WRITING A WINNING LOAN PROPOSAL
Business Development Specialist
I’m often asked by clients how long it takes to obtain a loan. And the answer is only a few days if you are prepared when you go to the bank. It takes a banker a relatively short amount of time to make a decision on your loan, but it takes a good deal of time to construct a credible loan proposal. How long it takes then really depends on you. You must address four major issues in any proposal to be considered a good candidate for a bank loan – or any other form of financing. How well you address these issues will determine the outcome. Being concise but also thorough in your approach will shorten the loan process, and make a favorable impression on your loan officer. The four major issues to consider are:
- CASH FLOW
It is too common an occurrence for the business owner to cover each critical area piecemeal, having gone to the bank with a few scattered documents and finding they need to be coached through the process by the banker. It is far better to complete all the preparations beforehand and appear well versed when you sit down to ask a financial institution for money. Let’s cover each area in a little more detail.
CASH FLOW: Banks are cash flow lenders not collateral lenders. That means they want the loan paid back through the profitable cash flow of the business not through the sale of assets. Cash flow usually can be proven by your historical accounting data from your Profit and Loss Statement and your Balance Sheet. In addition, you may be required to make cash flow projections for one to two years into the future to show the bank that the loan will contribute to future success. Bankers will use cash flow ratios to guide their decision, such as the ratio of cash inflow to cash outflow after the new debt burden is added to the business (Debt Service Coverage Ratio.) A typical threshold for this ratio would be 1.20:1. Which means that for every dollar going out of the business, $1.20 is being collected. Put differently, there is enough cash flow to pay for 120% of the companies debt obligations. Banks may also use data from the Risk Management Association (RMA) to compare your financial performance and projections to industry standards.
If you are starting a new business you will have only the projections with which to make this point. In this case, if your historical cash flows are marginal, you may need to show a secondary source of cash flows that could be used to repay the loan, such as: a job, interest income, or a cosigner.
CHARACTER: Character is a nebulous issue that hopefully demonstrates you behave like a person who is likely to repay a loan. This can be indicated by your longevity in business, your management/technical experience, and your credit rating. Any black marks in these areas will cast doubt on your ability to manage the banks money – particularly in the credit area. A bankruptcy within the last two years will probably eliminate you from consideration. Keep in mind that the bank is loaning you their depositor’s savings and has the responsibility to make a reasonable return.
COLLATERAL: Collateral is simply something the bank can take away from you if you default on the loan. Customary forms of collateral include your home, inventory, accounts receivable, the business property, and equipment with a ready secondary market. Primary collateral is matched to the source of repayment so that an operating line of credit is usually tied to receivables and inventory; machinery becomes its own collateral. Your home or business property may be tied to long-term investments in infrastructure or used collateral in abundance of caution. Tools and fixtures are usually not good forms of collateral because they are hard to turn into cash.
You show your commitment to your business and the bank through your knowledge, proactive approach, and willingness to take on a personal financial risk. Knowledge means knowing your financials inside and out, being prepared to answer questions, understanding issues and challenges particular to your industry, and showing the results of your SWOT analysis (strengths, weaknesses, opportunities, threats.) Being proactive means showing your commitment to growing and learning as a business owner, being open minded, and showing your commitment to the loan process by following up with the loan officer in a timely manner.
Your willingness to take on a personal financial risk means having enough of your own cash committed to the deal to incur a personal loss if you fail. Banks want you to take on risk beyond the collateral backing the loan. One way of determining your personal risk is the net worth of the business. Net worth, or equity, is what is left when you subtract all the liabilities of the business from all the assets, and represents the portion of the business you own. Banks are typically looking for a debt to equity ratio that makes sense for the industry. Capital intensive businesses are usually more leveraged than service businesses. Net worth/equity is looked upon as a cushion/breathing room by the bank. Ask your bank what equity formula they use
Make sure you ask for the right mix of a line of credit (LOC) versus a term loan. An LOC is appropriate for short-term flow cash needs and is meant to be revolved periodically and paid to zero at least once a year; a term loan is appropriate for long-term investments in capital assets, baseline inventory and startup working capital. Banks assume that short term needs for cash like lines of credit are paid from cash flow and that long-term needs like capital investments are paid from profits. Ask for the right mix of loans from the start, and you will make a lasting impression with your banker. If you are uncertain, ask your banker for assistance. Your banker has a vested interest in your success and they’re there to help. If you talk with a banker who suggests an improper mix of loans, you should say thank you, and find another banker.
Banking is a two way street and you should interview your banker as they interview you. Ask them: Do you have experience banking in my industry; will you be there for me through any bumps in my business; how long have you been a lender; who approves your loans; tell me about your bank; etc. You need to find a competent banker who is relationship oriented. Often times the best way to find out is to ask other successful businesses who they bank with.
How you put all this information together is also important. It should follow a logical order, be clear and concise, and have a professional appearance. A suggested outline follows:
- Title Page
- Table of Contents
- Summary of the Loan
- Description of the Business/Short History
- Description of the Market
- Management Resumes
- Use of Funds (Listed item by item)
- Past Accounting Data: P&L and Balance Sheets for Three Years
- Aging of Accounts Receivable
- Schedule of Long-term Debt
- List of Collateral
- Cash Flow Narrative/Assumptions
- Cash Flow Projections for Two Years
- Projected P&L and Balance Sheet for Two Years
- Tax Returns for Three Years
- Personal Financial Statement
With all of your information in good order, placed in a readable format, and well presented, the banker should be able to acquire a clear picture of your business and make a decision within a week or two. But beyond that, you will also have a better understanding of your business and be able to discuss and clarify for the loan officer any additional concerns.
Douglas Hammel is the principal Business Development Specialist with Douglas Hammel & Associates Inc. located in Olympia Washington. He consults with a wide variety of businesses in the greater Puget Sound area and can be reached at (360) 584-4075, email@example.com.
Copyright © by Douglas Hammel 2006