Most businesses need some type of external financing during their formative and growth years. The purpose of this article is to make the process of obtaining bank financing easier, less stressful, and more successful.
Types of Loans:
Generally, there are two basic types of loans: term loans and revolving lines of credit. Term loans are loans that are used to finance a specific capital purchase, such as for additional trucks, or large equipment purchases. A term loan is repaid principal and interest, over a specific number of years. At the end of the loan term, your loan is all paid off and you are debt free. The other basic type of loan, which is the primary focus of this article, is the revolving line of credit. This type of loan is used to help carry payroll and other operating expenses during large jobs or to help even out cash flow when the weather is sunny and 72 degrees. Typically, revolving lines of credit are for a period of one year, so the loan would have to be completely paid off during peak seasons. The company only pays interest on the outstanding balance. A credit card is a form of a revolving line of credit.
Step 1 – Do your homework:
At no time in your life is homework more important than it is now. By homework I mean making sure that you have all of your paperwork in order before you make contact with any bank. The goal is to put on the best dog and pony show for the loan officer with the least amount of effort on their part. Because first impressions are so important, a well organized loan package can get you off to the right start.
Let’s take a look at what you have to prepare or assemble before that first meeting.
Financial Statements – Most banks will request the last three years’ financial statements, plus a current financial statement that is dated within 90 days of your loan request.
Income Tax Returns – You should be prepared to present your last three years’ personal and business (if you are a corporation or partnership) tax returns.
Personal Financial Statement – This is a form that is often supplied by the bank, but I recommend that you have your own form prepared in advance. If you are unfamiliar with the form, please visit my Web Site for a sample.
Cash Flow Projection – A one to five year cash flow projection should not only show when you will be taking advances on the line of credit but when you will be repaying it as well.
Business Plan – A business plan is a five-year blueprint of your company’s goals, and how you plan to achieve them. Even if you are not currently in need of financing, this is an excellent roadmap to success.
Depending on the size of the loan request, a bank may not request a projection or a business plan. That may be to your disadvantage. Financial statements, income tax returns and personal financial statements only tell the bank where you’ve been, but it doesn’t say anything about where you are going to be in two to five years. That’s the job of projections and your business plan. So don’t short change yourself or your company.
Step 2 – Choosing a bank:
Now that you have enough paperwork to testify before congress, it’s time to find a bank. Because banks come in all shapes and sizes, a few minutes spent on how to choose a bank will save you some time and aggravation.
There are generally two types of commercial banks. There are the big multi-state, multi-branch banks, and there are local banks with one to a handful of branches located within the city. While both types of banks make the same kinds of loans and request the same documents, it’s worth mentioning a little about their lending practices.
Large banks, because of their considerable financial resources, tend to be aggressive. Large banks, become large in two ways - they buy other banks and they bring in new business. So when you walk in the door looking for a loan, they are secretly hoping that your business will fit into their financial guidelines. Those financial guidelines vary from large bank to large bank. I can tell you this, if you have lots of cash flow and plenty of profit you’re perfect. Seriously though, your loan officer will evaluate your financial package in relation to those financial guidelines and determine whether or not you qualify. In most cases, if you are within or close to the outer edges of those financial guidelines the loan officer has a good chance of getting you an approval. If your numbers are too far away, then there’s not much anyone can do. The good thing about a large bank is you always know where you stand; qualifying for a loan is a very black or white issue.
Local banks, because of their lack of considerable financial resources, tend to be more conservative and cautious. Local banks can’t afford to make a bad loan. Too many bad loans and they get a visit from the Federal regulators. Local banks are not as formula driven as the large banks. So the loan officer will probably spend more time with you and your financial data before presenting your loan request to a loan committee. The loan officer at a local bank has more of a dual role, they not only work for the bank, but they act as your representative before the loan committee. If your numbers don’t quite fit what the bank is looking for, your loan officer may just be able to persuade the committee to see things your way. The problem with a local bank is you’re never quite sure what factors ultimately persuaded the loan committee to accept or reject your loan request. It’s a more subjective process.
So which type of bank should you choose? Both types! In order to get the results you are looking for it will most likely take four banks, perhaps two large banks and two local banks. And if all four banks say yes, then you can pick the bank that has offered you the best deal.
With that said, how do you select these four banks. First, start with the bank you currently have a deposit relationship with. If you have been with the bank for a year or more and have maintained a reasonable average monthly balance you may have a little more clout than you would with an unknown bank. That still leaves three banks to choose. Next, you should explore the possibility of a bank or banker that has familiarity with the PHC Industry. Last but not least, call your CPA. Most CPAs have contacts at both large and local banks. My first stop is always with my bank contact, Chris Carter at Wells Fargo Bank. My clients most often benefit from the good working relationship she and I have together.
Step 3 – The dog and pony show:
It’s show time. Now that you have chosen your four banks, it’s time to schedule appointments with each to drop off your loan package. Plan on spending 15 to 30 minutes with each loan officer. Having your CPA at these meetings would be a good idea. These meetings are a good chance to tell them about your company, and answer some basic questions about your business. I recommend that you discuss the following. First, the history of your company, how it got started, how long you’ve been in business, what are your specialties, if any. Second, discuss some basic numbers, such as annual sales, number of customers, number of trucks, and the number of employees. Your CPA will come in handy here. Third, discuss the future. Tell them about any growth plans, plans to specialize in a new area, your marketing plans, and any other good news that you might have. Fourth, discuss why you need this loan. For example, to even out cash flow during slow months, to expand into another area of the business, because you are bidding /landed some big jobs that will have delayed billing, etc.
Keep the following in mind during your presentation. Be yourself - the loan officer is interested in you and your business. Be brief - too much detail at this point in the process may be wasted because the loan officer has not had a chance to review your package. Be honest – you can’t hide problems for long, sooner or later the bank will find out the truth. Don’t be afraid to be your company’s salesperson. Sell the bank on your business.
Step 4 – Connect the dots:
The loan officer will be spending four to five hours analyzing a business that you live 24-hours a day, year round. Even though you’ve laid out an impressive array of documents and narratives about where you’ve been and where you’re going, it’s just not going to translate to the loan officer in the same way you know it, unless you connect the dots. I recommend scheduling a conference call with the loan officer, your CPA, and you. This will be the time to fill in the blanks. Your CPA can help deal with financial questions, but your participation is also important because you help bring the company to life.
Step 5 – Congratulations:
If all has gone as planned, you should have one or more loan approvals in your hand within a week of submitting your packages. Don’t be discouraged by any rejections, and definitely don’t take out any frustrations on the loan officer, you might need this bank in the future. Whenever the outcome at a particular bank is negative, be sure to understand what factors lead to the loan rejection. This information may be useful to you at a later date if you need to change banks.
Conclusion:
Now that you have your line of credit, your work is done. Sorry, think again. Having a line of credit is part of a relationship. And the secret to this successful relationship is - communicate, communicate, communicate.
You or your CPA should call your loan officer at least quarterly to update them on what’s new with your business. Also, be sure to discuss both good and bad news. Waiting until the bank sees your bad news in the form of a financial statement is not how you want to break the news.
Keep this article in a handy place, because in ten months you will be starting the whole process over again when your line of credit comes up for renewal.
Stephen Hartfield, CPA runs an accounting firm that specializes in Outsourcing for plumbing and service companies. Steve can be reached at (714) 457-1783, at his Web Site www.debitsandcredits.com, or e-mail at srhcpa@debitsandcredits.com.