|Fred McKinney, president and CEO of the Greater New England Minority Supplier Development Council.|
Last week, Bank of America hosted and delivered an informative and essential presentation on small business lending from the perspective of the bank. We also had two alternative lenders and the Small Business Association (SBA) at the presentation to talk about where their organizations fit in the spectrum of commercial lending. As I sat in the room listening to the presentations, as well as the questions, answers and discussions, I walked away with one fundamental question: What do banks want from potential small business borrowers before they will make a loan?
The answer to this question will undoubtedly vary from bank to bank, but I do believe that Minority Business Enterprises (MBEs) can benefit and increase their chances of securing a loan if they thoroughly understand and respond to this question. I say this as a director of a commercial bank and one who sits on the loan committee of that bank. Therefore, I have some practical experience and I am not just pontificating as I so often have the ability and tendency to do. So what is it that banks want?
I think high on the list of what banks want from prospective lenders is transparency. Transparency is an often used term in business and finance today because the lack of transparency in financial transactions often leads to disaster. Transparency means that parties to a transaction have all of the relevant and material information associated with the transaction. This means that the bank will want to know about the borrower. They will want to know the purpose of the loan. They will want to know how the borrower proposes to pay back the loan. They will certainly investigate the business history of the borrower, particularly the track record in paying back debts. All of these things are line items on most loan applications, but a good borrower will have updated and current answers to these questions handy at all times.
In addition to transparency, banks want to be comfortable in the ability of the borrower to execute the plan associated with the loan. There is a saying in venture capital circles that smart investors bet on the jockey, not the horse. Similarly, bankers are looking to be assured that the entrepreneur and the team of managers can execute the business plan that is associated with the loan. The entrepreneur must be confident in the ability of his managers and their assessment of the risks associated with the business. It is important for the bank to become confident that the plan is realistic or they will question the ability of the borrower to repay the loan.
In today’s market, bankers are more heavily regulated and scrutinized than ever before. The recently signed financial reform legislation was motivated by abuses and speculative excesses in the industry that resulted in the loss of more than $17 trillion in U.S. wealth and more than eight million lost jobs. Congress and the federal government are trying to make certain we do not suffer a repeat of this painful experience. As a result, commercial banks are returning to their roots when it comes to commercial lending. Banks have become cash flow lenders. This means that bankers want to know that the borrower’s net cash flow will be sufficient to pay the debt. The new legislation reminds us all that banks for the most part are lending businesses the depositors’ money and not their own capital. Since the depositors’ money is insured by the federal government, the government does not want to have to make good on its guarantee on those deposits. Therefore, regulators scrutinize banks to assure that they make loans that are economically sound. Borrowers need to be able to show persuasively how their business is going to generate those cash flows if they expect a bank to grant them loans.
Banks will also assess past performance. It is somewhat ironic that banks typically are looking for at least a couple of years of profitability when hardly any bank made money in 2008 or 2009. Yet banks are looking for profitability because cash flows come from profitability. If the MBE is not profitable, and I might add, if it is not paying taxes on its profits, banks are going to be reluctant to lend.
Banks are also looking for a second and a third way home. This means, that if all else fails, if the business is unable to generate cash flows necessary to repay the debt, the bank can still get its money back because the debt is secured with collateral that can be turned into cash. So banks are looking for all small business owners to personally guarantee the debt. This means all owners in the business must be prepared to put up as collateral their homes and other assets such as bank accounts and stock investments. And while that is a second way home, the bank may also require that SBA get involved if there is any doubt about the ability of the borrower to repay the debt. The SBA guarantee of 75 percent of the loan does not take the borrower off the hook for the personal guarantee, it just provides an additional layer of protection. Business owners who chafe at providing personal guarantees need not apply for a loan. The banks believe that if you are not willing and able to put up your own assets, why should they put the assets of their depositors.
There are other things that banks want, like love and understanding, but unfortunately there is not much of that for them in their chosen profession. But when it comes to information, that is accurate and timely, banks have legitimate demands if you have any hope of getting a loan.