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by Jerry Chautin, SCORE Chapters, Alanta GA & Manasota (Sarasota), FL JKChautin@aol.com
One of the least understood concepts is how to make an effective loan presentation to a lender. A borrower is often told to create a "Business Plan" and to include various required documents. However, this generic approach may result in the loan request being relegated to a stack on the loan officer's desk and perhaps a rejection.
Our objective is to share with you the secrets of selling your proposal to a lender. This is not an academic exercise but rather a professional approach that works. It's similar to the process of gathering information that you would use for an internal management business plan to provide a map to success and profit. In that case, you may want to tweak the format a bit and be more conservative with your projections.
Lenders want to be assured that:
Your business will repay the proposed loan. And that there are sufficient assets (collateral) to pay off the principal in the event the loan goes into default. (For an internal management business plan, you want to assure yourself, partners, stockholders and key managers that you can make a reasonable profit, pay financial obligations and achieve your stated goals.)
It is your job to provide the lender with these two assurances in a clear and concise format. Lenders reject loan requests when they cannot understand the risk or the risk is greater than acceptable to them. An acceptable entrepreneur's risk is often greater than an acceptable lender's risk.
Choosing the Right Lender
Don't "shotgun" your loan request to many lenders. Instead, tailor it to the specific lender most likely to grant your request. Cultivate the relationship before requesting a loan. Who do you know that can introduce you to the bank's president or chief loan officer? Open a bank account before making application for a loan. It is more difficult for a lending institution to say "no" to a customer.
Ask lots of questions before preparing a loan presentation. Do you finance start up companies? Do you make loans under $100,000? Under $50,000? What are your minimum collateral requirements? Do you make equipment or working capital loans? Do you have a very active SBA department? Do not hesitate to switch to a lender that can better accommodate your borrowing needs. Avoid a formal submission if there is not a good chance of being approved because other lenders may find out that you were turned down when they run a credit report.
The Loan Presentation
A winning loan presentation has substantially more sizzle than a business plan designed as a personal planning tool. It may also use a more aggressive interpretation of the proforma operating numbers. Your loan presentation should contain several sections with extensive narrative and exhibits personalized to your situation and your lender's underwriting. Use quality white bond that is easy for the lender to copy and in an attractive type style which is easy to read. The following is a suggested table of contents that may be modified for different situations.
Table of Contents
Motivate the loan officer to pick your presentation out of the many on his or her desk because it seems more interesting and doable than the others. The cover letter, photographs and Memorandum of salient facts are designed to do that.
The cover letter is your first opportunity to sell your loan. Make it great! Lenders have been known to reject loans after reading a poorly constructed cover letter or one that is so impersonal that the presentation looks like it is being sent to every institution in town. Relate the cover letter to specific discussions you previously had with the loan officer and verbal understandings.
The cover letter should be no more than one or two pages long. Explain how the loan will be used. Highlight the strongest aspects. Note the weak points and how you plan to overcome them. If the collateral is particularly strong, emphasize it in your cover letter. Always recommend approval of the loan as your final thought rather than meekly asking the loan officer to call if there are any questions. If you cannot recommend your loan to the loan officer, don't expect him or her to recommend it to the loan committee.
If your presentation is for venture capital, you'll need to talk about an exit plan. How and when will your investors get paid back? Do you plan to go public in a few years? Or will you refinance them out of their investment? You should also discuss return on investment (ROI). How much will they get for taking the risk? And when will they get it? You can eliminate the cover letter entirely if your business plan is an internal management tool for your eyes only. However, many entrepreneurs want to share their business plan with key managers and advisors so that everyone has the same vision. In this case, a cover letter is a good idea also.
Use them! An interesting 5" X 7" on the cover of your presentation can get your proposal read first. Put lots of interesting photos inside. Get the most attractive shots you can and fully explain them. Use a professional if your own photographic skills are lacking. If real estate is the collateral, show the subject, comparables and the neighborhood. If a real estate appraisal is required, tell the appraiser to take attractive photographs too. They are notorious for taking photos showing overflowing garbage bins and water accumulations on the pavement. Negotiate with the appraiser on this issue. Show your officers, happy employees, smiling faces, machinery and equipment (if attractive). This may be the only opportunity for the loan committee to see these subjective exhibits that greatly help in selling your deal.
Captions under each photograph should tell the story you want the lender to know. For example: "Our offices will be located on this well-traveled street. The landlord has given us sign privileges that assures us walk-in business and helps us to lower our advertising cost." The caption under a photo of your store shows your business and marketing skills and gives the lender confidence that you'll succeed. Another example, "Joe Smith fine-tuning our new computer system. Joe majored in Computer Science at the University of Georgia." This caption under a photo of your equipment and an employee may be a solution to your lack of computer training or show you hire quality people.
Clip art and graphs used sparingly are good too. Cartoons and interesting artwork makes the lender's underwriting process more personal and enjoyable. Marketing yourself and your company well "proves" that you have the ability to market your product or service to your customers. You don't want to over do it but think outside of the box.
Memorandum of Salient Facts
The memorandum is also called the "Executive Summary". I call it the "memorandum" because lenders sometimes call it that when they pass it around to their loan committee. Limit it to one or two pages. It should contain the most important facts. Ask if he has an example he's willing to share with you. Ideally, you can use his format with your words. Your mission is to get the loan officer and you in a team effort in presenting your proposal to committee. This is an honest, full disclosure negotiation. You both have the same objective — to approve a good loan. Trust is the key.
Name and describe the legal entity. Explain why you chose that type of ownership. Describe your business and it's owners. Your objective is to sell to the lender the previous success of the company, its principals and officers. Enclose a biography of all the principals and key employees. Don't make them look like job resumes. Dates are not as important as the number of years of related experience you have. Awards and industry recognition of your accomplishments should be noted. Avoid fluff that doesn't relate to the skills needed to make your business successful.
Do a detailed sources and uses of loan funds. It should clearly describe how the requested loan will be used. List other sources of funds, your own personal contribution and how it's to be used. A simplified example is below.
Sources & Uses of Funds
|Sources of Funds|
|Cash from owner previously contributed||$ 25,000|
|Additional cash from owner||30,000|
|Proposed loan from bank||100,000|
|Total funds available||$155,000|
|Uses of Funds|
|Working capital||$ 15,000|
|Purchase computer & office equipment||20,000|
|Total uses of funds||$155,000|
Here are some things to keep in mind when preparing your startup budget and needs for working capital:
The Borrower section should include market value balance sheets (not book value) on the company (showing the status before and after the loan closing) and its principals. Be sure to foot note and explain all line items including how everything can be verified (i.e. account numbers and phone numbers). Show how there is enough liquidity (cash assets) already in your company and committed by its principals to make the venture successful. The weaker the overall deal, the more of your own cash will be required.
Historical and proforma operating statements must demonstrate the necessary cash flow from operations to cover debt service (the proposed loan payments) plus have an adequate cushion. The size of the cushion required will depend of the overall strength of the deal and the lender. Show cash flow available for debt service before non-cash-flow items (such as depreciation), loans to be paid off at closing and provision for income tax. Don't forget to include your own salary (be conservative here). If your salary will be temporarily deferred, show it below the cash flow available for debt service line and explain how you intend to support yourself and your family without it.
Every line item should be clearly explained. All proforma line items must be justified. Use third party "proof" such as industry trade associations, Robert Morris Associates statistical publications (RMA) and Dun & Bradstreet publications. Major accounting firms also publish statistics for small businesses in many industries. Check with your local library for statistical publications you can use. Successful loan proposals include extensive narrative discussions of how and why the numbers were selected. Don't be afraid to take several pages to explain the most important line items such as revenues.
Do not ask your accountant or a packager to generate your operating numbers. You must do your own research and believe the proforma is achievable. Internalize the numbers and make them part of you. Lenders reject loan requests from entrepreneurs who don't know their own deal. Many businesses fail because the owner never took the time to learn at least the basics of financial management and rely on outside help to "count their money".
Unless specifically asked for, do not include income tax returns. They can raise more questions than they answer. Items on the financial statements should be grouped in the primary categories using the chart of accounts that are traditionally used in your industry. (Your accountant can help here.) Exclude meaningless financial schedules such as your check ledger or intricate details of each and every operating expense item but be prepared to produce any backup that is asked for.
Include subjective information and news articles that support your projections. However, avoid using meaningless fluff that doesn't demonstrate your ability to repay the loan. An alternative is to note what documentation is available upon request.
We mentioned earlier that collateral is a secondary way of repaying the lender in the event of default. It's not very likely that a startup business will be approved by the lender with zero collateral. Sometimes lenders use the "lack of sufficient collateral" as a catch-all excuse to turn loans down. It's much more comfortable for them than to tell a customer he's an unqualified borrower, didn't save enough money or they don't like the concept.
Your objective is to "prove" the value and the marketability of the collateral. Well-located real estate may be quickly sold close to the value while equipment would be liquidated at a deep discount. Lenders can tell horror stories about having to drive all around town looking for collateral such as vending machines. Or not being able to sell tablecloths, knives and forks from restaurant failures. Lenders try to place a liquidation value on collateral but may be lenient if they really want to do the deal.
When the collateral is weak, get the lender to focus on other aspects of your proposal that are strong (i.e. strength of the principals, large cash investment, strong cash flow, etc.). Appraisals help if they are current, credible and tell the story you want. Critique and highlight the parts that sell your deal.
The Market & Marketing Plan
The words "market research" are often scary to entrepreneurs even if they have advanced college degrees. They don't need to be. Your challenge is to determine if there are customers for your product or service and how will you get them to buy. Furthermore, how many customers are there, how much will they pay and how quickly will they write you a check. Understand that this is not an academic exercise. Its objective is to generate meaningful operating numbers that can be used for your proforma (projected operating numbers). Ultimately, you will have to execute your business plan and place the actual results along side of your proforma numbers to see if you are meeting your benchmarks.
Providing extensive market information is simply sharing with the lender the research you did before you decided to go into business. If you did your homework, it should be easy. The market research should not look like a generic Chamber of Commerce report.
Describe your competition. Explain how you plan to compete effectively. Be sure to relate the data to your company. Demographics, census tracks and traffic counts are meaningless without explaining how it will get customers in your door. Growth in your industry is only beneficial if you can relate it to increased revenues. Your market research is the basis for the proforma operating statements. Refer back to your market research when explaining line items in your operating statements.
View the procedure as an upside-down triangle or funnel starting with a wide base of information gathering. Ultimately, the wide base of knowledge is narrowed down to specifically reflect your operating numbers on your proforma. Discard irrelevant information.
The wide base of information is available at the library. Major accounting firms also publish operating numbers for various industries. Your accountant may be able to help you get to the right accounting firm. Each industry's trade association has operating statistics. A list of all trade associations is catalogued in a good business library. Many trade magazines publish industry statistics. A list of most trade magazines can be found in Standard Rate & Data Services (SRDS) at your library online or the print media department of advertising agencies. Use online search engines and check out web pages such as www.findsup.com and www.census.gov . The more corroboration you obtain from various sources the better. Your business plan must identify the sources used. Avoid fluff that won't start your journey from the base of the triangle to your proforma.
This broad information may not reflect the uniqueness of your product or service, specific selling techniques, the personality and size of your company. Therefore, you need to narrow it down by making it a better fit. Perhaps the trade association or the accounting firm can refer you to some of the actual companies in your industry that may be willing to share information with you. Sometimes established companies are willing to help budding entrepreneurs who are introduced through credible channels. Your own experience may help in the narrowing process but its not nearly as credible or objective as a third party source.
Narrow the operating numbers even further by talking to prospective customers and salespersons with competing companies. If you are a would-be restaurateur or retailer for example, visit every restaurant or similar retail store in the area. Tactfully question customers exiting competing establishments. How did they like the product (food)? The service? What would they like to see in the neighborhood? What do they think of your idea and how much are they willing to pay?
Often you can learn from prospective sales persons you interview. Ask them to document their historic production claims with commission statements and pay stubs. What do they think of your concept? Your pricing? How would they improve it? What mistakes are their current employers (your competition) making? This anecdotal information should be weighed carefully depending upon the motives and credibility of the source. However, by interviewing enough people, a pattern of usable data begins to emerge.
If possible, test the market by making actual sales calls and trying to close deals. Go to a similar market elsewhere if confidentiality is a consideration. Often you will learn more by asking a customer to put up their money than gathering hypothetical data. Of course if you are already in business, your historical numbers are important in projecting the future. Include all the details and the math. Refer back to it when footnoting the operating numbers in your proforma.
This is a hands-on process and it must make sense to you. Don't hire a professional to produce a slick, generic product. It's important that you struggle through it, step-by-step. Internalize it and commit it to memory when telling the bank how you will repay their loan. Use it to share your aspirations with your partners, key managers and sales persons.
Choosing the style of your proforma, chart of accounts, when to use month-by-month, quarterly or annual numbers are determined by how it is to be used. Here your accountant can help. Your banker may have certain requirements. For example, SBA wants month-by-month for the first year and then annually for the next 2 years. Some equity partners like to see 10 years of proforma. If you need help, take your market research and ask your accountant to put it in the right form or do the spreadsheets.
There are many well-intentioned packagers and wanting to do your homework for you. They offer seminars, CD ROMs, books, audio or video tapes and even may do the entire process for a fee. Most of the time, their finished product is too generic and full of fluff. Their credentials may be superb, but their product is not what you need to get your loan or to run your company. If you don't clearly understand how the information specifically gets you down the triangle to the operating numbers in your proforma, it doesn't belong in your business plan.
The Underwriting (Analysis related to lender's criteria.)
You may need your accountant to help you with this section. Some successful loan applicants leave it out entirely and hope that their proposal meets the lender's benchmarks. When you initially selected the lending institution, you should have determined how they will underwrite your loan. Ratios such as Debt Service Coverage (cash flow available for debt service / debt service) and Return on Assets (assets / profit) differ in importance from lender to lender.
Calculate the ratios that the loan officer told you were important. Always add subjective comments focusing on ratios that exceed the required minimum. Wherever a ratio falls below the lender's minimum requirements, stress compensating strengths of your proposal (such as good cash position of the principals) and other ratios that exceed the minimum requirements. A business plan for your internal use only should modify this section to identify your risks. Underwriting is the essence of getting an approval. If your loan fails to underwrite, don't submit it. There are several other alternatives:
Most start up companies do not underwrite well. Understand that institutional lenders are not willing to take the same risk that you as an entrepreneur are willing to take. Likewise, venture capitalists rarely provide startup capital for small businesses. Many startup businesses get loans with a partial SBA guaranty since it transfers much of the lender's risk to the SBA.
Recommending your proposal to the loan officer and the loan committee is essential. If you don't believe in it, no one else will. Your recommendation may be brief. Recap all of the strong features of the deal and state that granting your loan is prudent.
In the real world, most small businesses are started with personal savings or funds from family and friends. Some government agencies help marginal proposals get funded. They don't work for deals that miss the mark by wider margins. According to a survey by Arthur Anderson Enterprise Group of businesses with up to 19 employees that got funding, the sources were: 68% bank business loans, 22% leasing, 16% vendor credit, 12% credit cards, 9% private lenders, 6% personal bank loans, 3% private stock sale, 2% venture capital and 9% other. In a broader context, far less startup businesses and companies with fewer that 10 employees get loans from banks or obtain venture capital. Since the study appears to be among Arthur Anderson's clients, they may also be more profitable than many other small business concerns and better qualified to get outside funds. I hope this guide will provide you with an understanding of the process and improves the chances of getting your proposal funded.