Business Advice Daily

Reprint and Repost Policy

To determine whether you qualify for SBA’s financial assistance, you should understand some basic credit factors that apply to all loan requests. Every applicant needs positive credit merits, which a lender will review and analyze before deciding whether to internally approve your loan application, seek a guaranty from SBA to support their loan to you or decline your application altogether.

Equity Investment

Business loan applicants must have a reasonable amount invested in their business. This ensures that, when combined with borrowed funds, the business can operate on a sound basis. There will be a careful examination of the applicant’s debt-to-worth ratio to understand how much money the lender is being asked to lend (debt) in relation to how much the owner has invested (worth).

Strong equity ensures the owner remains committed to the business. Sufficient equity is particularly important for a new business. Weak equity makes a lender more hesitant to provide any financial assistance. However, low equity in relation to existing and projected debt—the loan—can be overcome with a strong showing in all of the other credit factors. Determining whether a company’s debt level is appropriate in relation to its equity requires analysis of the company’s expected earnings.

Earnings Requirements

Financial obligations are paid with cash, not profits. A company must be able to meet all of its debt payments, not just its loan payments. Applicants generally are required to provide a report on when their income will become cash and when their expenses must be paid. This is usually in the form of a cash flow projection, broken down on a monthly basis, and covering the first annual period after the loan is received.

When the projections are for either a new business or an existing business with a significant (20% plus) difference in performance, the applicant should write down all assumptions that went into the estimations of both revenues and expenses and provide these assumptions as part of the application.

All SBA loans must be able to reasonably demonstrate the “ability to repay” the intended obligation from the business operation. For a new or expanding business with anticipated revenues and expenses exceeding past performance, the necessity for the lender to understand all of the assumptions on how these revenues will be generated is paramount to loan approval.

Working Capital

Working capital is the excess of current assets over current liabilities.

Current assets are the most liquid and most easily convertible to cash. Current liabilities are obligations due within one year. Therefore, working capital measures what is available to pay a company’s current debts. It also represents the cushion or margin of protection a company can give their short-term creditors.

Working capital is essential for a business to meet its continuous operational needs. Its adequacy influences the company’s ability to meet its trade and short-term debt obligations, as well as to remain financially viable.

Collateral

Collateral can consist of both assets that are usable in the business and personal assets, which remain outside the business. Depending on how much equity was contributed toward the acquisition of these assets, the lender also is likely to require other business assets as collateral.

For all SBA loans, personal guarantees are required of every owner holding 20% or more, plus other individuals who hold key management positions. Whether a guarantee will be secured by personal assets is based on the value of the assets already pledged and the value of the assets personally owned compared to the amount borrowed. In the event real estate is to be used as collateral, borrowers should be aware that banks and other regulated lenders are now required by law to obtain third-party valuation on real estate related transactions of $50,000 or more.

Certified appraisals are required for loans of $100,000 or more. SBA may require professional appraisals of both business and personal assets, plus any necessary survey, and/or feasibility study.

Owner-occupied residences generally become collateral when:

* The lender requires the residence as collateral.

* The equity in the residence is substantial and other credit factors are weak.

* Such collateral is necessary to assure that the principals remain committed to the success of the venture for which the loan is being made.

* The applicant operates the business out of the residence or other buildings located on the same parcel of land.

Resource Management

The ability of individuals to manage the resources of their business is a prime consideration when determining whether a loan will be made. Mathematical calculations on the historical and projected financial statements form ratios, which provide insight into how resources have been managed in the past. Some key ratios all lenders review are debt to worth, working capital, the rate at which income is received after it is earned, the rate at which debt is paid after becoming due, and the rate at which the service or product moves from the business to the customer.

This article was written by the U.S. Small Business Administration (SBA). For more information, visit www.sba.gov.

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