Small entrepreneurial companies account for more than 98 percent of U.S. businesses —many of them under-capitalized. Most small businesses turn to banks for their financing needs, typically relying on lines of credit for working capital and on term loans for asset financing or long-term expansion.
Bank lenders must carefully evaluate the financial state of the small business before approving a loan and generally will focus their financial analysis on three areas:
Performance over the last three to five years, if history is available.
Future performance, based on projected changes in a business’s financial condition.
The business’s strength, based on its balance sheet.
This financial analysis often is challenging, both for the small business owner and the lender. For example, small business owners may look for ways to reduce profits in order to be taxed at lower rates. This tactic can create a false perception of the company’s performance.
Additional challenges facing small business owners when attempting to secure a loan include:
1. Small business owners may be reluctant to take the advice of outside counselors, such as attorneys, accountants or lenders. Entrepreneurs often leave prior jobs, after having made it in highly competitive markets, to open their own concerns.
While they may need to take on substantial debt to open their businesses, they sometimes feel they can get by without advice from outsiders. Yet, ignoring such advice can leave holes in a business’s financial plan that send up a red flag to a lender. Entrepreneurs need the support of their team—their attorney, accountant and banker—for financial success.
2. Entrepreneurs can be highly protective of their management positions and may have everyone in the company reporting directly to them. The business therefore has no chain of command, and the owner makes all of the decisions.
Being in charge is what makes them entrepreneurs, yet they still must provide for back-up decision-makers to serve in their absence. Unplanned-for financial situations can come up at any time, requiring a quick decision to satisfy a lender. A good contingency plan provides this safeguards.
3. Entrepreneurs often are do-ers, not teachers. The founder of a small business may be reluctant to relinquish control and train a successor. Not having a management succession plan impedes the loan process, because lenders must ensure that the business can survive the death or disability of the owner.
4. Many entrepreneurs have not taken the time to set up an estate plan and may not have life insurance or a will. The business may have to be divided or sold to pay estate taxes and bank loans when the entrepreneur dies. Bankers need assurances that the business can continue after the death of the owner or can be sold or liquidated quickly enough to cover all the costs.
5. Some entrepreneurs operate without a working business plan. A business with no specific plan for growth cannot clearly articulate its borrowing needs to sustain that growth.
The lender may check trade references and supply sources to confirm that the business can be assured of an adequate supply of goods to continue its operation. The lender also may review industry competition and trends.
Are competitors outperforming the company?
Is the industry as a whole growing or shrinking?
Comparison of a company’s financial results with industry averages is another excellent way to determine a company’s strength. Finally, the lender may visit the business premises for a physical inspection to learn how the business is organized and managed.
Most important is a solid, long-term relationship between the bank and entrepreneur—it will pay dividends for the small business owner both in start-up and future expansion borrowing needs.
To protect themselves from the many variables in financing an entrepreneurial endeavor, many financial institutions rely on the SBA (Small Business Administration) loan guaranty program for small business lending.
Banks work in a mutually beneficial partnership with the SBA to meet the credit needs of small businesses. For the lender, a certain percentage of the loan is guaranteed by the SBA. For the borrower, the SBA provides flexible funds for working capital, machinery and equipment, inventory financing and real estate through its SBA 7A loan program. Loans specifically for fixed asset/real estate acquisition are available through the SBA 504 loan program.
SBA loans provide an excellent alternative source of term financing for new and established ventures.
Author David Gasca is vice president and leader of the U.S. Bank’s South King County and South Puget Sound business banking teams. He oversees 10 business banking lenders serving customers in South King, Pierce, Thurston, Kitsap, Grays Harbor and Lewis counties.