The ABCs of Bank Borrowing

Asked why he robbed banks, Willy Sutton, a wily stick-up man, once said, “Because that’s where the money is.” If you’re a small company, you probably do nearly all your financing through bank loans, which means that you’ll be taking on debt. There are sound reasons for financing the growth of your company by using debt rather than the other principal form of financing—selling shares in the company.
Debt-service payments are a deductible business expense; dividend payments are not. When you issue new debt, you leverage your company to increase earnings potential. Issuing new common stock dilutes your earnings. Most important, new debt does not weaken control of the company, as would an equity financing.

If it’s a bank you need, be sure to shop around and know what to look for. It’s important, for instance, to find out which banks are in the best position to lend money—and may even be under pressure to make loans. In this respect, a key number to know is the bank’s loan-to-deposit ratio. This will tell you what percentage of a bank’s deposits is tied up in loans. Historically, the loan-to-deposit ratio was about 60 percent. Today, it’s more like 73–75 percent. You can easily obtain this loan and deposit information through your state superintendent of banking.

Getting the most out of your banker: Even though banks supply well over 90 percent of the capital needs of small and midsize firms, few businesspeople take the trouble to develop a solid relationship with their bankers. It’s true in both your personal finances and your business dealings: The best time to get to know your banker is when you don’t need a loan. If you are in a position within your company to get to know the company’s banker, take full advantage of that opportunity. It’s a good idea to invite your banker on a tour of your facilities, and keep him informed of your company’s progress by sending quarterly statements with appropriate comments to his office.

Even if you don’t intend to borrow from your bank in the foreseeable future, a good banking relationship can help you in many other ways. For one thing, a banker makes an excellent character reference. As such, his endorsement might help in obtaining better terms from suppliers, equipment manufacturers and the like.

Presenting your case: By far, the most frequent mistake managers make in applying for a bank loan is to submit a late request for funds. To a banker, an emergency loan is anathema. It is an obvious sign of poor planning. No competent manager should ever allow a need that should have been anticipated to turn into a financial crisis. Thus, if you expect to have any chance of getting a bank loan approved, you must anticipate your cash needs well in advance, to provide enough time for the bank to process your application. It takes at least three weeks, and sometimes more, to process a loan.

Also make sure that you provide the proper information, which is similar to the ingredients found in your business plan. This includes the financial statements (going back three years is the norm, but some institutions prefer five years); personal statements describing the experience and capabilities of top management; and a statement of purpose detailing how the funds will be used, and how they will be repaid. A cash-flow budget covering the length of the loan is helpful, though not always required.

The loan interview: If you’ve done your homework, the battle will nearly be won by the time you appear for the loan interview. In many respects, your business plan or your supporting docu¬ments will do the talking for you. Nevertheless, you should take this interview seriously and be prepared to answer the banker’s questions, which will be similar to these:
1. How much? Tell your banker exactly how much money you need. Don’t be vague.
2. How long? Indicate how long the funds will be needed.
3. What purpose? Be specific about how you will use the money. “General corporate purpose” is no answer.
4. How will you repay? Again, be specific. If it’s from cash flow, be prepared with a cash-flow projection for the duration of the loan.
5. What if something goes wrong? Prepare your ace in the hole: an emergency plan to use if the loan doesn’t work out. You could plan to sell an asset, borrow elsewhere or have a new investor on tap. A sound emergency strategy can be most convincing.