By Charles H. Green
Q My banker thinks that SBA loans are “too much paperwork.” Changing banks would be difficult since I have been with this one many years, and they handle my merchant account, vehicle financing, and personal investments. What can I do to get an SBA loan anyway?
A There are a couple of options available to you:
Either you can try one of a non-bank Small Business Lending Companies (SBLC), which is licensed to make SBA-guaranteed loans. There are about thirteen, and many operate in several states and make loans virtually anywhere in the U.S.
Or, you can simply initiate a second bank relationship with another local bank that does make SBA loans. Legally, a bank cannot require you to move your deposit accounts to them to be approved for a loan. You may find you like the second bank more and move your other accounts on your own.
Working with one of these lenders would not require that you change your total banking relationship, since SBLCs are not depository institutions, and are usually only seeking your loan relationship.
Q I applied for a $200,000 loan for my business to expand our facility and buy more equipment. I projected how my revenues would grow accordingly but my lender said my â€˜debt coverage’ was too low. The bank would only approve a $150,000 loan. How is debt coverage calculated and how can I improve it?
A The lender was referring to the Debt Service Coverage Ratio, which compares your projected cash flow in a given period to the total debt payments (principal plus interest) required for that same period. This ratio is a crucial indicator of whether the business will produce enough cash flow to repay the loan as scheduled.
To calculate this ratio add any non-cash expenses (depreciation and amortization) back to the projected interest expense and net profit. This total yields the gross cash flow available to the business to service debt. Divide this number by the total loan payments (including all debt payments) required during the projected period. The result equals the Debt Service Coverage Ratio.
Lenders typically prefer for this ratio to be a minimum of 1.25x, although a less mature business may face stiffer requirements. Businesses can improve this ratio two ways: 1) reduce the total of debt payments, or 2) increase the gross cash flow. There are several ways to achieve both of these results, but the true determinant will be whether the business’ financial position provides them with sufficient flexibility.
The total of payments can possibly be reduced by consolidating debt, increasing loan terms, negotiating lower interest rates, and paying off some loans, particularly those with lower balances remaining.
Cash flow can be increased principally through expense reduction. Small businesses usually focus on profitability without being prompted by their lender but indirect expenses are sometimes ignored, which erodes the company’s cash position and profitability.
Q My bank has refused to provide a loan to my company unless I sign a personal guaranty for the funds. I want my business to stand on its own. Will other banks also require this guaranty?
A Yes. Remember that banks aren’t investors, they are lenders. Since they can’t control your business, they have to be assured that you wouldn’t later decide to take actions which could impair the company’s ability to repay the bank. Personal guarantees provide the lender comfort that the commitment of your company is your personal commitment as well.
Without personal guarantees, the bank would be exposed to loan losses in situations where the owner of a failing business might be tempted to abandon the situation before resolving the unmet liabilities. With the leverage of personal guaranty, the bank knows that you will attend to business of repaying their loan to the extent of your abilities, as you agree to do when the loan is originally extended.
Q My banker told me that their bank bases its prime lending rate on the Prime Rate published in the Wall Street Journal. Can you tell me how the WSJ Prime Rate is determined?
A The WSJ Prime Rate is the “best” interest rate offered to corporate borrowers by the nation’s leading banks, as compiled regularly by the Journal.
Q My company recently closed a commercial loan. The bank required my partners and me to sign a “joint and several” loan guaranty. Exactly what does that mean?
A Essentially, the bank obtained a personal guaranty from each partner for the entire debt, rather than for a proportionate share equal to each partner’s ownership. It is common in a ‘joint and several’ guaranty that the bank has the right to single out one owner from which to seek repayment in the event of default.
That means the bank can look to the deepest pocket for repayment of the entire loan, without bothering to file suit against any of the other owners, and without even necessarily going after the business entity. This situation should be a concern for any owner which may have a significantly stronger financial position that the rest of the owners.
The business should try to negotiate away from ‘joint and several’ guarantees, if possible. If that’s not possible, at least address the issue in the partnership or shareholder agreement so that a path to resolution among the business owners is prepared should a single owner be targeted in a loan default. Typically, owners will agree among themselves to repay a proportionate share of the defaulted loan, and indemnify other owners for each one’s respective share of the guaranteed loan.
Q In February, a bank issued my company a commitment letter to extend us a $400,000 commercial loan. We spent $11,600 toward preparations to close this loan (including appraisal, attorneys fees, and environmental report) only to have the bank change its decision and not make the loan. My company is in a terrible situation now, since we were counting on the loan, and now have wasted $11,000! Can I sue this bank for damages?
A Whether you can successfully sue the bank for these damages depends on exactly what the bank committed to do, and what they actually did. You would really need to consult with your attorney to get a legal opinion, but I would guess that the bank issued you a â€˜conditional’ commitment, which based their willingness to fund your loan on the confirmation of certain information or conditions. Usually their decision to rescind such an offer indicates that something did not meet their expectations.
Banks rarely issue an unconditional commitment to lend money – they always try to leave an “out” clause, which can be used to justify changes in their credit decisions. These conditional clauses typically involve the financial position of the borrower or the valuation of the collateral used to secure the loan. These conditions are necessary for the lender to protect itself from fraud or misrepresentations from unscrupulous borrowers.
Q When applying for a loan for my business, the bank obtained a report from the credit bureau which contain several errors about my credit history. Although my loan was turned down, the bank would not show me the report, and would not contact the credit bureau to correct these errors. Which bank can assist me in these circumstances?
A There aren’t any banks which have the authority or responsibility to correct your credit report. Your problem is with the credit bureau, which is responsible for reporting only factual, verifiable information about individuals. Your bank is probably restricted from showing the report to you by their license from the credit bureau to obtain these reports, which wants to protect the confidentiality of the credit score.
If you have been denied credit (personal or commercial) due to information contained in a credit report, the credit bureau is obligated to make any corrections you can substantiate. They will provide you with a free copy of this report annually upon your request. The bank should provide you with contact information for the credit bureau. You should get a copy of your credit report and review it thoroughly for any errors.
If you find any errors or misstatements, you can report these to the credit bureau detailing the corrections which need to be made. Provide the credit bureau with any written documentation you have to collaborate the corrections you are requesting. If you have had a dispute with a another party or extenuating circumstances which have resulted in negative information on your credit report, you have the right to add your side of the story to this report. The credit bureau is required to investigate the corrections you make known to them and make any appropriate changes.
At the time these corrections are made, you should be provided with another copy of your credit report to confirm the changes have been made. Should all of the errors not be eliminated as you suggested, write the credit bureau again. Persistence is often required to get your report completely corrected. Keep your bank appraised of your efforts to correct your credit report, and supply them with a copy of everything you submit to the credit bureau.
Q I got an SBA loan in the late 1980s and repaid it in 2001. Can I get another one?
A Yes, if you qualify financially and you are still eligible according to SBA size standards. Individuals are only restricted by the $1,500,000 guaranty limitation. This limit can be in one loan or ten concurrent loans, so long as the total amount of guaranteed funds does not exceed the limit. There is no limit as to the number of loans that can be obtained and paid back.
Q My banker said my balance sheet is â€˜too leveraged?’ What does that mean, and what can I do about it?
A Your banker was referring to the fact that your company may have too much debt in relation to the amount of equity (capital stock plus retained earnings). Excessive leverage can cause a variety of problems, such as disproportionate interest costs, exposure to rising rates, and limitations on the growth potential of the business.
You can address this problem by reducing debt as much as practical, and replacing it with more capital contributions. This solution may be implemented over time by simply lowering the owner withdrawals and accelerating repayment of any outstanding loans. It usually takes time, but will strengthen the company for the future.
Your CPA can advise you of other methods to employ in your particular company to strengthen your balance sheet and lower your leverage.
Q My recent loan closing was delayed because, according to the bank, they did not have adequate liquidity. My loan did close two weeks later, but does this delay mean that the bank is in financial trouble? How could this situation affect my loan account?
A A banks liquidity is similar to any business enterprise. Sometimes when cash is utilized faster than it is re-generated, there can be short term periods of inadequate liquidity. Much like a manufacturer may have to spend money on raw materials and labor faster than customers advance funds for payment of goods, banks, particularly smaller ones, can find themselves lending funds out faster than loan payments replenish their cash resources.
This situation does not necessarily indicate financial problems, but could be a sign that the bank is in a rapid growth stage which may be outpacing their current capitalization. On the negative side, it could reflect that the bank is facing some capital issues.
The net effect on your business, as a borrower, is negligible. If your bank were closed by regulators, it would be done overnight and sold immediately to another bank which would continue operations without closing for so much as an hour. Chances are this transaction would happen without you knowing anything was changing. Your loan payments would still be due as previously scheduled.