At Innovative Capital Corporation, we understand the importance of finding the right lending partner to finance your business. As alternative lending experts, we work hard to partner with the best bankers, private investors, and other alternative financing companies to serve our clients best. Our goal is to utilize our diverse resources to find you the best rate and term to fund your next project.
Through our high volume of transactions, we learn quickly how to determine which lenders provide the capital to fund the right projects for our clients. Our goal is to match lenders and borrowers for a successful partnership. Business owners are typically experts in their products or services. Knowing how to navigate the process of acquiring a loan can be very stressful and time-consuming. Innovative Capital has streamlined this process to save our clients time and money.
To understand the traditional loan financing process, and what banks look for during the loan application process, we’re sharing a recent post provided by Jay McCabe. Jay is Comerica Bank’s Vice President and Relationship manager with the Middle Market Banking team with over 15 years of banking experience. His recent article highlights the qualitative and quantitative factors that go into traditional bank loans for you to better understand your business’s position.
When looking for funding options, our team of loan officers has the resources to partner with businesses and find the right type of lending partner. We are designed to help a variety of different types of businesses reach their financial funding needs because we have the range of expertly chosen resources to match them. We utilize private money, alternative financing companies along with knowledgeable bankers, like Jay McCabe at Comerica, to help our clients find the right loan for their unique business needs.
Read on for Jay McCabe’s full article:
Is your company positioned for big growth
It takes capital to grow a company. All business owners recognize this reality, but do you know exactly what’s required to get access to that capital when you need it?
In this article, I’m going to take some of the mystery out of how to secure capital. And this applies to a wide range of sources and forms, including equity, a myriad of financing options, or bank debt. In fact, after doing the exercise outlined below, you will be able to locate your own company on the graph and understand your company’s bankability.
When you understand how to lay the groundwork, you can start to position your company for big growth.
A Good Banking Joke
Have you heard any good banking jokes lately? How about this one?
When will a bank lend you money?
When you can prove you don’t need it.
As with any good joke, the humor comes from the truth in the punchline. I can see why owners can feel this way. Banks ask for a lot of information and they secure their loan position in many ways. It can feel overly intrusive and conservative. On top of that, it can feel like the bank’s decision process is a complete mystery. I know this because I have some firsthand experience.
My Experience as a Business Owner
Prior to my career in banking, my wife and I owned a small franchise business. We purchased an existing franchise which helped reduce the start-up risk and allowed us to hit the ground running. Shortly after closing the sale, a banker from a nearby branch stopped by and asked if we would like a bank loan. I said “YES! Absolutely! What do you need to get started?”
The banker replied, “I just need three years of financial statements, three years of tax returns for the business, three years of tax returns for you personally, and a personal financial statement.”
I thought wow, that sounds like a lot of information. And this was before the days of easy electronic transfer, so I made the comment, “You are aware that we just bought this business, right? I don’t have three years of tax returns or financial statements on the business.”
The banker quickly replied, “That shouldn’t be a problem. Send me what you have, and I will get started.”
Somewhat cautiously optimistic, I took the time to painstakingly gather the information, photocopying each document. Once I compiled the information, I gave it to the banker and waited…and waited…and waited.
A couple of months later, the banker came by the store and told me he would not be able to make the loan. I asked, “Why not?”
The banker replied, “Because you just purchased this business.”
I did everything I could to keep calm because I was fuming inside thinking about all the time I spent compiling the documents. “I told you that when we first met!”
The banker did not have a response to that, and I was left confused. I wouldn’t forget that experience.
The Start of My Career in Commercial Banking
Coincidently, the next year I joined Bank of America in their commercial banking division. Having experience as a CPA, a financial analyst, and a business owner, I was eager to put my skills to work as a commercial banker. Thinking back to my experience seeking a bank loan, I was determined to answer the question, what does a bank consider when making a loan?
After attending credit training, and underwriting some deals, I began to gain some clarity. A career later, and with many more deals completed, I am in a position to succinctly answer this question. It has ultimately evolved into what I call “Peace of Mind Banking – Knowing Your Company’s Bankability.”
The Factors Banks Consider
Let’s start with identifying the ten key factors banks consider when making a loan. These factors fall into two categories: Quantitative Factors and Qualitative Factors. For each factor, score your company between 1 to 5, with 1 being low or weak and 5 being high or strong.
Quantitative Factors:
- Trends – Is your company growing or contracting? Are revenues, gross margin, and profit margins consistent or highly variable? Banks like consistency.
- Profits – Has your company been profitable? Profits can be reinvested into growing the company. If your company has not been profitable, it will likely be very difficult to obtain a traditional bank loan.
- Cash Flow / EBITDA – We’ve all heard that “cash is king.” It’s the lifeblood of any business. How well does your company manage its cash flow? Are you converting your inventory, collecting receivables, and managing your vendors appropriately? Cash flow is the primary source of repayment of bank loans, and also a major driver of the value of your company.
- Leverage – How have you capitalized your company: by raising money through equity or debt? Does your company have a strong balance sheet capitalized by years of profitable operations reflected in retained earnings, or have you distributed all excess earnings to shareholders? What are your company’s ratios of Debt to Cash Flow (i.e. EBITDA) or Debt to Equity? Typically banks like to see Debt to EBITDA under 3.0x and Debt to Equity under 6.0x.
- Collateral / Assets – What type of collateral can your company offer as secondary support for the loan? Does your company have substantial accounts receivable, inventory, or unencumbered equipment? Are you, as the owner, willing to offer a personal guarantee, and what is the strength of your personal balance sheet? Banks like to have multiple ways for loan repayment should the worst-case scenario occur.
Qualitative Factors:
- Industry Stability – How stable is the industry in which your company operates? Is it feast or famine, or are cycles fairly consistent and mild? Banks tend to prefer to lend to companies in stable industries that perform well in either growing or contracting economies. If you operate in a less stable, or specialized, industry you will likely want to work with a bank with experience in that industry.
- Customer Growth & Diversity – Do you work with a large number of customers? Is your business expanding or contracting based on those relationships? Or do you only have a few customers that drive the majority of your sales? Customer growth and diversity (or conversely concentration) will be scrutinized by a bank.
- Quality of Financial Reporting – What is the quality of your financial statements? Do you have CPA-prepared statements (i.e. reviewed or audited)? How timely are your financial statements prepared after month, quarter, and year-end? Are the statements accurate? Banks make loans based on the financial metrics of the company, so timely and accurate financial reporting is imperative. Late financial reporting will cause a bank to assume the worst.
- Competitive Position – How does your company rank among its competitors? What are the barriers to entry for your industry? Why do your customers buy from you? How would you rate your company’s pricing power? All these questions relate to your competitive position and the defensibility of your company. Banks want to ensure they are lending to a company that will be around for the long haul.
- Management – How experienced are you and your management team? Have you guided your company through an industry downturn? Have you operated a leveraged company and managed a banking relationship? Can you clearly and succinctly articulate the company’s growth strategy? Banks gain confidence in working with management teams that have relevant industry and operating experience and can clearly communicate their strategy to grow.
Determining Your Company’s Position
Now that you understand the ten key factors, and you’ve scored your company from between 1 to 5 for each factor, you should have two scores:
- Quantitative Factors ranging from 5-25.
- Qualitative Factors ranging from 5-25.
Armed with this information, you can locate your company’s position on the “Peace of Mind Banking” graph below.
This will give you some indication of your company’s bankability. Ideally, you would like to have your company in the Stable zone noted by the green area. This is where you would likely have access to a bank loan, which is one of the most cost-effective forms of debt capital. It’s also indicative of a company that is well-positioned for growth. So, what if your company isn’t in the Stable zone? What forms of capital are available to you? Let’s take a closer look at each of the zones.
Understanding the Zones
Early
If your company scored less than 10 on both the Quantitative and Qualitative Factors, your company is likely in the Early zone. I know this zone well through my experience as an owner of a small franchise business.
It typically indicates the company is facing several challenges, some of which might include the company was newly formed, thinly capitalized, or is in a challenging industry (to name a few!). In short, your company scores on the lower end of all the Quantitative and Qualitative Factors.
In this zone, your company’s capital options are somewhat limited and will typically include non-traditional sources such as:
- Loans from the owner
- Home equity
- Friends and family
- Private money
As you may guess, these forms of capital will likely be more costly and function more like equity.
Transition
This zone is exactly how it sounds. Your company is somewhere between the Early and Stable zones. This is the space in which your company may have more traditional financing options, however, it’s likely they will be more costly than a bank loan.
Companies in this zone typically have strengths in several areas that are offset by weaknesses in others. For example, you may have a company that is well known, but in a declining industry. In this case, it’s likely that several of the Qualitative Factors are strong (competitive position, management team, etc.). However, the industry in decline is negatively impacting the Quantitative Factors (i.e. trends, profitability, leverage, etc.). Or the company might be strong on the Quantitative Factors since growth and profits are strong, but it is driven by only a few customers. You can see where companies with these profiles might land on the graph below.
In the Transition zone, your company’s debt capital options broaden from the Early zone and will likely share some characteristics of a bank loan. The sources might include:
- Asset-based loans rely more on the collateral position of the company vs. cash flow.
- Mezzanine & Subordinated debt which have elements of bank loans and equity investments.
- Non-bank finance companies can provide more flexibility, but at a higher cost.
- All capital from the Early zone.
Stable
This zone is where your company scores relatively well on all of the key factors. While some may be stronger than others, you won’t have less than a total of 15 on either the Quantitative or Qualitative Factors.
In this zone, your company will likely have access to a bank loan which is typically only 2.0%-4.0% over the bank’s cost of funds. That is a cost-effective form of capital. Additionally, the company will have access to all the other forms of capital in the previous zones and will likely be highly sought after by both investors and lenders. This is a company well-positioned for BIG growth.
I am committed to educating owners regarding what they need to do to best position their companies to access bank debt, and ultimately position it for BIG growth. If you, or an organization you are involved with, would be interested in scheduling me as a speaker, please email me at jlmccabe@comerica.com
About Jay McCabe
Jay McCabe is a Vice President and Relationship Manager with the Middle Market Banking Team at Comerica Bank. Through direct and candid communication, Jay’s primary goal is to thoroughly understand his clients’ business objectives and to provide them with peace of mind that they have the capital they need to grow their businesses. Jay has been particularly effective in working with companies in the government contracting, manufacturing, distribution, and business services sectors.
With over 15 years of commercial banking experience in San Diego, Jay draws upon his diverse professional background including experience in public accounting with Deloitte, and operational and finance roles with Toys “R” Us and Qualcomm. He also owned, operated, and successfully sold a small business, so he knows the life of an entrepreneur.