Small Business Banking And The Six Cs
So, you need a business loan, huh? Right. You and a few hundred more small business owners in your market. Let's talk about how to improve your chances of success.When a professional salesperson is stalking a new prospect, he tries to learn everything possible about how that decision maker is motivated, and how the decision to buy is made. Armed with that information, our salesperson will significantly increase his chances of getting the sale.
You can be armed with the same information - how a bank is motivated, and how the decision to loan, or not to loan, is made - as you approach banks with your loan proposal.
In the old days, there was something called the "Four Cs of Credit." Today, that's been expanded to the "Six Cs of Credit." When a banker is considering a loan, any loan, a significant part of the process is developing this tried-and-true list as a kind of scorecard.
During one of the visits on my show with our Brain Trust's resident banker, Mike Menzies, President of Easton Bank and Trust, in Easton, Maryland, Mike talked with me about this scorecard approach.
By the way, Mike's bank is an independent community bank. That means it is owned and managed by local shareholders and board members. When you make a loan request to an independent bank, the entire decision process takes place locally. I like working with independent bankers, as you will see.
The Six Cs Of Credit
1. Character - Mike says this is the driver of all decisions. What is the character and integrity of the borrower? What do we know about this person?
Independent banks still operate in an environment where character means a lot. But I'm afraid in many larger banks, where credit scoring dominates the approval process of small business loan proposals, this "C" is less compelling.
The "character" component of your relationship with your banker can be the pivotal factor that makes a marginal proposal get approved, or a solid deal get rejected. The weight of your character in a loan proposal cannot be overestimated. Guard it well.
2. Capacity - What is the ability of the company to repay the loan? What is the company's cash flow picture?
A banker once told me that if he could only see one financial document of a company when considering a loan request he would ask for the cash flow statement, because that's where he could see if there would be enough cash to make the payments that repay the loan.
You've probably heard me say this before, "Profit is the Queen of business, but Cash is King." In the world of business lending, bankers want you to make a profit, but the first thing they look for is cash flow. Remember this: profit is an accounting concept; bank payments are made with cash, not concepts. Make sure you can show your banker how your cash flow picture looks with the periodic principal and interest payments included.
3. Capital - How much money is at risk. Is the dollar amount on the loan request justified by the supporting information provided by the borrower?
Bankers work with both fixed and variable numbers as lending parameters when considering your proposal. One variable number is how the amount you want to borrow compares to your financial strength (equity), sales volume, profitability, CASH FLOW, the underlying value of the asset being purchased, etc.
Two fixed numbers include the lending limit of your loan officer and the lending limit the bank can make to one customer. You might not bump the bank's single customer lending limit too many times, since that will likely be over a million. But you might well exceed the loan officer's limit. When you do it's not necessarily a bad thing, but it does add the next level of review, which means more eyeballs, more scrutiny, and more time until you get your answer.
If you're unsure about how your "capital" number fits with your proposal and with your banker, take him or her to lunch and have a preliminary meeting to talk about this "C".
4. Collateral - Collateral is the title to the truck you bought with the loan proceeds; the mortgage on your real estate; UCCs on inventory and accounts receivable. UCC stands for Uniform Commercial Code, and is a legal provision that allows a lender to record your financial obligation to them. It's the equivalent of a real estate mortgage, but is typically used to collateralize assets that are not planted in the ground, like inventory, A/R, furniture and fixtures, computers, etc.
Mike calls collateral the bank's "fall-back position." He says, "your loan was made possible by Aunt Minnie's deposits. If something happens and you can't pay back the loan, collateral minimizes the risk the bank is taking with Aunt Minnie's money."
It's true that some small business loans are made unsecured. But those are usually small amounts, and only when the "Character" quotient is very high.
Collateral is a banker's drug. They live for collateral. It is not possible for a bank to have too much collateral. Collateral makes their job easier, and helps them sleep nights. Remember this: Once a banker gets your asset(s) as collateral, short of a full payoff, getting it released is like getting a she-bear to give up her cub.
If multiple pieces of collateral are used to make one loan, fairly common in small business loans, make sure specific release triggers are in the loan documents. As your loan balance and/or other financial parameters are reached, pre-determined collateral is to be released. If you don't have this conversation before the loan is approved, be prepared to deal with the she-bear as you pay down your loan.
The Two New Cs
5. Coverage - Mike says this is insurance coverage primarily. Bankers are prepared to take the risks normally associated with banking. Your interest rate and loan terms are based on that level of risk over which they feel they have some control. When possible, banks look for opportunities to shed risk that can be placed elsewhere, and not borne by the borrower or lender.
Don't be surprised if a condition of loan approval is a recommendation to "cover" some of the risk through outside parties, like insurance companies. This will mean extra expense for you, but it may be the only way to get your loan.
Coverage is an excellent reason to approach more than one bank. It's not uncommon for Bank A to require significant coverage, while Bank B requires little or no coverage.
6. Conditions - Mike says bankers ask themselves, does it work? Are the conditions right?
This is where your banker decides if he likes your deal. For entrepreneurs, it can be the scariest and potentially the most frustrating part of making a loan request.
The best way to improve your chances here is to make sure your banker understands your plan. Before you make your request, think about how you will explain how you will use the money. How it will help you grow your business, strengthen your market position, make more money, etc. Practice on someone else in a role play before you go "live" with your banker(s).
One thing is for sure: If your banker doesn't understand your deal and how you are going to make it work, you won't get the loan.
Endangered Species
If every new idea, invention, or service had to be spawned from a bank loan committee, we'd still be hunting and gathering, naked as the day we were born. One of the rarest of all species in the marketplace is the elusive entrepreneurial banker: one who follows all the fundamental banking steps in evaluating your proposal, but who is also capable of seeing and believing in your vision.
With the level of regulatory oversight of banks these days, entrepreneurial bankers are definitely on the endangered species list. As you move through your small business career, keep a keen eye out for this rarest of species. If you ever find an entrepreneurial banker, make him or her your company's best friend.
On Any Given Day...
On any given day, one bank may want your loan more than another bank, which is why you MUST take your proposal to at least two, maybe three, banks simultaneously. In addition to increasing your chances of getting a loan, it's also a good way to find an entrepreneurial banker. And make sure that at least one of your prospective banks is an independent bank. That's where I think the last of the entrepreneurial bankers are found these days. By the way, having your loan approved at more than one bank is what I call a high class problem.
Write this on a rock... An element of risk is involved in EVERY loan a bank makes. It's your job to make sure your proposal helps your bank feel comfortable with the risk it is taking with your loan. You will have a better chance of getting your loan approved if you understand the Six Cs of Small Business Banking.
