David R. Evanson
Privately Published, Fall, 2004
Lenders are driven by many factors. One of them is self preservation. Simply put, no lender wants to make a deal that goes “upside down” Therefore as a would-be borrower, one of your jobs is to increase the comfort of the lender, and provide them evidence that your business will repay the loan. This job starts with the preparation of the loan request. Here are the elements of a winning one.
It’s All About the Numbers
Financial statements are the backbone of your loan proposal. Obviously, you need an income statement, balance sheet and statement of cashflows. Most small businesses don’t have audited statements, but nonetheless, should present statements that are compiled and perhaps reviewed by a certified public accountant.
Review is a technical term in the context of accounting. It’s not a full audit, but it goes beyond a mere compilation, which in the final analysis represents your financial statements on your accountant’s letterhead. A review, sometimes called an analytical review includes testing of certain components of the presentation, but not an assurance about the reasonableness of the financial statements.
At all costs, however, you should avoid presenting internally generated financial statements because they often raise more questions then they answer. You can and should however present a number of internally generated items including: A schedule of all collateral; An aging of accounts receivable; A description of all real estate including photos; Financial projections; Personal and corporate tax returns for the past two years; A schedule of inventory, if any.
The development of financial projections is an art unto itself, that goes well beyond the scope of this article. However, it’s fair to state that your financial projections are the linchpin of the proposal. After all, the loan request is being evaluated on whether or not the projections materialize and generate the kind of cashflow that will pay off the loan. True, the collateral for real estate loans – the property itself – is vital since, in the lender’s eyes it’s the source of repayment if the cashflow dries up. But few lenders want to make a loan knowing the lender will default, just because there’s adequate collateral.
Although five year projections are standard, it’s the first three years that really matter. And of these, the first year should be presented monthly. Subsequent years can be presented quarterly, if visibility becomes difficult after a certain point in time.
A loan request also includes qualitative information about the company, its’ management and the industry. This subjective, qualitative look, particularly important for newer companies without a lengthy track record, should consist of the following elements: company description, key personnel, industry analysis, marketing operations and description of the use of proceeds.
Putting it all Together
Here is a sample table of contents from a loan proposal prepared for a restaurant company interested in obtaining funds for a property acquisition and a refinancing. Note section A below, simply titled Loan Request. Keep in mind, the components of a loan proposal should be geared to a specific loan. Therefore the Loan Request spells out the kind of loan you want, the amount of the loan, and a one to two sentence description of why. Don’t give this section short shrift just because it’s little. If the lender can’t get past the first page, your loan request won’t go much further either.
Table of Contents
A. Loan request
B. The Restaurant Business in the Tri-County Area – An Overview
C. Company Profile
D. Management (including biographies)
E. Marketing Operations
F. Use of Loan Proceeds
Agreement of sale
Pro-forma Operating Statement
Appraisal letter (for real estate)
Photos (real estate, property, etc.)
G. Refinancing of existing property
Statement of Operations
Pro-forma Operating Statement
Introductory brochure (marketing piece for property)
List of improvements
List of inventory
H. Compiled, Reviewed or Audited Financial Statements for each of the prepared by (name of accounting firm)
I. Financial forecasts
J. Tax returns of principals
Selling the Deal
Now, here’s the shocking truth. No one ever landed a loan with a great loan proposal. The documentation is simply a blue print. To win the lender over, you’ve got to present and sell the deal.
This should come as no surprise. Remember, the basis of all loan underwriting are the three C’s: Cashflow, Collateral and Character. At the most fundamental level, character speaks to repayment. Specifically, has this person historically paid their debts? But at another level, character speaks to the confidence the borrower inspires in the lender. As you make your request for a loan, the lender is thinking, “Can this person pull it off? Can they get the loan, put it to work, and generate the kind of cashflow the forecasts suggest?” If the response is something like, “They can’t even sell me . . .,” it dramatically undermines the loan request.
Accordingly, you should prepare and rehearse a presentation that walks the lender through your loan proposal. A good lender will readily embrace the opportunity to hear your pitch. And even if a lender tells you it’s not necessary, you should press your case, and suggest you feel it’s important that he or she see the presentation. Even if you never get the chance to present the proposal, you haven’t wasted anytime making a formal presentation. The act of doing so will prepare you for answering the many questions that you will face during the loan approval process.
Here’s some important points to keep in mind regarding your pitch. Your presentation should be no longer than 20 minutes. This means that you should spend no more than two to three minutes on each section outlined above. Some common errors that borrowers make are droning on about technology, assuming a higher level of knowledge on the part of the lender about your industry, and being overly optimistic with respect to the future sales and earnings of the company. Some sort of visual support is helpful. But again, a common error is packing the slides or handouts with too much information. You want to create bill boards not manuscripts. There will be plenty of time later on for excruciating details.
As you draw up your loan proposal, remember that 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.