Small Business Loans - Banks
All lenders have one goal in mind, a return of their money with reasonable rent for the usage (interest, fees, penalties), given the risk.
All banks look at 4 basic factors to determine if the loan is worth the risk they will take:
1) Cash Flow -- Are the cash flows of the borrower sufficient to make the payments? When lending for a business purchase, most banks want to see cash flow of 1.3 to 2 times the amount needed for debt service (after the owner takes a reasonable living wage.) In addition the bank will look at the operating capital needs to purchase inventory and fund accounts receivable. This additional money will come as part of the cash infusion expected from the borrower, or through an operating capital line established at the same time borrower applies for a long term loan.
2) Credit Worthiness -- Your credit history tells the bank about your ability to manage debt and plan wisely, while not all banks look directly at the FICO score, nearly all banks will pull your credit report from one of the three major credit bureaus.
Your Score determines the amount of risk the bank is likely to take in the other 3 areas described herein. If you have a high score, you'll likely get better rates and terms and may not need as much of a down payment or collateral to back the loan. The following are some rough guidelines on the way a bank looks at your score:
720+ -- Excellent Credit --This is considered an excellent score and you should have little problem getting a loan if the other areas are reasonably covered.
680-720 -- Good Credit -- This is considered adequate and if all other areas are reasonable covered, you to should be able to get a loan, although you may have to answer more questions, and the bank may require more money down and higher collateral coverage.
650-680 -- Marginal Credit -- Most banks struggle to make business loans to individuals with these scores. Every other area must be strong and they may require substantial down payments and collateral coverage. Nearly all banks will require cosigners to back the loan. Some marginal loans can be submitted as Women owned or minority loans and get some preferential treatment.
650 and below -- Poor Credit -- Most banks consider the risk to great to be acceptable and the SBA will not normally guarantee a business loan to a lender with a score below 650. While you can still qualify for many home loans, commercial banks are not likely to be of assistance to you in purchasing or financing a small business purchase. You will need to work to improve your credit score and/or find a cosigner or partner who has good credit.
You can find out what your credit report contains (but NOT your FICO score) by requesting a free report from www.freecreditreport.com. This is a service offered by Experian one of the three largest credit bureaus and can be very useful. However, this will not tell you your Fair Isaac Credit Score or "FICO" score, instead it gives a PLUS score, which is not the same. You can obtain a complete credit report and your FICO score from www.myfico.com. At last check for about $19.95 to pull a single report from one of the three major reporting bureaus. In Utah we have always recommend Experian, however Experian no longer offers this report, so select one of the others. Requesting the report as a consumer does not affect your credit rating and is recommend to anyone considering borrowing. Be aware, there are many other "Credit Scores" sold or given on the internet (such as the new FICOplus), they are NOT the same as the FICO score and will not give you the score you need, if it does not say FICO, it is one of the new types that is calculated differently and will not match what the banks see.
3) Collateral -- Every bank wants to know how they will get repaid IF you default on the loan. This area defines a banks "criteria" more than any other. Generally, your smaller home town banks want more collateral, generally 100% coverage. While some of your credit unions and larger banks may be willing to rely on the cash flow and accept lower collateral coverage. Generally, if the assets of the business are not sufficient, they look at the borrows balance sheet for additional assets to cover the loan. When we speak of "collateral coverage" this is a measure what the bank will accept. Below is a chart showing what some major banks consider acceptable coverage for various types of assets
||As collateral for business purchase
|Furniture, Fixtures and Equipment
||up to 80%
||Up to 100%
||up to 80%
||up to 50%
For example, if you have $100,000.00 dollars in Furniture, Fixtures and Equipment, the bank is likely to borrow $50,000.00 to $80,000 of the Fair Market Value against it in a business purchase. If you have an existing business with established cash flows, and are purchasing new equipment you may be able to borrow 80% or more.
4) Related Business Experience -- The bank wants to know you will succeed and they know from experience that your more likely to succeed buying a business you know something about. Also, buying a franchise that offers training and a proven business model can help alleviate the banks fears.
REMEMBER -- Funding is a multi-faceted decision, deficiencies in one area can be overcome with strengths in others. For example, insufficient cash for the down payment can be offset by solid cash flows and collateral, or weaker collateral may be offset by good cash flows and solid business experience (such as in-place management buying out the company, or strong managers in the industry, buying a competitor). Weaknesses in more than one area may need to corrected before applying.
UNDERSTAND -- Put your self in the banks position and present you application in the best light possible, emphasize the strengths and address the weaknesses head on.
BE AWARE -- There are two types of lenders: 1) Asset lenders and, 2) Cash Flow lenders. Some banks make loans primarily based on the assets they have to secure the loan, this is general true of local banks. Other banks make loans primarily based on the Cash Flow of the business and it's ability to repay the debt from the Cash Flow. Alpine can help you select the right lender and package your loan appropriately.
Small Business Administration Loans (SBA)
The SBA is not a "Lending" institution that makes loans to the average business. The SBA is primarily a "Guarantee" agency that backs qualifying loans made by other lending institutions. The amount of the guarantee varies with each program, but makes it possible for normally very conservative banks to make loans that they would not normally accept. Outlined below are the main SBA programs and terms you should be aware of.
1) Preferred or Certified Lenders - Preferred Lenders have special turn around privileges and reduced paperwork that can result in faster SBA guarantee approval and quicker loans. Certified Lenders have even more authority to approve loans and are give a 36 hour turn around commitment on loans submitted to the SBA. All other lenders are required to submit the full required documentation and may have to wait longer for review and approval.
2) Guarantee Programs - The SBA has several guarantee programs designed for different needs they are:
A) 504 Loans - This program is designed for loans to purchase major assets such as land and buildings. The SBA works through Certified Development Agencies in each region, who in turn, work with your local banks. The maximum size of loan under this program is 1.5 to 2.0 million depending on your industry and number of employees. There is a special 4 million limit on certain "Small Manufacturers" who meet stringent criteria.
B) Basic 7(a) - This is the most common type of SBA guarantee program you will see. The SBA will guarantee qualified loans up to a maximum of 2 million dollars of which the SBA guarantees 75%. Each owner of 20% or more is required to personally guarantee the loan. Loans can be for up to 25 years for certain types of assets, but in practice, small business loans tend to be 5-10 years, depending on the useful life of the assets being purchased. Interest rates may vary from lender to lender but may not exceed maximums set by the SBA for each type of loan (number of years, fixed rate, or variable rate). The SBA guarantees up to 75-85% of these loans, depending the size of the loan.
C) SBA Express Loans - These are essentially, 7(a) loans for amounts less than $150,000. The SBA requires less paperwork and faster turn around. As a result, they only guarantee 50% of the loan. This translates into more stringent rules by the banks to insure there loan is secured.
D) Other Programs- There are a few other specialized programs such as the Export Working Capital Loan Program, which, as the name implies is for companies who are engaged specifically in export trade. Also, 7(m) Micro Loans which are short term loans of up to $35,000 for special circumstances and Disaster Recovery Loans that are offered from time to time to individuals and businesses in disaster areas.
Small Business Lines of Credit
There are several sources for Small Business Lines of Credit. Many banks will allow you to establish a line of credit to provide for working capital, either in conjunction with another long term business loan, or independently. Banks will consider the same criteria that is discussed above. In addition they will consider such items as Inventory and Accounts Receivable as collateral for such a loan. Other possible sources of operating capital are home equity loans, signature loans, and revolving credit lines such as credit cards. Alpine has a number of lenders who have been helpful in providing lines of credit for our buyers and we can assist you in structuring a loan package that is right for the business.
Small Business Grants
While we all hear about the government giving away money to small businesses in the form of grants, we have not experienced any success in getting grants for traditional business ventures.
Home Equity Loans
This used to be an excellent way fund all or part of a small business purchase. However, it is very difficult now to get Home Equity Loans above 80% of the value of your home. Home loans, whether primary mortgage loans or secondary loans or lines of credit,still remain a viable way to fund all or part of a small business purchase and have the best interest rates and longest repayment terms. Since a bank will want to secure a business loan with the equity in your house anyway, why not take out a home loan with better rates and terms anyway. Alpine has a number of direct lenders who make first and second mortgage loans without heavy fees and closing costs, in addition to traditional mortgage brokers who can look at a wide range of programs.
Nationally, 2/3'rds of all business purchases include some form of financing by the seller. This can take the form of a nominal amount, such as 10-20% of the purchase price, which assists with bank financing, or may be up to 70% or 80% of the purchase price. Alpine has been successful in assisting 70% of its buyers in securing sufficient outside financing to not require sellers to carry any financing.
Venture Capital & Angel Investors
When purchasing a company with 2 million in after tax profits, you can begin to attract participation from Venture Capitalists and Angel Investors. These groups are not looking to finance smaller businesses and expect that the company will grow rapidly, or can be improved and sold to a larger company.
Friends and Family
If you have family members who have been successful, or who may want to join in a new venture, it can be useful to see if they will borrow a down payment, or become a partner in your new company. It is important that you involve them early in the process and that they come to all the meetings, sign the confidentiality agreements and are in agreement from the beginning. Our own experience tells us that it is rare to for family members to loan money if they have not been involved from the start.
This is one of the most expensive ways to fund the down payment for purchasing a business, and banks take into consideration the minimum payments required to pay back this debt, and maxing out your cards will lower your credit score. However, when credit card companies offer low interest balance transfers, or other programs, it has been a source for some buyers.