The Three Questions Bankers Ask First

Feb 19 2014, 12:28pm CST | by

The Three Questions Bankers Ask First
Photo Credit: Forbes Business

Watching the 2014 Winter Olympics, I can’t help but notice an athlete’s ability to win Gold seems to depend upon the seemingly arbitrary (at least very subjective) opinions of judges who seem to be “all powerful.” Those athletes who are able to win over the judges tend to win the event. Ice-skating and snowboarding (among others) seem to fit into this category—whether or not the events are timed.

It’s been interesting to notice how this seems to correlate with so many other aspects of life generally, and within the context of small business borrowing specifically.

I have a colleague who used to compete at the highest level on the U.S. Ski Team as a mogul skier. Until he blew out his knee in a preliminary Olympic Trials event several years ago, he was headed to the big show. He and I have talked about how important pleasing the judge is to succeed. “If you know what the judges are looking for, and you can give it to them, you’ll likely get a better score than if you thumb your nose at the judge,” he would say.

There is no question in my mind, acquiring capital is one of the biggest challenges for a small business owner—Main Street business owner or otherwise. Although there are Main Street business owners able to woo a potential equity investor or two, most of the restaurants, dry cleaners, and small merchants we identify with Main Street probably look toward borrowed capital to fund their day-to-day operations or fuel growth. Wouldn’t it be valuable to know what the lenders (the judges) were looking for?

When I stumbled upon Kate Lister’s column on from a couple of months back, I thought of my mogul-skiing colleague as Lister described the three numbers that matter most to bankers. I’m going to borrow her three numbers (in the form of three questions), but include some insight I’ve acquired working with banks and other lenders both at Lendio and as a small business owner.

1) Can You Pay? Not too many months back, we talked about the Five ‘C’s of small business lending, “Can You Pay?” incorporates a couple of ‘C’s—Capacity and Capital—but I like the way Lister asks the question. If you have no capacity to generate income in your business, lenders will question your ability to pay.

This is why it’s so difficult for idea-stage or very young start-ups to get financing. Although an equity investor might be willing to put off recouping his or her investment until some future date (provided your business has the potential to exponentially expand with an influx of cash), a banker or other lender will be expecting a loan payment next month. No income and no ability to generate income today tells the banker you can’t pay.

2) Will You Pay? This question brings to mind a couple more ‘C’s—Credit Score and Character. Not too long ago I spoke with a lender about how he interprets a borrower’s credit score. He suggested he takes into account how the last few years have been tough on small business owners, but in his opinion, your credit score is still a pretty good representation of your willingness to pay. Granted, there are often extenuating circumstances that might push a small business owner’s credit score down. And, lenders understand a less-than-perfect credit score may be attached to a great borrower, but like a judge at the Olympics, a bad credit score isn’t going to win Gold.

If you have a crappy credit score what can you do about it? I wish I could tell you there was a magic formula to resurrect a problematic credit score, but there isn’t. First, visit one of the credit bureaus and find out exactly what your credit score is. Experian, TransUnion, and Equifax are the three major credit bureaus and for $40 or less, you can see the same report the bankers are looking at. You will also be able to go through all the items that show up on your report as late or in default. If you see mistakes, you can contact the company that is reporting to get the information updated or removed.

Otherwise, it’s going to take some time. Pay your bills on time—particularly your mortgage, car payments, or credit cards (for most Main Street small businesses, your personal credit matters just as much as your business credit). After as little as six months, your credit score can improve by 100 points or more. Invest the time it takes in your credit report to reap the rewards down the road. I realize this isn’t the answer you want to hear if you have bad credit and need a loan today, but there really aren’t any shortcuts to stellar credit. If this describes you, you should probably be working to improve your credit score before it’s time to get a loan.

3) What If You Don’t Pay? This is where the fifth ‘C’, Collateral, comes into play. Many loans use real estate, inventory, equipment, or cash as collateral. Some lenders in the MCA (Merchant Cash Advance) space or Factoring space will use your recurring credit card transactions or accounts receivables as collateral. Regardless of the type of collateral, it is at risk in the event you default. In other words, if you don’t repay your loan, expect to lose the collateral.

Sometimes I’ll hear from borrowers who have defaulted on a small business loan and are afraid they’ll lose their collateral. Maybe they’ve mortgaged their home or the building where they do business and are now scrambling to try to keep the property they put up as collateral. Although there are some lenders who might try to help you, the reason lenders usually like collateral of some kind is to help them recoup the loss caused by your non-payment.

This is why my Dad seldom borrowed money to support his small business. He was great at weighing those things that were nice to have versus the things he really needed to do business. If he didn’t really need it, he didn’t borrow to get it. Growing a business with cash flow often means slower growth, but slow growth sometimes means sustainable growth. Sometimes, just because you can, doesn’t mean you should. This is particularly true when putting valuable collateral at risk when borrowing cash for something that would be nice to have.

I’ve always thought the Five ‘C’s were pretty easy to understand, but Lister has made me a convert to her Three Things Bankers Ask First. “Bankers don’t actually read financial statements—at least not at first,” she says. “Here’s what they do look at.” I think she’s hit the nail on the head.

Source: Forbes Business


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