in your hands. Now, who do you want to lend money to?
The bottom line is that lending institutions select those borrowers that they deem to have the best chance at repayment. Like most of us, lenders have a risk-tolerance level that hovers in a conservative, self-protective mid-range. As a potential borrower, your goal should be to increase your bankerzzs “sleep factor” by providing the information they need to make a positive decision with confidence that their money — and their job — will not be on the line.
Financial statements form the backbone of the loan request and need to be complete and professionally presented. According to Alan J. Candell, Esq., president of Gladwyne Capital, Gladwyne, PA, a firm specializing in placing debt financing for emerging and middle market companies, all lenders require a:
• Balance sheet which shows the companyzzs assets, liabilities and equity
• Statement of cash flow which shows how much cash the business throws off each month, quarter or year
• Income statement which shows the companyzzs revenues, expenses and net income
(note: audited financials are generally required for loans over a threshold of roughly $2 million.)
Depending on the nature of the loan, lenders may also require:
• A complete description of all collateral
• An aging of receivables which shows the funds owed to the company by its customers. Accounts are typically aged in current, 30 day, 60 day, 90 day and 120+ day categories. This item is essential for asset-based loans that are based on a companyzzs receivables.
• A description of all real estate including photos (may not be necessary for loans that do not rely on real estate as collateral)
• A description of all machinery and equipment (not previously described under collateral)
• Financial projections
• Personal and corporate tax returns for the past two years
• An inventory listing may be required under certain circumstances.
Shop Talk: An aging of receivables schedule shows money is owed to a company by its customers and is grouped into brackets of time. That is, all the money that is currently owed in one bracket; money owed for between 30 and 45 days is grouped in another bracket; money owed for 60 days or more is grouped into another bracket. A company with chronically older receivables can often dramatically improve its cash flow simply by tightening up its collection process.
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MORE THAN JUST NUMBERS
Much like the business plan (although in a much briefer format), a loan request also includes qualitative information about the company, its management and the industry. These items are particularly important for newer companies without a strong financial track record. Each topic should be covered in no more than two or three pages. Why? Because bankers, whose main interest is in the financial information and whose schedules are as busy as yours, simply wonzzt read much more. So, if writing isnzzt your strong suit, consider hiring a business writer to help write the following elements:
– Company description. In the company section, include a brief history of your company, short product and/or service descriptions and plans for the future.
– Key personnel. A management profile section should include brief (two to three paragraphs) bios of each principal and/or executive. These bios should include education, pertinent work experience, managerial experience, industry knowledge and applicable outside activities (such as membership or activity in trade or professional organizations). Note–lenders do not want or need to know about part-time jobs you had in school or your job as a camp counselor unless the experience is relevant. They do want to know what it is in your background and education that will ensure your success.
Donzzt be shy. Be specific with regard to skills and accomplishments. The goal here is to inspire confidence and put an intelligent, experienced and successful person behind the numbers on the loan request.
– Industry analysis. An industry description would include a competitive analysis and a market analysis of the industry. Talk about trends in the industry and why these trends will support business growth. This section should make it clear that you understand your position in the market. One way to accomplish this is to do your homework in terms of the industry in which your business operates. This includes understanding the ratios, such as debt to equity, that can help to formulate a picture of how the business fits in with others of its ilk.
Taking Action: You can get a “statement study” report which details financial norms for your industry through banking trade group Robert Morris Associates in Philadelphia, PA. Call 215-446-4000.
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– Use of Proceeds. The Use of Proceeds section should tell the lender what the loan proceeds are being used for. Be specific about whether the funds will be used for inventory, working capital, staffing, etc.
DOING THE LEGWORK
Before beginning your quest for a lender, understand some of your options in terms of types of loans and what you–as a borrower–bring to the table. Are you, for example, in the market for an asset-based loan? These loans are based on collateral other than real estate, often accounts receivables and inventory. Asset-based loans are usually of a shorter duration and can be accompanied by various covenants.
Lines of credit, on the other hand, provide funds on a revolving, as-needed basis, and work well for businesses with seasonal markets that result in large peaks and valleys of cash flow.
Term loans, can be secured by real estate or large machinery or equipment. These loans are of a specific duration, typically more than five years.
For a description of these and other types of loans that are available in todayzzs lending environment, check out our “resume” sections to get a handle on which type is appropriate for your circumstances. There may be more than one which appears applicable to your circumstances. Talk it over with an accountant, a banker, or a loan broker (more on loan brokers later in this chapter).
“There are so many lenders with so much flexibility that finding the right lender has become a science,” says Candell. “Pricing and covenants can be substantially different and so it is critical to match the right loan package with the right lender.”
A Good Deal: If you donzz t have time to chase down a lender, and it does take time, consider using a loan broker. A good loan broker with experience can accomplish in an hour what it might take you three months to find on your own. Remember though, there are no professional standards when it comes to loan brokers, except satisfied customers. So, check references carefully before hiring anyone. Also see Loan Rangers sidebar about loan brokers.
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So donzzt waste time and money sending your loan proposal to every bank in town. Instead, do your homework. Call the banks in your area–both big and small. Ask to speak to a loan officer. Ask if they have done other loans to businesses at similar stages and in similar industries. Remember every lending institution and every lender has a personality and even major regional banks have likes and dislikes in terms of the types of investments they will approve.
SIDEBAR: BUSINESS-FRIENDLY BANKS
The Office of Advocacy of the Small Business Administration publishes an annual study called “Small Business Lending in the the United States” (a comprehensive state-by-state ranking of all 9,670 U.S. banks regarding their lending performance for business loans of less that $250,000).
It also publishes “The Bank Holding Company Study” which profiles the small business lending activities of the nationzzs larger banks, which includes a listing of the top three lenders in small business loan volume in each state.
These publications, among others are available through the Office for Advocacyzzs Web site at http://www.sba.gov/ADVO/stats/. Or contact the National Technical Information Service, 5285 Port Royal Road, Springfield, VA 22161; 1-800-553-NTIS.
Finding the right lender will not only improve your chances of approval but may also provide better leverage when it comes to the terms of the loan. “Itzzs more than interest rate alone”, says Candell. For example, a lender might generally allow receivables of 60 days or less as collateral. In certain industries however, where turnaround on receivables tends to be longer– such as health care which relies in large part on insurance payments– the lender who is familiar with this aspect of the industry might allow 60 – 90 day receivables. Or, certain lenders might allow a higher advance rate, say 80%, vs. 65% against collateral if theyzzre familiar with the intricacies of an industry.
Donzzt Forget: Consolidation in the banking industry presents a risk. If your lender is acquired, the new parent may not want to do business with you and interrupt loan agreements so strictly that it causes default. Choose your lender carefully, and as practical, assess the risk of an acquisition up front.
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Candell tells of a client who was in the specialty finance business — an area that can be perceived as risky. However, because the loan was placed with a lender who understood the nature of the business, Candell was able to obtain a higher advance rate than might otherwise have been offered. Another client needed funds to purchase vacant, unzoned land — typically a tough sell to a bank that wants good collateral. But, remembers Candell, his client received an informal commitment in a day. “Quick responses and favorable terms can be the norm if you know where to place a loan,” he says.
WHAT DO THE BANKS REALLY WANT?
Dominic DiMao, Assistant Vice President of FirstTrust Bank, a family-owned bank with 19 branches in Southeastern Pennsylvania, says that for small, individually owned companies, banks want proprietors to “stand up behind their company.” Small business owners should have a financial stake in their business. For new businesses, without a financial track record, the background and experience of the principals takes on greater significance. In these cases a “package” takes on a greater significance as well as showing a commitment and professionalism.
For larger loans–$2 million plus, DiMao says that reporting ability becomes a very important issue. That is, does the borrower have the systems in place to produce timely and accurate financial reports? Banks often require quarterly, even monthly, data and it is to a borrowerzzs benefit to have the systems in place to provide this information in a timely and professional manner.
The bottom line? Borrowers must understand their own business, and their position in the market and be able to clearly defend the purpose of the loan. A borrower must be able to explain how the loan will advance their business and finally, be able to prove that they have the ability to repay.
While most lenders donzzt require formal documents, a loan proposal can help to set a borrower apart from the pack. “They show that the borrower is professional with an organized and business-like approach and that makes the lenderzzs job easier by providing the necessary documentation in a succinct format,” says Candell. “This can help to speed up the loan process as well.”
The loan proposal does not have to be an imposing and formal document. It does however have to be neat and professional.
SIDEBAR: ANATOMY OF A LOAN PROPOSAL
Therezzs nothing like a table of contents to get at the heart of the matter. Here is a sample table of contents from a loan proposal prepared for a health care company interested in obtaining funds for a property acquisition and a refinancing. The components of a loan proposal should be geared to the specific loan. Thus, in this case, there are many items pertaining to real estate. If the loan were to be used for a different purpose, to purchase equipment, hire additional personnel, etc., the components would change, particularly under the Use of Loan Proceeds section.
Table of Contents
I. Behavioral Healthcare in the 1990zzs – An Overview
II. Company Profile – Past, Present, and Future
Exhibit A – Consolidated Income Statement (xx/xx/xx to xx/xx/xx)
Exhibit B – Satellite Locations
Exhibit C – Consolidated Income Statement (Fiscal Year xxxx)
III. Management (including biographies)
IV. Use of Loan Proceeds
Exhibit D – Agreement of sale
Exhibit E – Pro-forma Operating Statement
Exhibit F – Appraisal letter (for real estate)
Exhibit G – Photos (real estate, property, etc.)
B. Refinanced property
Exhibit H – Statement of Operations
Exhibit I – Pro-forma Operating Statement (FY xxxx)
Exhibit J – Introductory brochure (marketing piece for property)
Exhibit K – List of improvements
Exhibit L – List of inventory
V. Audited Financial Statements for each of the three years ending mm/dd/yy, as
prepared by (name of accounting firm)
VI. Financial statements for the period ending mm/dd/yy
VII. Budget for the fiscal year ending mm/dd/yy
VIII. Summary of note purchase agreement (relevant in real estate)
A three-ring binder works well as do the plastic bindings available from most office supply stores (they have the machines to put them on as well). Use tabs to separate and clearly mark each section. Donzzt rely on your own proofreading skills–youzzre too close to the project. Have someone else check your spelling, grammar, etc.
In todayzzs high-tech environment, many banks use an automated credit scoring system to say yea or nay to loans under $100,000. More and more banks are moving to these systems and it appears as if the dollar threshold is going to rise as banks gain confidence in these systems. Credit scoring can save both the borrower and lender a tremendous amount of time, and so you may consider approaching a bank that utilizes these systems.
But, while the process may differ, all banks are looking for the same thing–the ability to repay. Beyond this, different factors may be given different weights and emphasis depending on the personality of the lender.
In conclusion, remember. Lenders have many loan requests from which to choose, some of which are obviously stronger than others. But itzzs not their job to make the case for approving your loan. Itzzs yours.
SIDEBAR: LOAN BROKERS: THE 2% SOLUTION
Loan brokers are in business to assist businesses in obtaining appropriate financing. They can, of course, help to prepare proper documentation but perhaps the biggest advantage in using the services of a loan broker may be realized through their formal and informal lending network.
“You can save about 98% of your time if you go to a lender that understands your business,” says Candell. “You donzzt obtain funding by educating bankers, lenders or investors.
People who understand your business and industry are more likely to make a financial commitment based on the true worth of your company.”
Loan brokers charge a percentage of the loan proceeds for their efforts typically 1 percent to 2 percent for loans over $1 million and 3 to 5% for loans under $1 million. Oftentimes they will also charge an upfront fee. While this is not unusual, borrowers should be wary, cautions Candell. The industry has been seeing problems with these arrangements and there has been lots of litigation. Check at least two references, advises Candell, no matter what the financial arrangement.
You can find a loan broker in your area by checking the Yellow Pages under “Financing/Businesses.” Better yet, as you canvas lenders, ask them if they are aware of any good loan brokers who have approached them over the years. Finally, your accountant may have a releationship with a loan broker, since, when clients have problems, they often turn to their trusty accountant, who in turn might turn to a broker to run interference with lenders.
Donzzt Forget: A loan proposal is only packaging. You are really selling yourself, which means that to get a loan of any size, youzzve got to get out there, look the lender in the eye, and give them a sense of confidence they will get their money back.