plura Financial Blog

blog for plurafinancial.com, an online matchmaker between banks & small businesses

What Banks Look For in a Business Loan

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Brandon Hinkle/www.plurafinancial.com

Banks primarily care about three things when making business loan decisions: cash flow, collateral, and personal guarantor strength.  Generally in that order of importance.  Let’s look at each item in more detail:

What is cash flow?   For banking purposes, cash flow is the pool of company-generated cash that’s available to make debt payments each year; generally this is EBITDA less taxes, dividends, and capital expenditures.  Banks don’t care much about projections; they want historical financial info to ensure there’s a track record of consistent, predictable cash flow.  When a bank is evaluating your loan request, they generally want a 25% cushion (for each $1 of required debt payments you should have at least $1.25 of cash available to make debt payments).  In other words, you need to have more cash flowing in than cash flowing out; ideally, 25% more!

What is collateral?  Collateral is the base of assets available for the bank in case the company is unable to make its debt payments with company-generated cash flow.  Banks typically want the “liquidation value” of the assets/collateral to equal the requested loan amount.  Liquidation value is basically the cash that could be generated by selling the collateral in the next 90 days.  The most common assets that secure a loan are accounts receivable, inventory, commercial real estate, and equipment.  Banks typically give a 20% discount to current accounts receivable & real estate, and a 30-50% discount to inventory and equipment.  For example, if your A/R aging shows $100k of current receivables, balance sheet shows $200k of sellable inventory, no equipment, and real estate that appraises for $500k, you’ll likely be eligible for $580k of debt: ($100k of A/R @ 80%) + ($200k inventory @ 50%) + ($500k real estate @ 80%) = $580k of net eligible collateral.

What is personal guarantor strength?  A personal guarantee (“PG”) basically gives the bank the right to go after your personal assets if the business goes defunct and is unable to service the debt.  A strong personal guarantee, for banking purposes, is one that has liquid assets in excess of the requested loan amount.  Liquid assets generally exclude retirement plans and funds held in trust because they’re not easy for banks to liquidate in a bankruptcy scenario.  The primary goal of a personal guarantee is to align your interest with the bank’s interest of getting the loan repaid.  Afterall, if you don’t stand behind your company, why should the bank?

Other things banks care about: 

  • The company’s net worth because it’s an indication of the cash that would be leftover if the company was liquidated today.
  • Your business & personal credit history, to gain comfort that you’re a responsible person of good character that finds a way to pay your bills on time.  Bankruptcy, for example, is usually a deal killer.
  • Customer concentrations.  If most of your revenue is generated from few customers, you’re more vulnerable than most banks are comfortable with.

In conclusion, banks just need comfort that you can pay the loan back, plus interest, on time.  The more evidence you have of that, the higher your chances of getting a good loan proposal!

For more info about how to find the right loan for your business, check out www.plurafinancial.com

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Written by entrabanker

March 20, 2012 at 3:17 am

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