How Lenders Actually Evaluate Your Business Loan Application

How Lenders Actually Evaluate Your Business Loan Application (July 2014) – P2Binvestor Small Business Webinar Series

This webinar features Dennis O’Carroll of Juno Financial and John Goldschmidt of P2Binvestor. Dennis and John discuss how lenders representing different kinds of lending institutions and methods evaluate your financial information when considering your business for a loan. From the five Cs and beyond, learn all you need to know in this informational webinar about what lenders look for in a business loan application and what to consider in general when you’re looking for business financing. The end of the webinar will be reserved for participant questions and answers from Dennis and John, both of whom have extensive experience in credit analysis ranging from large international banks to alternative lenders.

Tips for preparing a business loan application

Whether you are in need of short-term or long-term financing, you will need to be organized with the information required by lenders and financiers. Here are a few basic tips to help you prepare

  • Have a business plan. For many lenders, this is a requirement, especially if you are a new business. Be sure you can show that there is a market for your service or product, show profit expectations, show how you have a competitive edge, and make it clear how your business will achieve what you project.
  • Skin in the game. Many lenders want to see a certain level of financial commitment by you and other business owners or stakeholders. Make a personal investment in your business if you can afford it.
  • Show that you can produce a decent profit and demonstrate financial savvy and responsibility by including strong but realistic financial projections. Be careful not to underestimate your financial needs and be sure to factor in any seasonal cashflow issues or other deviating trends.
  • Do your homework. Look for lenders that lend to businesses like yours or at least in your industry. You can approach local nonprofit lenders, chambers of commerce, the SBDC in your area, SBA, and others to gather insight into which institutions and lenders might be a best fit for your business.

Need more advice? We’re always happy to help, send us a note with your questions to hello@p2bi.com.

Webinar Transcript:

Erin Bassity: Good morning, everyone, and welcome to P2Binvestor’s third webinar, which is part of our small business webinar series. I’m Erin Bassity. I handle marketing for P2Binvestor, and I will be moderating our question-and-answer session at the end of today’s presentation. Today, we are discussing how lenders actually evaluate your business loan application. We have invited two field experts to present on today’s topic.

Without further ado, I’d like to introduce our speakers, John Goldschmidt of P2Binvestor and Dennis O’Carroll of Juno Financial. Welcome, gentlemen, and thank you for joining us.

John Goldschmidt: All right. Thanks, Erin, and hello, everybody. This is John Goldschmidt. I’m an accounting specialist for P2Binvestor. I used to work with some big corporations on the road and evaluated some other big companies, and there was a very kind of objective approach, what I would call plugging data into a black box in terms of evaluation.

Now, I have the pleasure working with small and mid-sized businesses at P2Binvestor and a role in helping them get their businesses to the next level, and it’s exciting. I love it.

Dennis O’Carroll: Good morning, everybody. This is Dennis O’Carroll. I’m the CEO for Juno Financial, and Juno, in a very similar fashion, helps small businesses get the financing they need when the bank isn’t an option. Juno works with pretty small businesses that have revenue of $3 million or under (a little bit smaller than what P2B would look at typically).

John Goldschmidt: Today, as Erin mentioned, we’re going to talk about how lenders actually evaluate your business application. There are a couple of things we’re going to talk about from a high level before we dig in.

We’ll go through the different sources of capital because one size doesn’t fit all for every business. We’re going to talk about how lenders evaluate your company – what each source will tend to look at. And then things that we prepare and think about along the way.

From a high level, it’s really important to know your business assets—know what they are—and to understand the liens that you have, that you might be placing on those assets.

Everybody knows a little bit about bootstrapping, and there’s not one definition for this, but I like to think of it as growing your business in a way that doesn’t incur significant debt on the balance sheet and also doesn’t give away a piece of the company. This includes things like credit cards and using friends and family and also perks-based crowdfunding or donation-based crowdfunding where people are basically giving away some money just kind of out of the goodness of their heart. If you can get that, great; but it’s not always an option.

In which case, you need to consider what you have, what your business assets are. Sometimes, depending on what stage you’re at or what type of business you have, it could be intellectual property; it could be code; it could be cash; it could be receivables; it could be inventory; it could be real estate. You just have to really understand that part because getting debt financing is going to put a lien on those assets.

What that means is, generally speaking, once you have lien on your assets, that’s all the financing that you’re going to get. We’ll go into a little bit more about how to break that up or what that means, but that’s something that you should be aware of. Also, I think, in a lot of times, people just aren’t really aware of what it means – what that lien means and how valuable it is to their business. The other thing is equity financing, which of course, is giving away a piece of your company. Understanding how that comes into play is important as well.

The next slide is about understanding the state your company’s at, and this a very kind of high level, general view. You have that startup phase, and then there’s this growth phase, and businesses don’t really… As a small business owner, you don’t really start making money until you get to that maturity phase. So that’s really where your cash flow has caught up with your growth, but we deal with businesses here at P2Binvestor that are in their rapid growth and eventually that rebirth phase where your company’s growing and need a little bit of extra oomph to keep it on that trajectory.

Dennis O’Carroll: That’s a good point, John. Let’s talk a little bit about the banks. Most business owners, when they’re getting to the point where they need financing for their company, they’ve already exhausted their own capital; they’ve invested everything they could; they’ve got their friends and family on the hook as well; they think, “Okay, great. Now, it’s time for me to go get a bank loan,” and, “I’m a good person. I’ve got good credit for the most part. My company’s awesome. I’m growing. Of course, the bank’s going to approve my loan.”

They go and talk to the bank, and they found out that that’s not necessarily the case, and then they go and talk to another bank, and they get the same answer. It can be difficult. It could be a little bit hard to swallow, and they have to…

It’s helpful to understand why the banks might not approve that loan. Everyone wants to get that bank loan because it’s the lowest rate you can get. It’s the best financing. It’s the cheapest cost of capital for the business owner. But there can be reasons why you’re not going to get approved.

The way to think about it or the way the banks look at it is they’re not set up to take on risk. What does that mean? Banks operate with a very small margin, so your typical commercial loan (this is a very high generalization), they’re going to charge roughly 6% interest on that line of credit; their cost of fund’s all in is about 3%. So in a ballpark, the number is at about 3% for them to cover operations, cover potential bad debts, and make a little bit of money.

Because they have these small margins, the only way the bank can make money or most banks can make money is that they have a very large portfolio. So the banks are out there every day going through all the best companies, picking and choosing just the very cream of the crop to put in their portfolio. As they’re doing that, they’re building their book; they’re generating more interest income; and they’re trying to become more efficient with their operation.

The other thing to keep in mind is, when there’s a bad loan (a loan goes bad for whatever reason), it has a significant and dramatic impact on the bank’s earnings. It depends, but one bad loan, it could take 10 good loans, maybe 20 good loans, 50 good loans to make up for that write-off that they incur. Because of that, the banks are very, very selective. It’s not that your company’s not a good company. It’s not that you’re not a good person. It’s just that the banks just can’t take risk.

How does a bank look at your business? Most of us have probably heard of the 5 Cs, and we’ll talk about those very quickly – the first one being cash flow. What does that mean? What is a bank looking for with that cash flow? They’re trying to see does your business generate enough profit to cover debt payments and typically looking for at least $1.50 of earnings with $1.00 of loan payments which includes principal and interest. If you don’t meet that, that’s going to be pretty hard to get approved by the bank.

There are certain things that they can look at. They’ll mitigate it if it’s a little bit below that. But generally speaking 1.5:1 is what you can expect. They’re also going to look at your collateral. The easiest collateral to look at is receivables. They also look at inventory, which is a little bit more difficult. And they look at equipment. You can get into some specific equipment financing as well.

They’re also going to look at your credit history. They want to make sure that they’re working with and lending money to people that are going to pay them back. So it’s very important that, from a bank’s perspective, the owners of the companies that they’re making loans to have very good credit. The next one is capacity. What does that mean? Capacity is simply the ability to take your asset, your collateral, and turn them into cash. Obviously, cash is great for a bank. They know they will get dollar for dollar on that. But other than marketable securities, everything else is a little bit iffy. So your receivables are your best asset from a bank’s perspective other than cash and securities because they can take those receivables, and those are going to collect out over 45, 60 days, maybe 90 days. That’s very good for the bank. Inventory’s a little bit more difficult. They have to go take that inventory and sell it on the market. And typically, they’re not going to get the price that an active business or concerned business would get. Again, you got equipment, which I like equipment because I can just repossess the equipment and potentially sell that on a secondary market. And then the last one is character. It’s not that “this guy is a real character.” They don’t want…

John Goldschmidt: That’s the opposite of what they want.

Dennis O’Carroll: Yup. They don’t want Chuckles the Clown. What they’re looking for is they take a look at your credit history. They do a background check. What they’re trying to establish is do the owners of the business have a history of paying their bills. In addition to that, what’s very important is, when you’re talking with your banker, are you giving straightforward answers; are you being evasive; are you supplying additional information when they ask for it; are you tailoring what you send them because you don’t want them to know the whole story. All that goes into your character. We had an issue here at P2B – a potential client. Everything looked pretty good. The financials are pretty good. The receivables look great. Good payers. All that was fantastic, but when we asked them questions around a couple of things, the owner was very evasive and didn’t want to provide additional information and didn’t think he needed to. Long story short, we had to turn him down. It just didn’t make sense from a character perspective to take on that risk. And the banks are going to do the same thing.

John kind of talked a little bit about how the banks are very rigid. They’re pulling your leg. They take all your information. They plug it into that black box. And then they’re looking for the answer that gets spit out at the bottom. And if the answer is “it doesn’t work; it doesn’t meet our standards,” there’s not a whole lot of wiggle room. They have to kind of stick to it because that keeps them in their perspective, safe from bad debts, bad loans.

John Goldschmidt: Ironically, that’s what happens sometimes, we do some creative accounting practices. But maybe that should be a separate webinar.

Dennis O’Carroll: Exactly. And that gets to the character of the person, right?

John Goldschmidt: Yeah.

Dennis O’Carroll: What are some of the key aspects with your loan application that are very important that the bank’s looking for? They’re looking for at least three years in business. They want to see if your company’s been profitable for, at least, the last two years. They’re, again, going to look at that personal credit, and it needs to be good, typically 700.

It’s kind of like when you go for, apply for a mortgage. The better your credit score, the better rate you’re going to get, the better loan options you’re going to have. Same thing here – if you’ve got bad credit, the banks, they’ll just turn you down. They just can’t take on that risk. They’re also going to look for the last three year’s financial statements and tax returns. They’re going to ask for a personal financial statement from the owners. They’re also going to be looking for the skeletons in the closet. What do I mean by that? Several things. Do you have any lawsuits pending? Either on you or your company. Do you have any liens? Tax liens are a big one. If the IRS has placed a lien on your company, that’s a very bad sign. Do you have any judgment? Have you had any prior litigation issues where you now have to pay up? All those kinds of things come into play with the banks and with most lenders. We don’t want to see those things. Those are skeletons. Those are red flags and bad for business.

All right. With all that behind us, let’s say we get to the point where we either got a bank line or your banker’s telling you that you qualify, “We want to give you this bank line of credit.” The question is, should you move forward?

As you think about that, you shouldn’t just jump up and down, and do cartwheels, and be so excited. Maybe you should, but you need to think about, is this facility, is this line of credit going to meet the needs of my growing company? Am I growing rapidly? Is there not going to be enough capacity from that line of credit to cover all of my growth prospects, so I can meet my goals? If you’re holding steady, you’re kind of a more mature business, and you just need that line of credit to cover some short-term or cyclical issues, cash flow issues, then it probably makes sense to move forward. As you’re looking at that line of credit, things to consider:

  • Is the bank going to increase that line anytime I need to just because I have more collateral? The answer is probably not. So a bank’s typically going to review that relationship once a year. Whether or not they’re going to make a change is going to be dependent upon getting a bunch of information again and going through that whole process. If they are comfortable, they’ll give you that increase, but it’s going to be a year down the line.
  • It might not be helpful today or in three months if you’ve got significant growth.
  • It can also take a lot of time. The banks, they’re kind of like an aircraft carrier. They don’t turn on a dime. It takes them awhile to make a decision. It can take 30 days or longer, and that’s if you’ve done everything that they’ve asked you to do very timely. If you got a very urgent need with your financing, it might not be practical to go through that bank process.
  • As John mentioned earlier, the bank’s going to take a lien on your company. Typically, they’re going to lien everything they can. They’re going to take a blanket lien, which is all assets of your company, which will make it more difficult down the road if you need to obtain some additional financing and use certain assets for that.
  • It can be beneficial in the long run or in the short run to look at some alternatives and maybe pay a little bit more in rate to get the flexibility that you think you’re going to need, like increasing that line of credit, looking at different types of assets for collateral.
  • The other issue that you have with banks is they’re going to put some restrictive covenants on you. They might limit the amount that you can take out as an owner, whether in salary or in distributions. They’re going to have ratios that you’re going to have to maintain and meet, leverage ratios, liquidity ratios, net worth. All of those things can hamper your growth. It can hamper your ability to grow your company the way you want.

And just a quick story. A couple of months ago, a bankrupt friend of mine came to me with a potential deal. He said, “Hey…” The company has a $250,000 line with us. It’s been at 250 all along. All they do is pay down the interest. There’s no principal payment on that line. The good news is they’re going. They hit a growth spurt, and they’ve got receivables $600,000+. So the company was trying to get more capacity to borrow. Unfortunately, the bank just wasn’t in a position to do that.

It’s not the kind of lending that I can do, but I made a referral onto somebody that I know that can take a look at a secondary lien position. And they’re in that process right now to see if that’s going to be an alternative for them.

John Goldschmidt: Just to reiterate in that, I’ve seen that plenty of times where a company is growing, and they say, “Oh, we need money. We need financing.” They get a term loan, and then a month later, they need more money, and that term loan ends. So they’ve already outgrown it and kind of back to square one. That’s just something to think about – again, what your assets are, where your business is on that growth trajectory. It might be worth a little bit more to have that flexibility. What to do when a bank denies you, or a bank says no, or when it’s just not the right option for you? Again, I’ll give you a very high-level view of some of these alternate options. The first one being equity, which I touched on earlier and which represents an ownership interest, and it’s you’re giving away a piece of your business, that golden egg. The thing about it is that, aside from being difficult and taking a long time to structure, the investors are expecting multiple returns, meaning it either doesn’t go well, and they don’t owe you anything, and your business is gone anyway, or if it does go well, you’re going to be paying effective interest rate in a hundreds of percentile. So it’s very expensive, and people think, “These guys need money,” and, “I’m going to grow the business,” but at what cost? We encourage people to think about bootstrapping the company a little bit more before going the equity route so that you’re giving a little less of it, and trying a debt option first.

The other thing to think about is there are a lot of synergies that need to take place because you’re bringing somebody into your business. And so, there really has to be a good fit, which takes a lot of time because these people are almost impossible to remove once they’re in. While equity seems glamorous, it’s not always the right point of view. Now, there are alternative lending instruments, which I’ll just kind of give an overview on. They can be a little more expensive. I mentioned earlier you pay for what you get. Unfortunately, some borrowers aren’t as aware of what stage their company’s at or what their assets are, and sometimes, they just fall victim to predatory lending practices. Obviously, we need to educate everyone so this stuff doesn’t happen, but that doesn’t ring true for all alternative financing, because it can be very flexible. It can be fast.

The great part about it is the assets can be divided up. Whereas a bank will take a lien on everything and it’s difficult to deal with rapid growth, and carving out, and getting new financing on top of it, with alternative financing, it’s very possible and easy to divide up, put a lien on your equipment, separating your receivables, borrow against you real estate, borrow against your inventory, and to be able to make the most of what you have, make the most of those things.

We’ll dive now onto some of the alternative finance options in a little bit more depth and to illustrate these, Dennis put together a chart about levels of risk with each to kind of illustrate what’s going on here.

Dennis O’Carroll: The page you’re looking at is kind of busy, and it’s not meant to be all inclusive. What it’s meant to do is give you an idea of the different types of lenders out there, and the risk that they’re taking, and the corresponding price that they’re charging. On the one side, you got the banks, which you have the best cost of funds, lowest cost of funds, and they’re going to charge you the least amount of interest or rate. And then as you move over, you got asset-based lending (ABL), which is going to be a little bit more expensive. You’ve got factoring, which is going to be typically a little bit more expensive than ABL. Although there are instances where that’s not always the case. And as John talked about, you got equity, which if your company is successful, it can be very, very expensive in the long run. We’re not going to go through all of this in nitty-gritty detail, but I do like to point out a couple of things. The next row down, difficulty to obtain. We talked a little bit about the banks. It’s very difficult. Asset-based lending is going to look at your company in a very similar manner to the banks, and so it might be a little bit less difficult, but it certainly isn’t easy. Factoring is one of the easiest options out there. And if you got good invoices and you’ve got credit worthy customers, there’s a really good chance you’ll be able to get approved for a factoring facility. And equity. It’s difficult to get, and that’s even more difficult to get rid of. As you move down, we look at the different types of collateral that are available and that will be tied up with the different types of facilities, whether or not you’re giving up equity to get that financing, whether or not you’re going to give up control of your company, and some other things that the facilities will look for, years in business: is this a startup? Profitability. Do you have a long history of stable profits? That’s great if you’re going for a bank loan. If you don’t have stable profit, it might not be so good. And are you going to be required to meet financial ratios? We talked about that for the banks. ABLs are going to be very similar in that respect. Equity, you’re going to have different goals that you have to meet, maybe different milestones that’s a little bit different. And of course, with factoring, there aren’t any specific financial ratios you have to meet. You’ve got to have good invoices. And then the last, ability to get rid of, it’s easy to get rid of a bank loan when you’re done. ABL’s the same. Factoring’s the same. Equity, it’s nearly impossible.

Let’s talk a little bit about asset-backed lines of credit. As I mentioned, they’re very similar to a lot of the bank lending that’s out there: looking at the same assets; they’re going to evaluate your company in much the same manner. If you’re lucky, and you get that bank loan, and it’s secured by receivables and inventory, that’s great. ABL is going to be an option if you can’t get approved by the bank.

With ABL, it’s more expensive because there’s more perceived risk. They’re going to have some of the same restrictive covenants. And when you start looking at the fee structure for ABL, you have to be very careful. They might give you a stated rate that sounds pretty good, maybe at the low –teens, “Okay, that’s not too bad. I can still make that.” But when you start adding in all the additional fees, it starts getting up into the 20s and high 20s, and it really might not be all that beneficial to you.

Why are they charging this higher rate and these other fees? They’re going to be looking at your deal, your loan a little bit differently than the banks. They’re going to do some additional monitoring that the banks don’t do because they don’t have the time to do it. They’re going to do field audits. They’re going to monitor your collateral. They’re going to have minimums associated with all of these and fees associated to cover those costs.

The last point about ABL—everyone says, “Okay. Well, it sounds like a decent option. The bank said no, but I’m still a pretty strong company. Okay, I need a $300,000 line of credit, asset-backed line of credit,”—unfortunately, it’s very difficult to find an ABL lender that will do a deal under $500,000. The reason is they’re doing all these additional things that the bank can’t do because they don’t have the time or money, so they’ve got to do these things and charge you more, and it doesn’t make sense to do it at that small dollar amount. So it’s very difficult to find anyone that’s going to give you an ABL line under $500,000.

All right. As we start talking about some of the other things that are out there, one that’s becoming more prevalent is called merchant cash advance. That’s also similar to cash flow lending. The primary difference is the way they collect on that loan.

Merchant cash advance, it’s all based on your credit card receipts. A lot of retail businesses, they will go down this path when they need money. The cash flow lenders are going to do what’s called auto debit. They’re going to make the loan to you, and then they’re going to take out their payment everyday directly from your checking account. And these are typically easy loans to get, relative to what we’ve already talked about, banks and ABL. The way they’re looking at your business is simply, “What are your credit card receipts? Well, what is the cash coming into your bank account?” and they’re going to lend you a portion of that. But then they’re going to control all your credit card receipts, and they’re going to take direct debits from your checking account to pay down that loan. What happens is, it’s a little bit tricky, and you got to be careful when you’re dealing with some of these folks. Some are better than others, but they’re going to make it sound like it’s not so bad. Here’s an example I just saw:

A company needed to borrow $8,000, and this lender said, “Okay. You’re going to have to pay back $10,000 over the course of three months, and we’re going to take a daily amount from your checking account to cover that loan payment.” You work out the math. That APR was well over 100%. So it’s not always a good option, and so we try and educate folks. Be careful when you’re getting into some of these other products that are a little bit newer because it might not be advantageous even though you need the cash today.

John Goldschmidt: I want to talk a little bit about purchase order financing. The best way to describe this one is, if your business is on that growth trajectory that I pointed out earlier, but you get some kind of a great, unexpected, large purchase order, this is a great product because it might be a little bit expensive, but if you consider the opportunity cost of not taking on that big order, it’s well worth it.

As an example, if you’re selling widgets $1,000 a month, and then all of a sudden, Wal-Mart comes in and wants to buy $1 million of them, you probably want that relationship; you probably want to pull the order. So you’ll do what you can to get the supplies to fulfill order. And the capital is provided directly to your manufacturers, so it really speeds things up. Also, in the case of one of our partners, they have a background in manufacturing. One of the hidden benefits is that they can try to consult them and help you on various aspects of the business as well. Purchase order financing is very specialized and a great option that people should be aware of. That leads us to factoring or accounts receivable finance, which is in a similar realm where it’s based on your orders and shipping and delivering them when you’re on that growth trajectory because it makes more sense or you really need to have the cash in order to continue to fill orders rather than waiting through the 30 or 60, 90 days that it takes for your customers to pay you because, as you know, for an entrepreneur or small business, two to three months is a lifetime. So that’s why this exists.

Dennis O’Carroll: Yeah. One of the benefits of factoring is it’s generally pretty easy to access. As we talked about a little bit earlier, if you got good invoices, and your customers are credit-worthy—they pay you relatively timely (relative being industry average of about 45 days)—then there’s a good chance you can get a factoring facility, and that’s going to help with managing your growth. As you get new sales, you can sell those invoices to a factoring company, and you get a significant amount of those funds upfront that’s called an advance rate.

Advance rates are typically anywhere from 70% to about 95%. It depends on a lot of things but industry is very important. Some industries are more competitive than others from a factoring perspective. And the strength of the business. The discount rates that factors charge, they run the gamut, and a lot of things influence that discount that they charge you:

  • Some of which are your industry. Some industries are more risky than others, like construction is difficult.
  • Your customers. How good are they, how quickly are they paying.
  • The volume that you’re going to run through the factoring program. If you’re only going to put $10,000 through the factoring program a month, you’re probably going to pay a little bit higher rate than if someone’s going to put $150,000 through that same type of facility. The volume makes it a little bit easier for the factor to do that.
  • And invoice size. Same kind of idea. The average invoice size is $500. It takes just as much time to process that invoice (verifications, get the collection) as it does to do a $50,000 invoice. That can impact the discount that you get charged.

Industry-wide, the average is about 3% discount per invoice sold to a factor. Lots of things influence that, and your situation may be different, but that’s something that is kind of a benchmark that you can think about. Another benefit from factoring is the factor can act in a receivable management capacity for you, for your company. All the checks are going to go to the factor’s lockbox, which saves time. You don’t have to people filling out deposit slips and running to the bank. The factor can help with collection calls. In fact, many times, they’re going to want to be involved with those collection calls, especially as the invoices start to age. They’ll help you with sending out statements. They’ll send them out for you. All of that activity that the factoring company’s doing is going to save you money from your accounts receivable personnel. You don’t have to have folks doing some of those functions. They’ll do it for you.

The other benefit that you’re going to see (that I’ve certainly seen) is, when you work with a factoring company, because they’re helping you with some of this receivables management, the average days outstanding typically comes down.

If you’re seeing 45 days is kind of your normal, it’s not unusual to see that come down to 40 days or even lower than that. So you’re going to get the benefit of professionals helping you stay on top of your invoices, and it’s going to ultimately reflect in the net discount or overall discount that you pay to that factoring company.

We talked a little bit about the credit-worthiness of the customers. It’s not just on the strengths of the business or the strength of the business owners.

I want to share a story. I’ve got a client who unfortunately has a very bad credit score, about 460, and of course, most banks, every bank’s going to say, “We’re sorry. We can’t help you,” and you’re saying, “Dennis, why did you help them?” Because I did. 460 is pretty bad, but as we started talking, his company was doing pretty well. It was growing. It was profitable, but he shared that one of his children had some very serious medical issues. And so they spent every dime they had for the care of their child. So they didn’t pay the car loan. They didn’t pay the mortgage. So their credit score reflected that. So if there’s a story, a reason as to why someone’s credit is bad, even a bankruptcy, as long as the story makes sense, you can get over that from a factoring perspective, because you’re, then, going to rely more on those customers and their ability to pay.

The other nice thing about factoring is—we talked a little bit about the banks and how it’s difficult to get that increase in that line of credit until you come up with your annual review—that’s not the case with factoring. Most factors, if you’re a good client, invoices are getting paid timely, and you have significant growth in your business, they’re happy to increase the line based on those receivables that you’re generating. So it’s very easy. It can be done in a day or two with most factoring companies.

John Goldschmidt: I think that’s a great point. That’s something that I love about alternative finance space. You can look at a company and take a very subjective approach. Your company might not be cash flow positive, but if it looks like you’re doing the right things, we can underwrite it, and we can work with you and figure out a way to get you what you need to grow. Whereas a lot of traditional forms that if you don’t meet the covenants or you don’t have X, Y, or Z on your balance sheet, then it’s just not going to happen. And evaluating the company as well as evaluating the owners, I mean we can be very flexible and kind of make our own decisions, not deal with the black box. Some things to think about when you’re going to apply are… Actually, I’m sorry. There are a couple other alternative finance options that Dennis wanted to talk about.

Dennis O’Carroll: Yeah, thanks, John. You’re getting ahead of me. I’m a little slow today.

John Goldschmidt: Jumping the gun.

Dennis O’Carroll: Other things for your business, if you got real estate or you’ve got equipment, there are plenty of options for you. For example, if you got an owner-occupied building or you’re looking to buy an owner-occupied building, a lot of banks are going to look at that, and you’re probably going to get bank financing unless you got some serious credit issues.

If you’re more of a company that is looking to fix and flip, there are hard money options out there. It can be a lot more expensive than banks, but it’s an alternative for those types of entities.

Another thing is equipment leasing, equipment finance. If you’ve got hard assets, a bank maybe ought to do it. If not, there are plenty of leasing companies out there that are experts in dealing with those types of collateral.

Again, unless you got something really scary in your background, it’s typically pretty easy to get equipment financing if you need it. A quick story there. I’ve got a client who I just met a year ago, brought them on—they were a startup—long story short, they needed some equipment. They also needed some working capital financing, which I was able to provide. But the equipment financing that they need, they were able to get from a bank. They were a startup. They didn’t have any history to go on. They’re kind of in a new industry for the two owners. But they had a great idea, and they were executing not even just a couple of months into their business. And the bank was very happy to make the equipment financing deal on some trailers that they needed. So it’s definitely easier to get this type of financing when you have hard assets. Someone at the bank, they can see; they can touch; they can repossess.

John Goldschmidt: Okay. Now, for the slide that you’ve all been so eagerly waiting for here, but we won’t spend too much time on, is just the things you need to apply, and generally speaking, some things that you’d have to prepare:

  • Of course financial statements for the company,
  • Bank statements,
  • Tax returns for the business and generally personal as well.
  • And then any preexisting loan documents because that goes into the whole lien thing that I mentioned.
  • Depending on what kind of financing you’re pursuing, you might have to also supply receivables, and payable aging reports, customer list, and other general documents for the business.

And then we’ll take those documents and run some reports checking the background of you and any principals in the company I guess. Checking tax, putting tax liens, and UCC search, which is going to show, any liens that exist, any secure debt on the business, and of course, there’s looking for things like litigation and bankruptcy. We’ve touched on the process times, but this is kind of in generally from the longest to the shortest. Banks can take a month or two, but ABLs are a lot shorter, but then, when you get into PO, factoring, and merchant cash lenders, it can be done in a matter of days. That’s about it for the content. Right now, we’ll open up the floor to any questions. It looks like we have a couple on the line here. The first one is…

What if I have a first lien? Can I get funding at all?

The answer is yes. Absolutely. We do have partners, and there are people out there who will provide subordinate financing, and it certainly tends to be a little bit more expensive. Dennis, do you have anything to add?

Dennis O’Carroll: Yeah. That’s a good explanation, John. It really depends on what type of first lien. If it’s a blanket lien with a bank, they’re unlikely to subordinate their position. What that means is you’d have to work with somebody who’s willing to be behind the bank. The way they get comfortable with that is if there are enough assets, enough collateral where they feel comfortable that, yes, even if something goes bad, we’ll be able to get paid off by taking that collateral and turning that into cash. There are options there, yes.

John Goldschmidt: And of course, yeah, depending on the flexibility. We can carve out some options. So the next one was…

I’m considering an SBA loan. What should I be thinking about?

Dennis O’Carroll: Good question. We’re not focused on SBA loans today obviously, and maybe that’ll be a future topic.

One of the things to think about in an SBA loan—a couple of things—when the banks are making those loans, they’re getting a guarantee from the federal government. So a large portion of that loan is guaranteed. So the banks are willing to do that with startups in many cases because they’ve got that backstop. On the downside, when you do an SBA loan, if you get one, they’re going to tie up everything – not just your business assets, but they’re going to tie up all of your personal assets as well. So if you have a house, they’re going to take a second mortgage on it.

Where that comes into play… just recently had a guy who had an SBA loan on a business. Of course, they had his house as well. He was open to sell his house and move into a newer, bigger house. But he couldn’t because they wouldn’t release that lien.

So be careful. Understand what’s getting tied up with that SBA loan. But they are definitely an alternate option for a startup business. Just be careful with some of those downsides.

John Goldschmidt: I’ve seen many cases where we have a first lien, and the borrower would like to go back to the bank, and if it’s just through the bank and it’s a general term or involving credit facilities, they can work with their relationship and try and make or car out some kind of inter-credit agreement happen. But with an SBA loan, it’s usually just not going to happen. It’s a little bit less flexible. They’re taking more risk, but along with that comes a lack of flexibility. So keep that in mind. The next question is…

What about using CDFIs and non-bank loans provided by alternative lenders like Lighter Capital and Bills Trucks?

Just so everybody knows, CDFIs are community development financial institutions. Their primary mission is to finance… how would you describe it, Dennis?

Dennis O’Carroll: They’re really focused on developing the community, so they’re going to take… They make those types of loans. They’re taking more risks. They understand that there’s a higher probability that things might not work out, and they’re doing it because they want to develop that community; they want to bring jobs in, businesses to areas that might be rundown, etc. Those are definitely possible in certain circumstances. Absolutely.

John Goldschmidt: So if you can find non-bank loans? Sure. I mean Lighter Capital, Bills Trucks, those are absolutely options for term loan and type lending. I don’t have an experience with receiving loans from either of those guys, but I think they do tend to be a little more… I mean they’re obviously a lot more expensive than a bank, and they’re just expensive in general. I don’t know. Are there any other factors to Bills Trucks that we want to touch on? Any experience there?

Dennis O’Carroll: Yeah. I’d just go back to some of the comments we made earlier, which is if you go down that path, make sure you fully understand what you’re getting charged, how you’re getting charged, and does it make sense to incur that much cost? Just make sure you understand the documents well and what you’re going to be paying.

John Goldschmidt: Yeah, understand the repayment, because I think I have heard of situations where there’s a repayment and amortizing payment, but you’re being charged on the full amount of the loan, the initial loan. So the effective rate can be a lot higher. I’m not saying that that’s necessarily the case, but just generally speaking, make sure you pay attention to the repayments and interest rates you’re being charged. The next one…

How expensive is hard money? Is it ever a good idea to use it?

Dennis O’Carroll: John’s looking at me.

John Goldschmidt: I don’t have any assets, so I don’t really know anything about this.

Dennis O’Carroll: It’s certainly not something that I do, so I don’t have a lot of experience with it.

I think there are situations though where it makes sense. Again, like I mentioned earlier, if your business is to buy rundown houses, and fix them up, and sell them in a very short turnaround time, I think it can make sense because the effort and materials you’re putting into that property are going to substantially increase its value. So you should have room, enough profit to cover that hard money loan. I don’t want to give out what I think the rates are because certainly I’m going to be wrong. But be very judicious if you go down that path.

John Goldschmidt: Next one…

I haven’t paid my taxes in the last two years because I’ve had some complicated circumstances. Can I still get financing?

I think this goes back to, obviously, there’s some kind of an extenuating circumstance. This goes back to Dennis’s point earlier about taking a case-by-case look at what’s happening. So I would definitely say that it’s a possibility, and it’s the kind of thing where if you’re going to a traditional institution, the answer would be no. But there are definitely things out there.

Dennis, do you know any specific examples?

Dennis O’Carroll: Yeah. You’re probably going to be more in the merchant cash advance or cash flow lending arena. Even for factoring, if someone doesn’t have tax returns, for me personally, with my company, I’d say, “Let’s get them caught up, and we can take a look at it at that point.”

John Goldschmidt: Are there any benefits to working with community banks and credit unions over big banks?

I would say, just from a kind of personality, personal perspective … I think the community banks and credit unions obviously tend to have less black-box type practices where, they can be a little friendlier and more subjective in that approach. Anything to say there, Dennis?

Dennis O’Carroll: Yeah, that’s true. And they’re going to be a little bit more focused on the relationship, and they’re typically going to be able to and more willing to look at smaller deals.The bigger banks, they all have small business lending divisions, but when it comes down to it, if you work with a community banker, he/she is probably going to spend more time understanding your business and trying to find a solution, whereas the big banks, it’s more of a numbers game, and they want to, again, pick the very best deals, and run with those, and not spend time in the ones that are a little bit more work and maybe take your loan up because they want a relationship, “We’re going to make money,” that they want it on that particular underwriting, but they want to give you a credit card, and they want to give you financing.

John Goldschmidt: The next question is…

Where do alternative lenders source their funds?

Dennis O’Carroll: There’s a varied answer there. Everyone is going to be potentially a little bit different. There are some lenders out there, alternative lenders that they’re using the owner’s money. Some are going out and getting private debt. Some are getting bank lines of credit or they’re going to other finance companies and getting a line of credit or some combination thereof. That’s what drives up their cost.

If they were able to have the cheap loans like the bank—the bank is getting their funds primarily from people like you and me with their checking accounts, which they pay almost no interest on, or they’re able to borrow from the federal reserve, and they got access to other markets, whereas alternative lenders, we’re getting it from more expensive places, which translates then to we have to charge more to our clients to be able to cover that and make a profit.

John Goldschmidt: We have a couple more here. I’m not sure… we have about five or 10 more minutes, so the next question is…

What is a reasonable amount to ask for? If I need a $5,000 loan versus $50,000 versus $500,000 or $1 million, and I have the appropriate collateral, which lenders are appropriate for those loan amounts?

I would think that not many lenders can handle the million-dollar level, so you certainly can look either a bank or certain alternative finance options that involve maybe crowdfunding, crowdlending. $5,000, it can be more like a merchant cash advance number. Dennis touched on earlier, when you’re talking about ABL, it needs to be one of the higher dollar amounts, $500,000 or $1 million, just because of the economies of underwriting and servicing that kind of loan. Anything to add, Dennis?

Dennis O’Carroll: That’s good. When you say $50,000 loan, you and I are talking about things like factoring. You might be able to get, with your bank, kind of a signature loan, typically they only go up to about $25,000, but you’re going to be looking at other avenues, like factoring, and that’s a little bit higher for a merchant cash advance typically.

John Goldschmidt: Okay. We have an interesting one.

Can you talk about personal guarantees?

I guess personal guarantees are something that come up very often. We actually like to have them at P2B. A lot of it has to do with the fact that we don’t typically even look into the assets of the guarantor. It really is a thing where the borrower is warranting that they are willing to (just what it says) personally guarantee that things are going to work out. They’re invested in this deal. It kind of sends up a yellow flag if they’re not willing to provide some kind of a personal guarantee that they’re behind their business. It’s not to say that there aren’t lenders and that we don’t consider deals without one, because we can definitely be flexible, but it’s an important thing, especially in our case because we pass our transactions with an interest rate on to the website where investors come alongside us. If an investor comes on and sees 12 deals that has personal guarantees and one that doesn’t, they’re going to be wondering why that one deal doesn’t have one, and they’re probably not going to want to invest in it.That much we can explain and have a good rationale for why there’s not a PG there.

Dennis O’Carroll: Yup, well said. I think we have time for one more question. The next question is…

I always thought that factoring is a last resort for troubled companies. You’re saying it’s not.

It’s a great question. Over the last five, six years, in particular with what’s going on in the US economy, with the banks, the prices from a few years back, banks got tight, even tighter than they already were. So, more and more companies have to look at alternative financing sources. Kind of what we talked about earlier, if you’re a young company, you’re growing really fast, you don’t have a 750+ credit score, the bank’s not going to work with you. They just won’t. So factoring, for example, can get over those hurdles and likes the fact that you’re growing. In fact, most factoring companies are looking for companies that are growing because what we want to see is a company that… well, they’re young and small today, they’re growing, and they’re going to be profitable, and becoming profitable means they can wean off of the factoring product, which reduces our risk. So we’re excited to see that.

Back in the day, it had a very negative connotation because there were—let’s face it—some very predatory factoring companies out there, and they were only interested in making money off of the invoices they were buying, and they didn’t care about the success of the company.

We’re seeing a shift in those attitudes, and as a result, it’s a more commonplace to see companies using factoring companies. All the big companies are slow-paying. They’re small vendors. So, all the big companies are used to having a factoring company in the middle of that relationship. Absolutely. It’s much more acceptable. It’s not nearly as negative a connotation as it used to be.

John Goldschmidt: That’s a fantastic note to end on. Well said, Dennis. Erin, is there anything to add to wrap things up?

Erin Bassity: No, I think if anyone has questions to follow up to this webinar today, feel free to reach out to us. You’ll see our email address there on the screen. You can give us a call as well. Dennis is available for questions and follow-up, as well as John. Feel free to reach out to any of us.Most of all, we just want to thank you for joining us today. We hope you enjoyed this webinar. We apologize for going a bit overtime, but we hope you found the content to be valuable, and we hope you’ll take a look at our upcoming webinars and join us again soon.

Thank you very much, and have a great day.

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