Approved or Denied: The Small Business Loan Underwriter’s Perspective

I had the pleasure of interviewing a loan underwriter several days ago.  He’s been underwriter biz loans and lines for almost 20 years.  His analogy was simple.  Yet, how many times do we overlook the most critical elements of applying for a loan.  Here it is:

Underwriter’s Point of View

In my years as a small business loan underwriter, I have worked with a variety of applicants and transactions across the country, ranging from start up enterprises, purchases of existing operations, franchises, partner buyouts, etc.  As such, I am able to compile a few tips to help you have a positive experience with your potential lender.

First of all, be HONEST, particularly to any information you disclose in writing. Fraud or misrepresentation is grounds for immediate denial of your application. In addition, most lenders will require that you be able to produce documentation to verify certain items on your application or have the means to verify the items themselves (i.e. credit reports, background checks, etc).

Secondly, all applications should be accompanied by a business plan of some sort, regardless of your level of industry experience.  Below are the criteria to include in your business plan:

  • Industry experience and/or “motivation” for wanting to start/purchase this business: How did you find out about it? What experience, if any, do you offer? If a franchise concept, have you visited existing locations or talked with other franchisees?
  • Proposed location for your business and demographic profile of area (if applicable):  What type of traffic patterns are in the area? Population of target market? Visibility from main thoroughfares? Size of work space?
  • Marketing/Advertising Plan & Budget: What types of marketing are you going to use to attract new business? Have you included any discounts in this budget or in your revenue projections?
  • Transition/Opening Support: If purchasing an existing business, what type of transition plan is in place with the seller to ensure that a major defection of the client base does not occur? If working with a franchise, what type of training and post-opening assistance is offered?
  • Sources/Uses of Funds: How much of your personal funds do you have available to invest in the business? Where are these funds coming from (i.e. home equity, retirement plans, savings)? What do you estimate the opening costs to be (if purchasing an existing business, how was the sales price determined, if construction is needed, have bids been secured)?
  • Financial projections: Are they realistic? How did you arrive at that figure (i.e. number of customers/day at an average ticket of $xx each)? Are they in line with industry averages or with franchisee averages (if applicable)? Are all  “nontraditional” expenses included (i.e. franchise royalties, etc)
  • Note:  Although it is advisable to be conservative when projecting cash flow for the 1st year of operations , be sure that there is enough cash flow to repay the debt! If not, you are telling a lender that they may not get paid even after the business has been open for a year.  (More details in working  capital discussion below.)
  • Working Capital: Have you budgeted enough, either in personal cash flow or in your loan amount? Depending on the type of business being offered, you will want to budget at least 3-4 months of working capital. A quick calculation of working capital includes all monthly fixed expense overhead, including: workspace rent, utilities, employee wages, PERSONAL LIVING EXPENSES, LOAN PAYMENTS, taxes, inventory, advertising, etc.

Below are a few “red flags” I have when reviewing loan applications that you will either want to avoid or have plausible explanations to justify:

  • Application is incomplete (blank spots where existing debts or assets/liabilities are not listed or questions are unanswered)
  • Items listed on application that are not able to be verified: (secondary source of income, cash available, etc)
  • Incomplete business plan (missing any of the items listed above) and/or unrealistic expectations for business (financial projections too high/low)
  • If purchasing an existing business, no available explanation for “large swings” in revenue and/or net profit figures. (My general rule of thumb is any growth or decline exceeding 10% from one reporting period to the next requires an explanation from the seller.)
  • Loan amount being requested  is significantly higher/lower than comparable transactions.
  • Lack of at least one owner/operator managing the business on a full-time basis, on site or within a reasonable physical distance.

Due to technological advances (e-mail, phone, fax, etc) it is no longer necessary to deal with a local lenders in a face to face meeting. Like any other loan application, there is no automatic formula for approval necessarily. Being honest and prepared can speak to your character and can sometimes be more effective than just facts and figures alone.  As such, the more you can communicate directly with your loan officer and/or underwriter, the more comfortable the lending institution may feel about your willingness to ensure the success of your business.  Good luck!

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