How to Increase Your Chances of Getting a Business Bank Loan

Introduction

Applying for a loan at a bank or any financial institution with lending capabilities can be frustrating, especially if the applicant does not know exactly what they need to do to win a loan officer's confidence. Banks have an obligation to protect the funds and assets that clients have entrusted to them; as such, they tend to be very conservative. At the same time, they are also businesses seeking profit — by recouping the principal of loans they extend to borrowers, obtaining a profitable rate of return, and ensuring that borrowers prosper and increase their deposits over time.

In the final analysis, it is the borrower's responsibility to develop and maintain a positive relationship with the bank, and to provide sufficient reason for the bank to feel safe entrusting its capital to them. This paper is, in basic terms, a guide for business owners on what needs to be done to satisfy bankers. It outlines the various factors that bankers consider before approving or rejecting a loan application, and the fundamental measures that borrowers can take to improve their chances of approval.

Factors Considered During a Loan Application

Regardless of the type of loan being applied for, bankers will typically consider the following four factors when determining whether to approve or deny an application.

Credit History

Loan officers will often review a borrower's personal credit history as well as that of their business — if it is not a start-up — to determine their degree of creditworthiness (Abrahams & Zhang, 2008). For an established business, lenders will generally consider it creditworthy if it has at least five trade experiences. Business owners who have been running their operations using personal assets alone, with no credit history, can boost their chances by making a number of trade credit purchases before submitting their loan application. An applicant's personal credit history can be obtained from consumer credit reporting agencies; it serves as an outward representation of an individual's character in terms of honoring their debts (Abrahams & Zhang, 2008).

Availability of Collateral

Collateral is a form of security that a borrower offers a bank or lender in exchange for credit. If the borrower defaults, the lender may seize the property put forth as collateral to recover the principal amount (Abrahams & Zhang, 2008). Collateral is one of the crucial requirements for obtaining credit and is intended to minimize the risk associated with extending it. The collateral offered will generally need to match the value of the loan, and its useful life must either meet or exceed the loan term. Most lenders will also require that the property offered as collateral carry no prior or superior liens — ensuring that the lender holds a priority claim over the property in the event of default.

The Business's Cash-Flow History

A lender will often review a business's cash-flow cycle — the average period between when inventory is purchased and when it is sold, or when accounts receivable are collected — to determine whether daily operations can support the loan being sought. In other words, lenders assess whether sufficient money is being generated on a regular basis to help repay the loan. Beyond revenue from sales less everyday expenses, a business's cash flows also include proceeds from financial or investment activities such as leases, purchase of machinery, insurance, and contracts. A business is generally deemed creditworthy when its ongoing collections and sales represent a regular and sufficient stream of cash (Abrahams & Zhang, 2008).

A business owner can improve their cash-flow position — and thereby boost their chances of obtaining credit — by delaying debt payments where possible, collecting receivables as promptly as possible, accelerating cash receipts, reducing credit allowances, or reviewing relevant tax strategies. For example, applying accelerated depreciation can increase a business's short-term deductions (Abrahams & Zhang, 2008).

The Debt-to-Net-Worth Ratio

This ratio measures the degree to which a business is supported by debt. A high debt-to-net-worth ratio indicates that the entity is funded to an unhealthy degree by borrowed money — that is, it is highly leveraged (Bangs, 2010). Entities with a high debt-to-net-worth ratio are considered less creditworthy and are, therefore, less likely to receive credit than those with lower ratios (Bangs, 2010). This is largely because net worth represents the amount of owner's equity invested in the business: the higher it is, the greater the business owner's stake, the more committed they are likely to be to the business's success, and the higher the likelihood that the business is a going concern.

In summary, bankers will typically turn down a loan application if:

• There is insufficient owner's equity and, consequently, a considerably high debt-to-net-worth ratio
• The business for which the loan is being sought shows a record of poor earnings
• The property offered as collateral is of low quality and does not guarantee a priority claim
• The business owner has a poor history of debt repayment

Strengthening a Loan Application

Business owners can increase their chances of obtaining credit by (i) drawing up a business plan and (ii) developing a contingency plan (Bangs, 2010). A business plan is intended to make the banker feel confident lending capital to the borrower. It demonstrates, among other things, the amount of the loan being requested, why and when it is needed, and the planned repayment schedule. It also adds credibility to the business through income statements, projected cash-flow statements, and balance sheets (Bangs, 2010). This gives the banker assurance that the borrower has a clear proposal — one that, if successful, could see the borrower return to expand the banking relationship by opening additional accounts.

In addition, a business owner should have a contingency plan: "a short worst-case business plan that examines the options that would be open to the business and how those options would be treated" (Bangs, 2010, n.p.). A well-prepared contingency plan not only demonstrates that the business owner has thought ahead, but also reassures the banker that the borrower anticipates business cycles and has put measures in place to address them effectively when they arise.

Conclusion

Bank loans are among the most common sources of finance for both start-up and established business entities. However, owing to the effects of the 2007–2008 financial crisis, banks have tightened their lending policies, which means the chances of a loan application being rejected are relatively high. Banks will consider a borrower's character, credit history, the business's cash-flow cycle and degree of leverage, and the availability of collateral when deciding whether to extend credit. Nevertheless, a business owner can still pursue alternative avenues — including borrowing from friends and family, seeking soft loans and venture capital, and engaging in asset-based financing — to obtain the capital they need if their loan application is denied.

References

Abrahams, C. R., & Zhang, M. (2008). Fair-lending compliance: Intelligence and implications for credit risk management. John Wiley & Sons.

Bangs, D. (2010). Getting a loan. Entrepreneur Media Inc. Retrieved 19 February 2015 from http://www.entrepreneur.com/article/241831

Bartram, P. (2014). When the bank says no. Director Publications. Retrieved 20 February 2015 from http://www.director.co.uk/magazine/2009/8%20September/finance_when_bank_says_no_63_01.html