Expert Advice on Small-Business Lending

You’ve probably read plenty of articles about small-business lending. But what if you could talk to a lender and get inside information that might not appear in the advice columns?

The Intuit Small Business Blog recently spoke with Mitchell Weiss for that very reason.

Weiss (pictured), an adjunct professor of finance for the Barney School of Business, previously owned several commercial finance companies and served as an executive officer at several banks. He now runs a consulting practice that advises private equity firms, banks, and small to midsize businesses.

We asked Weiss for his expert insight into small-business lending.

ISBB: Why are small businesses finding it so difficult to secure bank funding right now?

Weiss: The banks are conflicted. On the one hand, they need to make more loans because they have more deposits, which are liabilities on the lender’s balance sheet. Then, they have receivables, which are assets. However, they’re also still wary about what took place a few years back.

Can a startup secure a loan before opening its doors?

[That’s] hard to do, especially now. A startup is more likely to bootstrap its start — utilizing personal resources such as savings, credit card capacity, and asking for money from family and friends.

How is the lender evaluating the applicant on the most basic level?

All lenders use the credit underwriting process to answer four fundamental questions: First, whether to make the loan. In other words, do they want you as a customer under any circumstances? Second, how much to lend. You can ask for as much as you want, but that doesn’t mean you’re going to get it. Third, how much to charge. There is a direct correlation between risk and reward; the higher the risk, the more reward a lender will demand in the form of interest and fees. Finally, what terms and conditions to require. That old adage regarding the golden rule applies in this case — those who have the gold make the rules.

To answer these four questions, lenders will apply what’s known as the five C’s of credit in the course of their credit underwriting process.

Capital: Simply put, the difference between what you own (your assets) and what you owe (your liabilities) is what you’re worth — known as your equity. Lenders focus on the extent to which you have skin in the game in terms of money left in the business.

Capacity: Although you may have great promise and a hugely talented team, unless you can prove you have enough cash flow to make the loan payments, the lender won’t want anything to do with you.

Collateral: This represents the thing you’re looking to finance or willing to pledge to back up your promise to repay the loan. It also represents a way out for a lender in the event of payment default. Let me also add that, although you may have the most amazingly valuable collateral in the world to pledge, it still boils down to sufficient cash flow.

Conditions: These are rules set by those who have the gold.

Character: This has nothing to do with what your spouse, parents, or friends think of you and everything to do with how you’ve conducted yourself in the past. In particular, if you had previously been granted credit, did you pay it back on time and in full? Do you have any blemishes on your personal or professional credit [reports]? The personal credit bureau report is important because most small businesses are closely held. In other words, few people control the business, in which case the lender will want those persons to be financially liable along with their company.

Is a formal business plan important to the lender?

Speaking as a lender and as a professor who teaches entrepreneurial finance, I thoroughly disagree with those who say that an elevator pitch is more important. Business plans serve two purposes: They fully articulate the idea you have in mind and how you plan to go about realizing it, and they force you to come face to face with the echo chamber inside your head.

In my view, unless you have an idea that can stand up to paper and pen, you have little more than cocktail chatter.

What are some of the common mistakes small-business owners make in the loan application process?

Failing to fully prepare and failing to fully disclose. The preparation part is straightforward: Understand the five C’s, and be clear about your purpose and justification.

As for the failure to fully disclose, lenders will view the first omission as the tip of the iceberg and dig deeper. They’ll begin looking for reasons to say “no” rather than “yes” once you’ve given them reason to doubt your representations.

Assuming there’s a face-to-face meeting, do you have any additional tips for impressing the loan officer?

Dress for the part. You’re asking for money, so respect your lenders by taking the time to make [your appearance] presentable. You only have one chance to make a good first impression.

Can small-business owners negotiate the terms of the loan? If so, what should they focus on?

First, focus on prepayments. Negotiate for the right to prepay your loan in full or in part during the course of its term. Lenders won’t easily yield on this point, but it’s worth playing hardball over, so that you have the option to use some extra cash to retire your loan or to refinance under better terms later on.

Second, focus on amortization. Term loans typically amortize the way mortgages do, where each payment consists of interest and principal. As the loan is paid down, the interest component becomes less and less, while the principal component becomes bigger and bigger.

That’s how the payments remain the same over time, if that’s what you want or need. However, the alternative would be to structure the loan with even-principal reduction, where the payments are higher at the start and lower later on. The principal will decline more rapidly and, consequently, the interest paid over the duration of the loan will be less.

Finally, focus on fixed vs. floating rates. The banks will push floating-rate loans because they cost less for them to do and, often times, yield a higher profit margin for the lender in the process.

I prefer fixed-rate deals because no one knows where interest rates will head. I also prefer them because it forces businesses to honestly address the affordability of the project they are contemplating undertaking. If you can’t make it work under a fixed-rate scenario, then you can’t make it work. However, if your only option is a floating-rate loan, then negotiate for a cap above which your rate won’t increase.

About Tim Parker

Tim Parker is the owner of ECS, LLC, a company specializing in financial and small business content. His writing has appeared in many of the top financial blogs including Investopedia, Yahoo! Finance, Benzinga, Business Insider, and Forbes. Find him on Twitter @expositioncreat and Breaking Finance News.com
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9 comments
Alexi Davenport
Alexi Davenport

I loved the part about the 5 C's! So helpful. My brother has been reading up on getting loans in Toronto. He really wants to start up a business. Do you have any other tips I could give him? Thanks! "http://www.poweraid.ca/getaloan.html

Jessie Singh
Jessie Singh

That information was very helpful. The 5 C's will definitely help me remember your advice. I promise to make good use of it

ChrisFletcher
ChrisFletcher

In my opinion, a formal business plan should be important to the lender - however, credit scoring coupled with generally accepted financial ratios drives most credit decisions whether the lender is a bank, equipment finance company, factor, or otherwise.

Advantage Leasing
Advantage Leasing

Don't forget equipment leasing as a source of funding for business equipment needs. It's often an easier process than a straight bank loan.

mitchelldweiss
mitchelldweiss

 @Jessie Singh Thanks, Jessie. Small business folks need know this information, not only so they can prepare for their bank meetings, but also to negotiate more effectively. Good luck.

mitchelldweiss
mitchelldweiss

 @ChrisFletcher Credit bureau reports comfe into play because most small businesses are closely held--few owners wielding significant over the operation. As such, their typically asked to personally guarantee their firms' debts, hence the background check. As for the business plan, sure, it's important to prospective lenders and investors, but it's also a vital exercise for entrepreneurs because it forces them to think through all that's involved in launching a venture. New biz ideas sound great--in our heads. The question is: can that great idea stand up to pen and paper?

mitchelldweiss
mitchelldweiss

 @Advantage Leasing Leasing is but one of the many different types of financing options small businesses should investigate. Unfortunately, though, the focus of this interview was limited to bank loans. My new book, Business Happens covers all the alternatives. It'll be published next month.

LeaseQ
LeaseQ

 @mitchelldweiss  @Advantage Leasing I would have to agree that leasing is one financing option that a lot of business owners and budding entrepreneur are exploring. It does have its huge drawing in terms of the long term benefits. I would really encourage Tim and the rest of the community to put out more information about equipment leasing to give businesses a better alternative.