Our friends at Revitalization Partners help companies make better decisions about business operations. This blog from their newsletter focuses on securing new or renewed business loans in our recovering economy. At Juniper Capital, we are committed to sharing business advice that helps you achieve or maintain business success. We specialize in real estate investments with hard money loans in Washington, Oregon, and Idaho. Share your thoughts on this blog, so we can continue to provide you with quality information about doing business in the Pacific Northwest:
Despite an economic recovery that is well underway, many businesses still get turned down for new business loans and loan renewals. Despite a company showing signs of bouncing back from recession-based problems and their projections making a clear case for the future, regulated banking entities still often decline to make the loan.
There are many factors that go into making the decision of ‘creditworthiness,’ beginning with the banking system. In the end, anyone who says size doesn’t matter is lying– at least when it comes to business lending. Size matters a lot and perhaps more than any other factor, size determines which bank will and won’t provide a credit facility. Borrowers that need loans between $2 million and $10 million are finding that they have the fewest choices and pay the most for their money.
All banks have legal lending limits that they cannot exceed when making loans. A bank legal lending limit is the maximum amount that any particular bank can lend to a single borrower or related group of borrowers. Also, banking regulators want banks to spread their risk by having a diversified portfolio and not a lot of loans at or near the legal lending limit. As a result, for most banks the effective in-house lending limit is considerably less than its legal lending limit.
As a general rule, borrowers that need loans larger than $2 million are too big for about 80% of U.S. banks. After a generation of bank consolidation, the U.S. banking industry has been hollowed out from the middle. Only about 6% of U.S. banks are larger than $1 billion in size and have the capital base to concentrate on middle- and lower-middle-market businesses. On the other hand, small banks lack balance sheet size, geographic reach, back office infrastructure and a product mix to satisfy the needs of most middle- and lower-middle-market businesses. Regulators that are rightfully concerned about future loan losses and credit quality are further restricting small bank credit in an effort to prevent today’s new loans from becoming tomorrow’s mistakes.
Bankers who say that the rules really changed after the 2008/2009 banking crisis are only partially correct. The rules for small business and lower-middle-market lending are essentially unchanged. What has been added is the effect of Dodd-Frank legislation on regulators, recently causing them to play a greater role in enforcing their rules rather than trusting bank executives to self-regulate.
The rules for providing business loans secured by accounts receivable and inventory have been around since March 2000, while the rules concerning floor plan lending to retailers haven’t materially changed since May 1998. These rules are set forth in easy to understand and very detailed “how to” manuals published by the Office of the Comptroller of the Currency and can be easily found on the Internet. Unfortunately, only a few banks under $1 billion in size comply with the lending rules, and as result only a few banks can participate in the collateral-dependent secured commercial loans market without being criticized by their regulator.
The problem that small banks have is that it is expensive to comply with the lending rules. Unless banks are going to make a large number of accounts receivable and inventory-secured loans or inventory-dependent floor plan loans, it just doesn’t make economic sense to spend the money required to comply with the rules. Many small banks have pulled out of collateral-dependent business lending and business borrowers are finding that their financing options have been restricted.
Many times when banks say no, it’s because they’ve looked at what the company is requesting in light of historical performance or its balance sheet, and see that it really needs equity in addition to debt. Obviously, it’s more appealing for a business owner to pay a low percentage to the bank than to give away a portion of the company, but unfortunately, equity investments are the reality that most entrepreneurs face once they are past the bootstrap stage. Most companies can’t grow just with debt.
A good rule of thumb is that for every $1,000,000 in debt you’re seeking, you should have $300,000 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 over-leveraged.
Banks look at an application like this: if we give them that money today, could they make the payments based on their cash flow from last year? Companies often want a lender to make a loan based on their projections.
If you’re asking for a loan based on projections, nail down the proof. “The market’s great and we think we can grow 20 percent” probably is not going to be assurance enough for a bank. If you can demonstrate why the profit is going to be greater and have a very convincing story built around facts, often a well put together projection will get a successful hearing.
One of our major services at Revitalization Partners is assisting our clients to get new loans. We see these problems constantly, not just with companies that have sales in the low millions, but with companies that have tens of millions in sales. We’ll start analyzing their financials and see that something doesn’t make sense and something else doesn’t balance. We’ll see projections that don’t tie in with accounts receivable levels or current payables. Any lender looking at the data would think the company has poor financial controls.
This is a problem you can fix (or ideally, prevent) by making sure that you have help from people who know how to present your situation in the best light to the lender. People on your side who can make certain your data and projections are accurate and tie together. People who know what the banks want to see before you finalize your presentation to the bankers.
Revitalization Partners is a Pacific Northwest business advisory and restructuring management firm with a track record of achieving the best possible outcomes for clients. They specialize in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Contact Revitalization Partners if you want the best resolution in the fastest time with the highest possible return.
Revitalization Partners… when a company is worth saving.