Surviving the Meltdown

The traditional banking model is simple: Consumers deposit funds that a bank lends to businesses or other consumers while collecting fees for ATM use and other services. According to the Mitchells, Industrial is considering selling insurance and investment products, or offering such fee-based services as financial planning. Consolidation is also on the table. “We want to do an acquisition because the bank needs to be larger,” says Patricia. “There’s thousands of dollars in new compliance costs as a result of the new regulations, and the only way to absorb a lot of that is to grow. We are currently in a strategy to raise capital that will, in turn, lead to an acquisition.”

How to Obtain Bank Financing for Your Business

While small business loans slid 4.1% from 2009 to 2010, there was still some $310 million that banks extended. So while credit may be tight, capital is out there. But what do banks look for these days before extending a small business loan? “I think a lot of people have the impression that banking is rocket science,” says Douglas Dillon, senior vice president of commercial lending for Industrial Bank. “But even non-bankers can understand the basics.” He says banks look for the following criteria:

• Strong historical cash flows. A banker will first examine your income statement and bottom line, and then add back a few things that are fairly essential to the cash flow analysis, such as depreciation, a noncash expense. They’ll use the business’ interest expense to come up with a rudimentary cash flow number. “That’s important because bankers just want to have an idea of your capacity to repay their loan,” says Dillon.

•  A good debt-service coverage ratio. This is the ratio of cash available for debt servicing to interest, principal, and lease payments. The banker will calculate this by adding annual net income with amortization/depreciation, interest expense, and other items, and dividing that sum by the borrower’s loan principal, interest payments, and lease payments. “This is the key ratio that most bankers are going to look at,” Dillon says. He notes that most banks consider a debt-service coverage ratio of 1.20:1, or 1.25:1 to be very good.

•  Core financial strength versus just operational strength. Dillon cites loan applications from two restaurants, both of which look good operationally. “One has a little bit stronger following—both serve good food. But one negotiated a lease with a rent that’s below market and has low annual escalations. It’s also in an excellent location with major tenant improvement allowances from the landlord. Plus, it’s secured a contract, so some of its revenue is assured. The second did a good job establishing a financial foundation, but not as good as the first.” As a result, while both have operational strength, the first one also has a more established financial foundation.

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