- While small business loans slid 4.1% from 2009 to 2010, there was still some $310 million extended in 2010. So while credit may be tight, capital is out there. But what do banks look for these days before extending a loan? “I think a lot of people seem to have the impression that banking is rocket science,” says <strong>Douglas Dillon</strong>, Senior Vice President of Commercial Lending for <strong><a href="http://www.industrial-bank.com/" target="_blank">Industrial Bank</a></strong> (No. 8 on the <strong>BE BANKS</strong> list with $382 million in assets). “I’m not of that impression.” He says banks look at the following five criteria before extending a business loan. <em>—Alan Hughes</em>
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- <ul> <li><strong>Strong historical cash flows</strong>.</li> </ul> A banker will first look at your income statement and bottom line, add back a few things that are fairly essential to the cash flow analysis, such as depreciation, which is a non-cash expense. They’ll use the business’ interest expense to come up with just 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. “So, the basic equation in a bankers mind is, ‘this is how much it’s going to cost for them to repay my loan.’”
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- <ul> <li><strong>A good debt service coverage ratio</strong>.</li> </ul> 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 things and dividing that sum by the sum of the borrower's loan principal, interest payments and lease payments. “This is the key ratio that most bankers are going to look at,” he says. Dillon states that most banks will consider a debt service coverage ratio of 1.20:1, or 1.25:1 as very good.
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- <ul> <li><strong>Core financial strength versus just operational strength</strong>.</li> </ul> Dillon cites loan applications from two restaurants, both of which looked good operationally. “One has probably a little bit stronger following, but good food at both restaurants. The other negotiated a tremendously favorable lease with a low rent rate, low annual escalations, in an excellent location with major tenant improvement allowances from the landlord. The second also did a great job with establishing the financial foundation.” As a result, while both have operational strength, the second also has a stronger, established financial foundation.
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- <ul> <li><strong>A solid credit score.</strong></li> </ul> <strong></strong>There’s no getting around the fact that banks will look at the majority shareholder’s credit history. “It’s important to look at your credit score to know what it is and I’d say if it’s lower than probably 660 or 680, then, you need to start thinking about ways to improve it and try to get that up, I would say, before you walk into the bank, if at all possible,” says Dillon. “Now, that’s not to say that if you don’t have a 660 credit score that people won’t take a look, but it makes it a little bit harder. In some banking institutions, your personal credit score for small business is one of the key determinants of whether or not the bank is willing to lend, that’s not necessarily the case with us, but it is at least an indicator of ability and willingness to repay personal debt.
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- <ul> <li><strong>Collateral, or some other way to repay</strong>.</li> </ul> The c-word isn’t something many small business owners want to hear from a banker, but according to Dillon, it can come into play right behind cash flow in terms of importance. This is even truer as banks continue to try to mitigate risk as much as possible. “We need to have a secondary source of repayment behind the operating cash flows of the business,” he says. That can be hard to find these days. We’re actively seeking out clients that have a need for lines of credit, utilizing the SBA product where we hadn’t been doing that previously because the product’s become much more attractive and that helps mitigate some of the collateral concern so that we don’t necessarily have to have 100 percent collateralized loan.”
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![Have the proper capital to invest to build a franchise system that lasts. “When you build a franchise system, there are a lot of hidden costs you may not be aware of,” he says. “You have to be able to have the right people, the right amount of capital to put into your marketing program and legal costs related to your FDD [Franchise Disclosure Document].” The FDD is a legal document which is presented to prospective buyers of franchises in the pre-sale disclosure.](http://cdn4.blackenterprise.com/wp-content/blogs.dir/1/files/2011/09/Money-ladder-620x480-90x100.jpg "Money-ladder-620x480")
