Over 20% of companies are underfinanced. But when you look at companies that have grown their revenues by 20% or more over the past three years, you’ll find that over 30% of them are underfinanced!
It is obvious from this data that it is the young, high performing companies that are currently experiencing the greatest difficulty in obtaining the financing they need to operate their businesses.
Many entrepreneurs are so discouraged that they don’t even apply for financing. Only 60% of small and medium sized companies try to raise capital. Only 53.8% of businesses with zero to four employees apply for financing.
As a result, in the late 1980’s, only 15% of entrepreneurs were concerned over their financial situation. Fast forward to today and that number rises to almost 40%! So why are these numbers so discouraging? Most entrepreneurs only turn to one source of potential capital: Banks.
This section will provide you with some background information on banks and how you can maximize your chance of getting your loan approved.
Banks typically have a $200,000 threshold loan limit.
Over the past 15 years, the number of loans given to companies over this $200,000 limit has grown over 30%. On the other hand, loans given to entrepreneurs who need less than $200,000 has been stagnant for the past 15 years. If you look at this number in real terms and account for inflation, the loans given to small businesses has actually been decreasing.
As Chuck Loewen from Online Business Systems says, “Understand the real role of a financial institution is to lease safe capital to low-risk borrowers. Entrepreneurs, full of vim and vigour mistake the bank’s role as the entity that will share the risks with them to see the entrepreneur’s dream come true. Not so. Always understand you are the entrepreneur, he or she is the banker.”
Key Loan Factors
There are four key factors that can dramatically increase your chance of obtaining a bank loan. They are: account manager turnover, business experience, business banking services, and size of company.
Key Loan Factors #1 – Account Manager Turnover
Your bank account manager is responsible for understanding your business and going to bat for you within the organization when you need a loan approved. If she does not have an established long term relationship with you it will be difficult to get her to pull strings for you.
The chance of you being rejected for a bank loan depending on how many account managers you have is as follows:
One account manager: 7.1% rejection rate
Two account managers: 8.5% rejection rate
Three account managers: 16.3% rejection rate
Four or more account managers: 22.8% rejection rate
Develop a good relationship with your banker early. Talk to her before you need the money and she’ll be there for you when you actually go for the loan.
Key Loan Factors #2 – Business Experience
Banks want to lend money to established businesses with a track record of experience. The reason is pretty simple: you have proven that you can achieve certain results which make your future projections less risky. If you can show that you have done it before it is easier to have faith that you can do it again compared to a startup with no experience.
Banks prefer companies that have been around for 10 years or more. These companies:
Get rejected for loans over 50% less frequently than inexperienced firms
Pay around 0.4% less interest on their loans
If you do not have 10 years of company history, as most entrepreneurs do not, point to your other experiences that will help give you credibility. Maybe you worked as an employee in a small company and helped double their sales. Perhaps you ran another small business and made it profitable within 6 months. When you do not have the company track record, the banker immediately flags your business as having an increased risk of not being able to pay back the loan. You need to show whatever experience you can from related jobs or companies to reduce the banker’s perceived risk and maximize the chance of you securing the loan.
Key Loan Factors #3 – Business Banking Services
Let’s say you run a website design company. You have two clients. One client uses your services on a regular basis. Every month she comes to you with a plan to update her site and she sees you as a trusted business partner. The other client had you set up her site but you have not heard from her for six months for any improvements or updates. She sees you as a necessary evil to getting her business going and wants to deal with you only when she absolutely has to. Now, say both clients come to you and want site changes but neither can pay up front. They want you to credit their account and they offer to pay you in a couple of months. Assuming you could only grant the credit to one person, who would it be?
The answer is obviously the first client who uses you on a regular basis and sees you as a trusted business partner.
Banks work the same way. The more you use their business services and the more you are in contact with them, the more they get to know you, the more they want to keep you as a client, and the more likely they will give accept your loan application over other businesses, with all else being equal.
Develop this relationship by setting up all of your accounts with one bank. Use them for your checking account, your savings account, your credit cards, your loans and lines of credit, and every other business banking service you end up using. When you sit down with your account manager for your loan application and she pulls up your account history on her computer, you want her to be thinking “Wow. This client is really using a lot of our services. I want to do as much as I can to make sure I can keep her at our bank.”
Key Loan Factors #4 – Size Of Company
Finally, the size of your company will be a crucial factor in the bank’s decision to give you a loan or not. Again, remember that banks like lending safe capital to low risk borrowers. They do not like high risk entrepreneurs. Therefore, the bigger you are, the safer you are and the more likely you are to get your loan.
The loan rejection numbers by size of your company look like this:
0 to 4 employees: 13.6% rejection rate
5 to 19 employees: 10.7% rejection rate
20 to 49 employees: 6.0% rejection rate
50 to 99 employees: 4.1% rejection rate
Over 100 employees: 2.5% rejection rate
Who Makes The Decisions When applying for a loan it is also important to know who is going to be making the final decision as to whether you get accepted or rejected.
According to recent data, the decision maker breakdown looks like this:
36% of decisions are made by the head or regional offices
31% of decisions are unknown who the final decision maker is
25% of decisions are made by the local branch office
8% of decisions are made by automated credit scoring models
What is interesting to note is that most of the decisions are still made by real people, not computers. And people make emotional decisions, not always rational ones. By presenting your case and letting the decision maker get to know you and your story, you can increase the chance that they will say yes.
Why Banks Say No
Finally, according to a CFIB survey of entrepreneurs who have applied for bank loans, here are the most common reasons the banks give them for why their application was rejected:
26.6%: Too much outstanding debt
26.6%: Lack of owner equity
24.8%: Insufficient cash flow
17.2%: Too new in business
13.7%: Poor industry conditions
11.6%: No reasons were given
7.8%: Products not considered profitable
4.1%: Inadequate business plan
4.0%: Environmental risk factors
These are the major warning signs that bankers will look out for before approving your loan. Before submitting your application you must try as hard as you can do anticipate and counter possible arguments in each of these areas.
One disturbing fact is that over 11% of entrepreneurs who get their loan applications rejected are not given a reason from the banks as to why this happened. The most important thing you can do if you get rejected is to listen to your banker. Always find out the reasons why you got turned down. Then ask what you can do over the next couple of weeks or months to improve your business so that they will accept your application.
Credit Criteria Suppliers of SME financing also use credit scoring to evaluate the risk of a potential loan. Capital One’s loan criteria breaks down as follows:
35%: Payment History – Account payment information on specific types of accounts (credit cards, retail accounts, installment loans, finance company accounts, mortgage, etc.)
30%: Amounts Owed – Amount owing on accounts
15%: Length of Credit History – Time since accounts opened
10%: New Credit – Number of recently opened accounts, and proportion of accounts that are recently opened, by type of account
10%: Types of Credit Used – Number of (presence, prevalence, and recent information on) various types of accounts (credit cards, retail accounts, installment loans, mortgage, consumer finance accounts, etc.)
What To Look For
You should also evaluate your banker and pick the one that best suits your business purposes. Some of the more common measurements entrepreneurs use are:
– Level of financing
– Lending terms
– Information requirements for financing
– Service charges
– Understanding of your business
– Treatment by account manager
– Access to branch
– Online banking services