Blog: Banks ─ Not as Friendly as You Believe

Two of the last three presentations I reviewed, assumed a bank loan would be available when their excel spread shows the timing.

The first thing you need to understand about dealing with banks is that they are not investors, and they want to deal in the short term not the long term. They recommend you use other sources such as insurance companies for long term loans. Too often borrowers get frustrated and disappointed when the bank is not caught up in their dream. The bank makes money on the loan money; they do not speculate on the future. Generally, they will not lend funds for the borrower to make acquisitions or develop product for futures. They want evidence that the borrower can make payments the day the loan is given. When they are ready, they will fund needs for working capital, including inventory and accounts receivables, and they want proof of collateral now.

In dealing with banks, approach them with the following in mind:

Banks will not usually tell you why you have been rejected. Today, they can hide behind “the regulators,” using them as the bad guy, the excuse for turning down a loan. They will also use the lame excuse, “I tried hard for you, but the guy downtown shot the loan down.” Someday I would like to meet that invisible guy downtown.

I believe loan officers would take a little more risk if bank management put more emphasis on their need not to lose business. It is too easy for a loan officer to reject a loan rather than stand up in front of his peers weekly to report on a loan that made him nervous going in. If rejected loans were analyzed more carefully, more risk might be taken, with greater rewards for all concerned.

It can help to look for banks that allow loan approval by an individual rather than by committee. With a committee you are relying on your loan officer to make the pitch to his committee, and this is scary. In that situation, it pays to make sure the loan officer (interface to the loan committee) is knowledgeable about your business and convinced you are successful. The more informed the bank is, the greater your chances of getting the loan.

It is worth the effort to present your business to the bank officials you are dealing with, and to try to get above the loan officer.

The financial cash flow projection must include a line specifically for payments to the bank. You should point out to them what actions and alternatives you plan if in fact the business doesn’t go quite as you planned. An impressive report will show what can be adjusted, if necessary, in order to ensure that the bank gets theirs.

Banks with put their emphasis on evaluating the balance sheet and base the loan on various ratios and specific numbers. These are called covenants.

  • When you make the presentation asking for a loan, make sure you do the following:
  • Include a business analysis.
  • Make sure your bank contact understands both your request and the nature of your business.
  • Make sure they feel secure about what they know.
  • Make sure the bank feels comfortable with your management team. Get them to meet as many people as possible, and convince them that the company is strong enough to withstand the turmoil of key management staff leaving the company.
  • Make sure the bank feels sure that the company will survive a downturn. Show them a disaster plan under which the company could withstand a 20% drop in sales and still be able to make payments.
  • Make them believe that the company has liquidity, good performance, and adequate cash flow.
  • In any presentation to the bank, make sure there is always a line showing when and how the bank gets their money.
  • Always be prepared to offer collateral.

Banks are trained to require two sources of repayment, cash flow from the business and collateral. The primary source, cash flow for short term loans and earnings for long term loans, needs to be supplemented by some form of collateral such as accounts receivable, inventory, or a mortgage. Banks are the happiest when receivables alone can cover the loan. Even when the loan is covered by receivables, the bank will also have first claim on all the assets. Then, if something goes wrong with the original plan, the banker will always have something to fall back on.

Now, here is where the banks become hypocritical for start-ups and small companies because after saying they will only need two sources repayment, cash flow and collateral, they say, “Oh, by the way, we would like a personal guarantee from the majority owner.” This guarantee is almost universally required of small companies, so this talk about only needing two sources of repayment is bunk.

The banks say that the personal guarantee ensures that the borrower is committed psychologically to the business’s success. Banks don’t expect a great deal of security from the personal signature, and say that they may not even go after the individual. What they want is that individual’s total support and dedication to making the business successful. The loan officers are reluctant to risk the bank’s money if the borrower is reluctant to risk his or her own. In other words: no guarantee, no loan.

Keep in mind that the bank is always comparing the risks to the rewards. Since they work on a small return on assets (ROA), they have to be right 99% of the time. They need several good loans to make up for one bad one. Therefore, they also need to be convinced that you are in command of your business and will respond appropriately to any downturn. They also do not generally lend in high leverage situations, and might use an upper limit (the ratio of all liabilities to the tangible net worth). Anything above this ratio will probably scare them off. Banks are limited in the risks they can take from both a business and a regulatory viewpoint.

Since banks like NO surprises, keep them informed, especially when you are having trouble with the business or the loan. Banks can also give far more help than just credit. Use their services in other financial matters. For instance, if you plan to go to international markets, seek the advice of your banker.

It is important that you build a good relationship with your bank, and there are several ways to create and maintain this relationship:

  • Communicate with them in a timely manner, even when you have bad news.
  • Stay off the “bad” lists, like the overdrawn account list, the late payer list, and the personal exception report.
  • Keep the bank informed of trends in your industry and your goals for the company.

Today, most banks will only lend money when (1) the company is profitable, (2) the debt to net worth ratio meets their criteria, and (3) the borrower is personally willing to guarantee the loan. Many borrowers rejected come to believe, Banks will only lend you money when you don’t need it (company is doing great). Therefore, prepare ahead of time by developing a good relationship with your bank and demonstrating your commitment to repaying them.