ARE YOU IN SEARCH of a business loan from a local bank? When you first approach the bank, the most important factors are cash and collateral.
In the past 20 years, commercial banks lent freely to small businesses with an asset used as collateral. Now times are changing. The savings and loan crisis sparked the recent push to increase commercial bank reserves, causing banks to have less money available to lend. The oil crisis has pushed the economy to the brink of an economic recession which scares lenders and borrowers. Meanwhile, baby boomers have sharply increased their loan demands to start new businesses, which means banks can be selective.
According to James Stewart, assistant vice president of The Bank of Maryland, a borrower's cash flow was always an important item, but past competition among the banks for new loans "forced them to stretch their standards." But now, he says, "Commercial banks are moving back to basic banking. They are looking heavily at the company's cash flow for the repayment of any loans."
So should you have lots of cash before you borrow money? Not exactly. Banks want to confirm that the business will have enough cash flow to pay for both the operating expenses and the loan repayments. Then your bank will ask, "What happens if your business plan does not work?" The lender will look for a second source of repayment, and at this point, your collateral becomes important.
Collateral: The most basic type of collateral for a new company is the entrepreneur's house and/or any real estate owned by the business. Typically the lender will approve a loan amount that equals 70 to 80 percent of the appraised value. When you apply, the bank will ask for your "guesstimate" of the value so that the banker can determine if your loan request can be seriously considered.
The bank will ultimately use its own appraiser to confirm the value before the loan is made. The bank will charge you about $500 for one of its qualified employees to appraise the property. If an appraisal was recently completed, check with the bank to ensure that your appraiser is on the bank's list of appraisers whose estimates it will accept. Your own appraiser will cost more than the bank's employee. The cost for your private appraiser's work could cost approximately $2,000 on up for the valuation of a relatively basic commercial building and property worth $500,000. An MAI (Member Appraiser Institute) appraisal is the most widely accepted. This means that the appraiser is certified by the American Institute of Real Estate Appraisers as qualified to estimate the market value of either commercial or residential property.
If the bank's appraisal is significantly different than your personal estimate, or that of your personally hired appraiser, suggest to the banker that that another independent appraiser should be jointly selected. Unfortunately, this will be at your expense.
Inventory: One source of collateral is your company's inventory. The bank will lend a percentage of its value, but the nature of the inventory determines its worth. For example, if your business makes copper pipes that are used by plumbers, and the pipe is in good condition, the bank will probably lend you 80 percent of its market value. If you make plastic pipe that is used for pleasure boats, the bank may lend you only 40 percent of the market value. The difference is due to the differing customer markets. A slump in the pleasure craft industry dampens demand for your boat pipe. The market value of the pipe, should the bank have to sell it at an auction, would be severely depressed. The bank lowers its level of risk by setting the percentage lower than it would for the maker of copper pipes.
Accounts receivable: A typical asset used for collateral, your accounts receivable can be pegged to a line of credit that equals 70 to 80 percent of the value of current receivables. Current receivables are those where less than 90 days have passed since you sent your customers their respective invoices. The accounts receivable line provides immediate cash from the bank while you wait for your customers to pay you. If you borrow against your receivables and an invoice is not paid within the 90 days, the bank can request that you pay back the amount borrowed against the uncollected invoice. From this respect, the management of the relationship with the bank can be a challenge. That actual balance due to the bank will change as new receivables are pledged and old ones are paid.
Securities: Many people use investment securities as collateral. Banks generally limit the amount you can borrow to about 50 to 70 percent of the market value of the securities. Your portfolio will be more highly regarded if the securities are easily recognized by the lender. Companies listed on the New York Stock Exchange or government securities are the most acceptable.
Equipment: Using business equipment as collateral can be a challenge because it may be hard to agree on the estimated value. This can be a much more subjective process than appraising the value of real estate.
What if you do not own any collateral? You may know someone -- a family member or close friend -- who owns an asset that you could use as collateral. Your friend or relative will not be responsible for your loan. But if you fail to pay it off, the bank will seize this collateral.
The bottom line: While bankers now place extra emphasis on your company's cash flow, they continue to require collateral.
Patrick Rossello, president of The Business Consulting Group, is a member of a number of local advisory boards, including the Baltimore Economic Development Corp. Send questions and suggested topics to him c/o Money At Work, The Evening Sun, 501 n. Calvert Street, Baltimore, Md. 21278.
HD Colateral remains important key in securing a loan