Small Business Financing – What Do Banks Look For?

Small Business Financing – What Do Banks Look For?

Underwriting a new business loan centers on the 5 C’s of credit: Capacity, Collateral, Character, Capital, and Conditions. Below are some general guidelines that are followed within the banking industry. For small businesses, the focus should be on the bottom line. One of the most important factors in determining if a loan is going to be repaid is the capacity of the business to pay back the loan. Many businesses get into trouble because they try to “manage the bottom line” to reduce taxes. Unfortunately, this is a double edged sword. Here is what you should focus on and what banks look for:

Capacity: Can the business repay the loan? This is based on the cash flow of the business. You must show that you can repay the loan with cash generated from operating activities. It’s a major uphill battle when cash is not being generated. Some businesses try to “manage the bottom line” to reduce their tax burden. Be aware that this is a double edged sword. Show a healthy bottom line in order to give yourself the best chance of getting your loan approved.

Collateral: Is the loan backed by sufficient collateral? Sometimes collateral is simple i.e. we underwrite a mortgage loan on a business property and we take out a mortgage lien on the property as collateral. Other times it’s not so simple. An all business assets lien is a blanket lien on all assets of the company. Sometimes there is not sufficient collateral to cover the loan (think law offices, or consulting firms where the assets are the people and a few computers). In this case, the Bank might utilize a government guaranty, such as through the SBA (Small Business Association), to help bolster the loan.

Character: What can be said about the quality of character of the borrowers? This is typically determined through research, reputation, and interactions. We want to lend to high character, trustworthy business owners that stand by their business commitments. Be prepared to discuss any personal credit or public reputation issues. Credit reports show how you treat your other creditors and are a good indication of how you will treat the bank.

Capital: Does the owner have “skin in the game”? This is simple, we apply an “advanced rate” to all loans. This means if you are buying a new $250,000 machine, we will lend up to 80% or $200,000. This ensures that the business is investing in the machine and therefore, has something at stake to ensure the venture is successful. Be prepared to put a down payment towards your loan.

Conditions: What is the health of the borrower’s industry? The Great Recession of 2008 affected most everyone. Some more than others. Although it seems as though we are through the greatest economic hardship since the Great Depression, there are still some lingering effects. In small businesses, we saw landscapers, electricians, construction companies, restaurants, and select retailers take a hard hit.

Overall, it’s not a bad time to apply with rates at all-time lows and with banks starting to open up to a wider range of businesses. Any questions? Feel free to reach out!

Andrew H. Howard

From Middlesex Savings Bank

291 Main Street
Acton, MA 01720


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