Wednesday, September 2, 2015
By Henry Snorton, III, CEcD, Principal Partner, Mission Vision Partner, LLC. (MVP)
I was fortunate to participate in Kentucky’s 5th Annual Women in Business Expo at the prestigious Galt House Hotel, just a few blocks away from Louisville happening “4th Street Live” venue. My session was a clinic entitled, “The Clinic: Tips That Every Borrower Should Know About a Business Loans.” The clinic was well attended and participants asked question after question. This led me to believe to write this article to expound upon this topic, “the clinic.”
I started the clinic by asking the attendees to reach into their pocket or pocketbook (because this was a women’s conference) and pull out a bill of some sort and raise it high into the air. They displayed ones, tens, twenties and hundreds. Then I said, “let me borrow that money that you have in the air until next year’s Women in Business Conference and I will repay you with interest.” You should have seen the expressions on their faces. Needless to say, my loan request was denied!
My analogy applies to a borrower walking into a bank or credit union and applying for a small business loan without any account or relationship with the bank or credit union to which they are applying. In life and business, relationships are simply important. Then, I told them about the 3 things that every borrower should know before applying for a business loan. The 3 “secret” and underlying test questions lenders and underwriters attempt to answer in order to make small business loan are listed below:
Question #1: Can the applicant/perspective borrower repay the loan?
Question #2: Will the applicant/perspective borrower repay the loan?
Question #3: What happens if the applicant/perspective borrower does not repay the loan?”
Each of the three (3) questions directly corresponds to what is known as the 5 Cs: capacity, character, collateral, capital and conditions:
· Capacity is how much money is available to repay the loan, debt ratios, etc.
· Character is the credit worthiness of the applicant, such as their payment history, credit (beacon) score, etc.
· Collateral is the assets, property, wealth, etc. that a borrower has to pledge or to use to “secure” the loan. This can include a home, vehicle, real estate, financial instrument, etc. Please note that lenders typically do not want your house or pledged collateral, but they do want to properly motivate the borrower to do all they can to repay their loan accordingly.
· Capital is the funds/money that you have or that will be contributed to the project’s (business’) total cost. For example, if the loan is for $50,000, do you have 2% capital ($1,000) or %10 ($10,000). It is rare, but possible to obtain an 100% loan because lenders want borrowers to have “skin in the game.”
· Last but certainly not least, conditions are trends, environmental issues or concerns, political implications, etc.
The process goes something like this… you visit a lender and inform them that you are interested in a business loan. They will ask you for a number of “prerequisite documents” such as a business plan, 2-3 years tax returns, governing documents, maybe form SBA 413 and of course their very own application. Once you submit this paperwork, then the underwriting process beings.
As noted above, the underwriter tries to answer question #1 using the provided documents, “can you repay the loan?” The answer is provided for by your “capacity.” Do you or will you have enough money to simply repay the loan. If no, then the loan is denied.
If yes, then the underwriter proceeds to answer question #2, “will you repay the loan?” This answer is determined by analyzing your “character/credit” and what you have available to pledge to secure or guarantee the loan, “collateral.”
If no, then the loan is denied. If yes, then the underwriter proceeds to answer question #3, “what happens if you do not repay the loan?” The underwriter evaluates the value of your collateral if the lender should need to liquidate it. The underwriter also evaluates its own risk, if its loaning 100% or less, typically less which requires you to put some “skin in the game” called “capital.” Last, the underwriter/underwriting process considers your industry’s market conditions. For example, energy and environmental are growth industries along with pets and travel. The “conditions” can help or hurt your application depending. If when answering question #3, the lender’s likeliness for loss or loss potential is higher than its profit potential, then your loan may be denied.
Now you know what to expect prior to applying for a business loan. If I can help, simply give me a call or drop me an email, Henry Snorton, III, CEcD at 270-839-3426 or email@example.com
Snorton is the founder and principal partner at Mission Vision Partner, LLC. (MVP). MVP serves as the #1 economic development firm that assists rural communities and undeserved markets to create jobs through small business startup, expansion and development. MVP's experts apply a practitioner-based approach that produces results in four areas: economic development, entrepreneurship & small business startup and expansion, grants and application development and training and consulting. MVP has written grants scored/evaluated by USDA RD as #1 in the Natio and partners with the Small Business Administration (SBA) and Syracuse University to deliver "Boots to Business" Service to Startup training workshops at Fort Campbell and Fort Knox, Kentucky. MVP’s has internationally credentials, national, state and local awards and recognitions that have assisted in the creation, retention and expansion of more than 400 jobs and millions in capital investment in the USA.