5 Ways to Help Your Small Business Client Get a Bank Loan
In today’s economy, it’s no easy feat for a small business to get a bank loan. Since the 2008 financial recession, banks have tightened access to capital, so much so that lending to small businesses declined by more than 20% since that time.
This decline was caused by two things. First, banks put in place very strict qualification requirements. Generally, applicants only get approved for a bank loan when they have excellent credit, profitable businesses that are at least two years old and sufficient collateral. Second, banks aren’t making much profit on smaller loans (under $150K), so they often turn away small business applicants that need smaller amounts of capital.
Despite these trends, it is still possible to get a bank loan, but it’s more important than ever to thoroughly prepare to get the loan. This article will cover 5 steps your small business clients can take to better position themselves for successfully obtaining a bank loan.
1. Help Clients Improve their Credit Score
The approval requirements for getting a bank loan are similar to a three-legged stool: credit score, collateral and cash flow. If one of those legs is weak, it’s harder to get a loan. Yet, the most important leg is the credit score. A good credit score goes a long way toward getting approved for a bank loan.
Small business owners can check their credit score for free on various services, including Nav or Credit Karma. In addition, WalletHub offers free credit scores and full credit reports that are updated on a daily basis. Most banks will be looking for a FICO score of at least 680, but the higher, the better. If your clients’ scores aren’t this high, the most simple step they can take to improve their score is getting a copy of their credit report and carefully reviewing it for errors. Note that four out of five credit reports contain errors, but errors can be disputed for free. If a dispute is resolved in the business owner’s favor, it can increase the credit score in 30 days or less.
Other ways to improve credit include paying all bills on time and paying down high rate debt, such as credit card and student loan debt.
2. Educate Clients about Business Credit
While most people are familiar with their personal credit score, many of your small business clients may not know their business also has a score. Business credit bureaus, such as D&B, Experian and Equifax, collect trade data and loan data to evaluate how likely a business is to pay its bills. A bank will most likely check a business’ commercial credit score before approving it for a loan.
It’s easy to start building business credit. Some steps your client can take include getting a free DUNS number to establish a credit file, opening a business bank account, and getting and responsibly using a business credit card. If they’re not in the habit of doing so already, your clients should also pay all their suppliers and lenders on time to maintain good business credit.
3. Help Clients Create a Good Business Plan
Banks want to know as much about a business’ future plans as it can before it trusts the business with its money. Your clients should take the time to think about, and put down on paper, the business’ future goals, marketing and customer acquisition strategies, as well as financial projections for the next 3-5 years. While this is especially important for startups, what a lot of people don’t know is that a business plan is just as important for an established business seeking a bank loan. As the accountant, you can help your client gather historical financial data, estimate future income and profits, and present the business in a positive light.
Even with your help, small business owners may feel intimidated at the idea of creating a business plan. However, there are many user friendly software tools, such as LivePlan, that can help your clients create a professional-looking business plan in just a few hours.
4. Help Clients Gather the Right Paperwork
One of the downsides of applying for a bank loan is that it is paperwork intensive. The bank will ask for numerous documents, including the following:
- Organizational documents (incorporation papers, organizational chart, for example)
- Last 3 years of business and personal tax returns
- Last 3 years of income statements, and profit and loss statements
- Recent business bank statements
- Recent merchant processing statements (if applicable)
- Collateral statements
- Business plan
As the accountant, you likely have access to most, if not all, of these documents. Just keep in mind that specific types of bank loans call for specific kinds of paperwork. For example, the SBA has a specific list of documents it needs to see for SBA loans; for business acquisitions, the borrower will need to show a purchase agreement and other transfer of ownership documents.
5. Make Sure Your Clients Know How Much to Ask For
When applying for a bank loan, small business owners should only ask for the amount of money they really need and have a realistic chance of getting approved. In other words, if a business’ annual profits are $100,000, you probably don’t want to ask for a $5 million loan unless you have a high personal net worth.
Knowing how much is too much will vary for every business, but you can get a good idea of a cap by calculating the Debt Service Coverage Ratio (DSCR). DSCR compares net operating income to total debt and interest payments. For example, if your client’s business has a net annual income of $100,000, and the annual estimated loan payments are $300,000, the DSCR is $100,000 divided by $300,000, which comes out to 0.33. In this case, the DSCR is too low; most banks will want a DSCR no lower than 1.25.
Final Thoughts: Consider Bank Loan Alternatives
While bank loans are certainly an economical source of capital for a business, they’re not the only option. When your client has been rejected for a bank loan, needs smaller amounts of capital that aren’t attractive to a bank or needs money fast, there are alternatives.
For example, there are several fast online loan options that will give loans to small businesses that may not qualify for bank financing. These are available for lower credit borrowers and newer businesses, and successful applicants can get funding in as little as one business day. Examples include OnDeck, Funding Circle and personal peer to peer lenders such as Lending Club.
Business owners who don’t want to take on any debt can do what is called a Rollover for Business Startups (ROBS). A ROBS allows a business owner to use his or her retirement funds to start a new business, buy a business or (more rarely) capitalize an existing business. There are no income taxes or early withdrawal penalties, and no debt to pay back since the money already belongs to the business owner.
Ultimately, the solution is to be creative. Finding out why your clients need a loan, how quickly and what credit box they occupy will help you, together, find the best fit.