It is really simple.
It does not matter if you are starting a new business or if your company has been around for decades. If you want a business loan- be it for commercial real estate, equipment, inventory, working capital or for any legitimate need – you will have to convince a lender of two major items:
- Your willingness to repay – this is determined from your past credit history which we will not discuss here except to say that if your credit is bad – fix it or no loan what-so-ever.
- Your ability to repay – which is all important and which we will discuss here.
Know that if you cannot repay, no lender will provide you the money you seek – no matter how well you have everything else in place – including your credit score.
In fact, it is all lenders want to know – how they will get repaid – both principal and interest (how they make their money and profits).
Can’t pay – no loan.
How Lenders Determine That You Can Repay
Your ability to repay is all based on your cash flow – be it revenue from a business or income from some other source. But, it is this cash flow (the amount of money coming in less the amount of money going out) that lenders look for.
In business, you earn revenue – top line revenue. From that revenue you subtract the direct costs of earning that revenue then subtract all your company’s overhead expenses (management salaries, marketing, R & D, general and administration expenses, selling costs, rent, etc.). At this point, your business is left with operating revenue.
And, it is from this operating revenue that your company has the ability to make loan payments.
If this value is negative – you do not have positive cash flow to repay. If it is positive, then that figure determines how much you can qualify for.
Example: Your business has operating revenue of say $5,000 per month – this is after all your expenses except taxes and interest are paid.
Thus, you have $5,000 to make monthly payments. If you take that $5,000 and back into a principal amount – say at 7% for 5 years – you get an amount of about $250,000. This means that you should be able to qualify for a $250,000 loan given those other factors.
Simple enough. But, what happens if you need more than that? Or, what if you need this amount but your operating revenue is less than $5,000 per month.
Well, you can ask for a lower interest rate which will hopefully make your monthly payment requirement lower – making it fit with what you do have in operating revenue. But, what might surprise you is that your interest rate really does not make all that much difference unless you are talking about very long-term loans – for 20 or 30 years.
So, in our example, a $250,000 business loan at 7% for 5 years results in a payment of around $5,000 – thus you have to have operating revenues of at least $5,000 to get approved. Now, let’s cut the interest rate in half – to 3.5% – what does that do to the payment amount?
At 3.5%, you anticipated monthly payment would only drop to $4,550. Just a $450 drop which is about a 10% reduction. And, while it is a reduction, is it enough? Probably not.
So, you can’t change the amount you need. You can’t improve your cash flow – at least not in the time needed. And, asking for a lower interest rate does not really work. So, what is left?
The 1 Item You Can Manage To Improve Your Approval Chances
All that is left is the term. And, what I hope you get out of this is that this one item can be quite powerful.
Let’s go back to our example. A $250,000 business loan at 7% for 5 years results in a payment of $5,000 per month – which you have to cover with your cash flow in order to get your approval.
But, let’s say that your business has only $3,000 per month in operating revenue to make payments. Thus, you just do not qualify. And, as shown, asking for a lower rate will not help all that much.
But, what happens if you increase the term – say double it from 5 years to 10 years? If you double the term, your anticipated monthly payment would drop to about $2,900 – well below your monthly cash flow and a better chance of getting your potential lender to say yes (which is the goal at this point).
Thus, you can take a given no and turn that into an easy yes.
However, there are costs to everything – including extending your term. The longer the term, the more in overall interest you will pay.
From our example: Our loan for 5 years at 7% would result in total interest over for those 5 years of about $47,000. However, increase the term to 10 years and your overall interest jumps to $98,000.
But, know that this is about getting approved and growing your business more than it is about not getting the loan and not growing your business.
And, if you manage your term as you should, the term sets your minimum loan payment – for those months that you can only meet that minimum. But, what happens when you get the money (which you would not at a 5 year term) and use those funds to grow your business – to the point that your operating revenue is now $5,000 a month or more.
Thus, you now have the ability to pay that loan down faster than the ten years – essentially reducing that interest back to where it could have been.
And, none of this would have been possible if you kept the term at 5 years and did not get approved.
This is the flexibility issue – a powerful issue – that you can control with your term. I constantly tell potential borrowers to get the longest term possible – not only will it help you qualify with a lower monthly payment but it gives you flexibility. If you have a bad month, then you only have to meet the minimum payment. But, if you have a good month, you can pay more; reducing both your overall term and interest paid – all up to you and all in your control.
Further, it does not stop there. I see great businesses everyday get turned down for credit – not because they do not meet the minimum payment amount with their cash flow but because they only just meet it. Many lenders, most these days, also like to see a cushion in cash flow of say 10% or 15% above the payment amount. This provides a cushion should your business have a bad month or two – it will still be able to make the payment given the cushion.
Example: Bryan Desmond owns and operates a small auto body shop just outside Oklahoma City. Through his business, he earned about $2,000 per month in operating revenue – after covering all his other expenses.
But, he needed to buy a new motor for his painting booth – an industrial motor that pumps the paint to the applicator. And, this motor costs a whopping $65,000 – but would also allow Bryan to make twice that amount in revenue over the next 5 years.
However, his banker only offered him the loan at 8% for 3 years which put his payment right at $2,000 per month. Then, when his banker took that request to be approved, the credit committee turned the application down as there was no cushion in the cash flow. Thus, no needed money.
So, Bryan took his deal to a local credit union that offered business equipment loans and negotiated a deal with the same interest rate but for 5 years – reducing his monthly payment to just $1,300 per month. Not only did Bryan get his approval and his motor but he had additional operating revenue left over each month to either apply to the principal if he wanted to or use that money on other opportunities to grow his business. In the end, Bryan paid the loan off after 3 years and just simply made a lot of revenue (all keep in the business) after that.
Now, know that most lenders – especially banks – want to have the shortest terms they can get. To them, loans represent risk and the longer they are out there, the more risk they present. So, you will have to fight – and fight hard – to get them to extend the term. But, if you really want that money and the opportunity it signifies, it will be an easy fight for you. Because, without the longer term, you might not get the approval you need anyway.
To get your
business loan approved, you have to be able to convince a lender that you can repay it. It is that simple. Can’t repay, no matter what else you bring to the deal, then no approval and forget all the benefits that come with it.
But, you can help manage your approval as well as help your business out by simply fighting for a term that balances both the lenders risk (their willingness to say yes) with the costs to you.
The good thing about it is that this one thing is all in your control and can really make a huge difference in how far you can take your company.
So, what do you have to lose? Get out there and fight for the term that makes both you and the lender say yes!
Capital LookUp – seeks to make your capital raising efforts easy. On our site, you can search for a myriad of different
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We seek to simply make your capital raising process an easy and productive venture – allowing you to quickly get back to focusing on what you do best, growing your business.