Having talked with hundreds of companies about financing over the past 10 years, I know that one of the most frustrating experiences for growing businesses is getting turned down for a loan. And I get it: the business’s leaders are confident the company will grow and be able to pay off a loan and they think they’ve made a clear case. In New Resource Bank’s situation, because we’re looking for borrowers with a commitment to sustainability, when people can check that box a loan seems all the more assured.
And yet sometimes we still say no. We don’t like to. We try not to. But any bank has to consider creditworthiness when evaluating a loan application. And if your application sends up major red flags, the banks you apply to are likely to say no, even if they agree that your business has great potential. Many factors go into assessing credit risk, but the top three leading to turn-downs are:
1. Undercapitalization. Most often when we say no, it’s because we’ve looked at what the company is requesting in light of historical performance or its balance sheet, and we see that it really needs equity in addition to debt. Obviously it’s more appealing for a business owner to pay 6 or 7 percent to the bank than to give away a portion of the company, but unfortunately, equity investments are the reality most entrepreneurs face once they’re past the bootstrap stage. Most companies can’t grow just with debt.
A good rule of thumb is that for every $300,000 in debt you’re seeking, you should have $100,000 in equity. If you are asking for a loan that will put your company at a debt-to-equity ratio of more than three or four to one, a bank will think you are overleveraged.
2. Insufficient historical profitability. Banks look at an application like this: if we gave them that money today, could they make the payments based on their cash flow from last year? Companies often want us to make a loan based on their projections. If they can demonstrate why the profit is going to be greater — say, they just signed a new contract with a major retailer or other significant buyer — we’ll consider it.
If you’re asking for a loan based on projections, nail down your proof points. “The market’s great and we think we can grow 20 percent” probably is not going to be assurance enough for a bank. “We just did energy-efficiency improvements on our manufacturing facilities and we can show that our utility bills have dropped 20 percent” can help your case.
Source: Huffington Post | Gary Groff, Senior Vice President of Commercial Banking, New Resource Bank