William C. (Bill) Deegan, Sr. bdeegan@westga.edu is the Director of the Small Business Development Center, Richards College of Business, State University of West Georgia.

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There are more than twenty-five million small businesses operating in the United States today. They employ fifty–eight percent of the country’s private workforce. These small businesses generate more than fifty percent of the USA gross domestic product. They are also the main source of new jobs in this country. American youth and displaced workers are depending on successful small business to be there. Therefore, their success is very important to the nation.

Many of those twenty –five million have been and continue to be successful in borrowing and repaying small business loans. A small business can be successful in obtaining loans by having the right numbers before their owner goes to the bank. The small business owner should seek out any the assistance they need in getting the numbers right and go for it!

Loans from banks or other lending institutions needed  to start a new business or expand an existing small business are often difficult to obtain. The major reason for this relative difficulty is based on the increased risk of a loan to a business as opposed to the relatively lower risk of potential loss to the lender in making a home or car loan.

If, for some reason, we fail in our repayment obligation on our home or auto loan, the lender can repossess either of these physical assets with relative ease. Plus, there is a ready and large resale market for the home or auto because most everyone needs one or both.

However, if, for example, a hardware store fails to repay a loan on time, what options  are open to the lender? He could restructure the loan  to make the repayment less financially demanding. He can increase the risk lending to this borrower exposes him to by granting new short term funding to carry the borrower until his cash position improves. Or the lender could call in the loan and foreclose. If he does the latter, he is now faced with disposing of  inventory assets that will probably be valued at 25 to 50 percent of their original cost. In addition, the lender now has to find someone who wants hardware store inventory. That is a much more limited market than those who need a home or an auto. Therefore, the potential risk to the lender is much higher when lending to such a small business owner than to an individual. 

Because of this reality , there are certain criteria that most lenders require the small business owner to meet in order to successfully acquire the funds needed for the business. These hurdles or requirements can be generally categorized as: Good  Credit , Equity, Experience, Business Plan, and Collateral.

These general criteria for successful borrowing by the small business can be quantified. That is to say, numbers or ranges of values can be placed on them before one ever applies for the loan. It would be wise for the small business operator to become generally aware of these criteria and their value ranges as they relate to his or her particular case. This should be done before going to the bank or lending institution.

Let’s review these five guidelines of successful borrowing for small businesses. We will examine the numeric range of values that must generally be met in the eye of the lender , in order to get the necessary funds for the business.

1. Good Credit - Without question one must have a credit history which is not only good, but more to the outstanding side of the scale. The reason for this lender requirement is obvious to all. Every day any are coming to banks and lenders applying  for loans for a variety of reasons. The funds do not belong to the loan officer, but rather they belong to the institution’s depositors and investors. The loan officer and the lending institution's management have an obligation to manage these monetary assets to the positive benefit of the owners, namely the depositors and investors of the bank. Therefore, loans must be made only to those who present the least risk of failure to repay. Past repayment history (i.e. Good Credit) is the first and probably the most important requirement for a successful loan.

Lenders have in recent years subscribed to a credit measuring system in which a generalized credit score is rendered from various factors for each individual who has a recorded credit history. These scores range from the low end at 300 to the high end at 850.

Observation of past successful lending has shown that the numeric value of the credit score from the range of 300 – 850 needs to be at or above 700 in order to predict potential loan application success. This does vary from case to case, but a 700 credit score or above is the value one needs to achieve for consideration of having Good Credit. 

Credit Score (700+)  

2. Equity- Equity in borrowing can be thought of as similar to a down payment. The lender wants the borrower to have a financial commitment to the venture for which the loan is requested. Some say that the borrower has to have some “skin” in this business “game” to insure his or her best efforts toward success and timely repayment of the borrowed funds.

This is to say,  that even if all the other four criteria for successful borrowing ;Credit, Experience, Business Plan, and Collateral are met, the bank usually will not lend 100 percent of the funds requested. The numeric value often placed on required Equity  is in the range of 10 to 20 percent of the needed funds. 

Equity (10% – 20%)  

3. Experience- No rational lender wants to or will turn over monies to a borrower  to manage and expend in a business or venture in which the person has no or very limited experience.

This criteria for successful borrowing should be easy to  see from both the lender and borrower’s point of view. Lenders need to be more certain that the person or persons borrowing the funds have the experience and expertise to manage the money and that day to day the business is conducted in a prudent manner. This is needed to insure positive results from the business and further insure that the lender will be repaid with interest and in a timely manner.

Here again the question relates to risk. The more experience and talent the borrower has shown in the past, the lower the risk in lending from the bank’s point of view.

The minimum   numeric value often expected here is that the borrower should have at least three years of experience in the management of the type of business in whose name he or she is borrowing the funds. This experience can be as an owner and/or management experience. It could also be experience as an employee  in a similar type business. 

Experience (3+ Years)  

4.  Business Plan- The fourth requirement of the bank or lender is a well thought out, researched and constructed business plan. This is a document that:

a)      Will introduce the business in a clear and complete manner;

b)      Describes the business ,the potential market for the goods and service to be offered , the existing competition  ,states who will be employed ,who will lead and manage and how the borrowed funds will be expended;

c)      The good business plan will have pro-forma (estimated) financial documents. These are the Cash Flow Statement, Income Statement, and Balance Sheet.

Cash Flow shows the cash revenue coming into the business and the funds sent out in paid expenses as the business operates from period to period. The net result is either negative or positive on a month to month basis. Here the lender is looking for positive Cash Flows at least enough  to make the loan repayment.

The Income Statement is a listing of the total revenue of the business over the past year and a summarized listing of all the expenses of the business. These two values, one positive and  one negative, when combined give the net income of the business operations for the period being reported.

The Balance Sheet can be thought of as a instant photograph of the financial “health’ of the business at an instant in time, normally at the end of the year. The balance sheet displays the assets (positive values of the things that the business owns) and the liabilities (the negative obligations that the business owes and  is obligated to pay in the short or long run). Liabilities combined with the owner’s or shareholder’s equity (value of the ownership) will equal ( balance)  the value of the assets .

Finally, the good business plan will have a section of Supporting Documents. These will add validity to all that has been included in the previous sections. This section should include such documents as the Resume(s) Credit Report, Net-Worth Statement of the borrower(s), and any other reasonable support to verify the facts and estimates on which the plan is based.

The well constructed, thought out and documented Business Plan is essential to successful business borrowing. It is also used as a guide of the business progress or lack of it to the owner(s).It can also be used  as an aid in soliciting partners and or other  investors in the business.

If we were to put a numeric value to this criteria, we would say that in most cases the business plan’s cash flow should become positive and remain so after the first six months of operation.This is a rather general rule, which could vary to longer periods for specific businesses and special circumstances. But normally the banker will be looking for a positive cash flow from six months forward. 

Business Plan (6 Months forward + Cash Flow)  

5.  Collateral- One would think after we have shown good credit, put in equity cash or goods, shown we have experience in the business and produced a positive cash flow business plan, that the lender would now be willing to open the vaults and ask us to  come in and select all the cash we desire. However, there is one last hurdle that the borrower must clear to reach loan success. This final criteria is collateral. 

Collateral is any asset of value that can be pledged by the borrower(s) as security that the loan will be re-paid in full and with interest. Collateral requirements in the process of borrowing for a business can range up to and above 100 percent of the loan principal. This percentage depends again on the amount of risk that the lender calculates that his institution is exposed to from this particular loan and the accumulation of all loans currently  in process.

Collateral assets can be in the form of  real  property owned, inventory of the business, cash savings or deposits, stocks /bonds equity in a home equipment and other like assets both tangible and non-tangible. IRA, 401k, 503b accounts are not usable under normal circumstances for collateral asset pledges. They cannot be assigned but they can be cashed in with the associated restrictions and penalties.

The value to be placed on a collateral asset in the securing of a business loan is usually  estimated or appraised by the lending institute. The number to remember or meet in the final area is often seen to be 100 percent + of the loan amount. 

(Collateral 100%+)  

To summarize:  when going to the bank or other commercial lender, the numbers that the business borrower is likely to have to meet or better are:

1. 700+ -  Credit Score

2. 10-20% - Equity

3. 3+ Years -  Experience

4. 6 Months -  to Positive Cash Flow

5. 100% + - Collateral Assets

To many new, small business people this may seem difficult. It has been observed that new start ups have less than a 10 percent  loan success record. Most have to use  their own funds or  those of relatives and/or partners. Despite the high failure rate,  new businesses are opening all the time.

Existing small businesses with a few good years of operations are more successful in borrowing funds to stabilize, expand. or add new lines of offerings than new start-up ventures.

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