Bank Financing for an Established / Mature Businesses
By Christopher Yuskiw, Guest Contributor
So, you’ve made it two years and are now entering your third year in business. Congratulations! You are no longer a start up! If you’ve been in business for two years or longer, most banks will view you as an established business. What does this mean? Well, it should mean that you won’t have to jump through as many hoops as you had to while seeking out start up capital. By now, your business should have a stable cash flow cycle and there is hard evidence of the business’s revenue. The more stable your cash flow, the easier it is for banks to better understand your business, which should help them to be more comfortable with lending your business money.
Again, while each deal is different, there are some common things you can do to determine how likely you will be in requesting credit; you should also keep these points in mind while preparing a credit request. You should really perform your own “acid test” prior to submitting your request so that you aren’t caught off guard by a bank’s decision. Banks will initially use the following five metrics to determine how credit worthy the business is:
Prior year results, two or three years of year end financial statements, will be used to determine the business’s trend; banks like to see positive net income and a positive trend. Be prepared to provide at least two years of business tax returns.
2. Debt Service Coverage
Debt Service Coverage will be used to determine how much of the business’s income is being use to pay debt. To determine your DSC, take your free cash flow (net income + interest expense + depreciation expense) and divide this by the sum of all the debt payments (short and long term). Banks typically like to see this number above 1.2, the higher the better though. Don’t forget to include the projected payments of the request in your calculations. How much of your income is being used to pay off debt?
3. Debt to Worth
Debt to Worth will help the bank to understand how leveraged your business is. To determine your DTW, divide all of the business’s liabilities (short and long) by the retained earnings (net worth) of the business. Typically a 3 to 1 ratio or better here (i.e. 2 to 1 or less) is what a bank hopes to see.
4. Collateral Coverage
Collateral Coverage is the amount of assets that the business has to put up to secure the deal. Collateral includes everything from real-estate, accounts receivable, inventory, equipment, etc. Anything that has tangible value here counts. Banks typically like to see a collateral coverage of 1.20 or higher; this means that your business has $1.20 worth of collateral for every $1.00 in debt you have. If your business doesn’t have much in terms of assets don’t worry too much! This does not mean that you won’t be able to get financing; while this might reduce the options available, or the amount you can apply for. There are ways to get financing when you do run into a collateral shortage; the SBA is often utilized to help with a collateral shortage. Also, if you are purchasing real estate or equipment, this will help with collateral coverage.
5. Guarantor Strength
Guarantor Strength, i.e. credit score and personal net worth, will be factored into most decisions. The stronger the personal guarantee, the more comfortable the bank will be.
Again, while each deal is evaluated on a case by case basis, these five things should help you get a feeling of how your credit request will go. Other factors to be aware of include: industry risk, fall back capital, economic conditions, and institutional appetites (some banks don’t like certain risks on the books). My advice is to start at the bank you know and go from there. If you and your business have an existing bank relationship, then it might be factored into the decision. Banks are becoming more conservative in today’s environment and they are not looking to lend money to new clients as aggressively as they use to.
One last note: use the information above as guide and not as scripture. Every bank has their own set of underwriting policies and procedures; what works for one bank might not work at another. Also, if your business is light in one area but strong in another, then they might compensate for each other.