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Private Lending & Conventional Mortgage Advice

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Christopher Perez
  • Philadelphia, PA
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50% of Loan Requests get Turned Down Due to Improper Packaging

Christopher Perez
  • Philadelphia, PA
Posted Feb 15 2018, 16:22

Preparing Loan Requests That Get Funded 

Lenders are driven by many factors; one of them is self-preservation. Simply put, no lender wants to make a deal that goes “upside down” Therefore, a would-be borrower, wants to increase the comfort of the lender by providing evidence that the business will repay the loan. This job starts with the preparation of the loan request. Here are the elements of a winning one:

A) It’s All About the Numbers: Financial statements are the backbone of your loan proposal. Obviously, you need an income statement, balance sheet, and a cash flow statement. Most small businesses don’t have audited statements, but nonetheless should present statements that are compiled and perhaps reviewed by a certified public accountant.

A “review” is a technical term in the context of accounting. It’s not a full audit, but it goes beyond a mere compilation which, in the final analysis, represents your financial statements on your accountant’s letterhead. A review, sometimes called an analytical review, includes testing of certain components of the presentation, but there is no assurance about the truthfulness of the financial statements.

You should avoid presenting internally-generated financial statements at all costs, because they often raise more questions then they answer. However, you can and should present a number of internally-generated items including: a schedule of all collateral, an aging of accounts receivable, a description of all real estate (including photos), financial projections, personal and corporate tax returns for the past two years, and a schedule of inventory, if applicable.

The development of financial projections is an art unto itself that goes well beyond the scope of this article. However, it’s fair to state that your financial projections are the linchpin of the proposal. After all, the loan request is being evaluated on whether or not the projections materialize and generate the kind of cash flow that will pay-off the loan. True, the collateral for real estate loans (i.e., the property itself) is vital since, in the lender’s eyes, it is the source of repayment if the cash flow should dry-up. But few lenders want to make a loan just because there’s adequate collateral. Lenders don’t want to own property; they want to make money from the interest charged on each loan.

Although five-year projections are standard, it is the first three years that really matter. And of these, the first year should be presented monthly. Subsequent years can be presented quarterly if visibility becomes difficult after a certain point in time.

A loan request also includes qualitative information about the company, its management, and the industry. This subjective, qualitative look, particularly important for newer companies without a lengthy track record, should consist of the following elements: company description, key personnel, industry analysis, marketing operations and a description of the use of proceeds.

B) Putting It All Together: Below is a sample table of contents from a loan proposal prepared for a restaurant company interested in obtaining funds for property acquisition and refinancing. Note section “A” below, simply titled, “Loan Request.” Keep in mind that the components of a loan proposal should be geared toward a specific loan. Therefore, the Loan Request spells out the kind of loan you want, the amount, and a one to two sentence description of why you want it. Don’t give this section short shrift just because it’s little. If the lender can’t get past the first page, your loan request won’t go much further either.

Table of Contents

A. Loan request

B. An Overview of the Restaurant Business in the Tri-County Area

C. Company Profile

D. Management Profiles (including biographies)

E. Marketing Operations

F. Use of Loan Proceeds

1. Acquisition

a) Agreement of sale

b) Pro-forma Operating Statement

c) Appraisal letter (for real estate)

d) Photos (of real estate, property, etc.)

G. Refinancing of existing property

1. Statement of Operations

2. Pro-forma Operating Statement

3. Introductory brochure (marketing piece for property)

4. List of improvements

5. List of inventory

H. Compiled, Reviewed, or Audited Financial Statements for each of the borrowers, prepared by (name of accounting firm)

I. Financial forecasts

J. Tax returns for principals

C) Selling the Deal: Now here’s the shocking truth: no one has ever landed a loan with a great loan proposal alone. The documentation is simply a blueprint. To win-over the lender, one must present and sell the deal. This should come as no surprise. Remember that the basis of all loan underwriting are the THREE C’s: Cash flow, Collateral and Character. Character, at the most fundamental level, speaks to repayment. Specifically, has this person historically paid their debts? But at another level, character speaks to the confidence the borrower inspires in the lender. As you make your request for a loan, the lender thinks, “Can this person pull it off? Can she get the loan, put it to work, and generate the kind of cash flow her forecasts suggest?” If the response is something like, “They can’t even sell me on this deal,” it dramatically undermines the loan request.

Accordingly, you should prepare and rehearse a presentation that walks the lender through your loan proposal. A good lender will readily embrace the opportunity to hear your pitch. And even if a lender tells you it’s not necessary, you should press the case and suggest that you feel it is important that he or she see the presentation. Even if you never get the chance to present the proposal, you haven’t wasted any time preparing a formal presentation; the act of doing this will prepare you for answering the many questions you will face during the loan approval process.

Here are some important points to keep in mind regarding your pitch:

1. Your presentation should be no longer than 20 minutes. This means that you should spend no more than two to three minutes on each section outlined above.

2. Some common errors that borrowers make are: droning-on about technology, assuming a higher level of knowledge on the part of the lender about your industry, and being overly optimistic with respect to the future sales and earnings of the company.

3. Some sort of visual support is helpful, but again, a common error is packing the slides or handouts with too much information. You want to create billboards, not manuscripts. There will be plenty of time later for the excruciating details.

As you draw-up your loan proposal, remember that lenders have many loan requests from which to choose, and some will be obviously stronger than others. But it's not their job to make the case for approving your loan; it’s yours.

D) The Problem with SBA Loans: There’s no doubt about it: the Small Business Administration (SBA) has assisted millions of small businesses since its launch in 1953. In the last decade alone, the SBA has helped more than 435,000 businesses with nearly $95 billion in financing.

But the truth is that the SBA is not for every small business owner. In several instances, the time and energy spent pursuing government programs can be more productively spent in the private sector where business moves faster with fewer encumbrances.

Though this latter point seems to be a knock against the SBA, it’s not meant to be. In fact, the slower speed and higher degree of difficulty associated with obtaining SBA financing is due to the significant and unique hurdles the agency faces in conducting its business.

Specifically, with taxpayer funds at risk, federal regulators must take every possible precaution to protect them. In addition, they must take all possible steps to ensure universal access to the loans. Imagine the protest if SBA-sponsored financing was channeled to one specific industry and experienced substantial losses. These two constraints, combined with common misperceptions of the agency held by borrowers and entrepreneurs, often conspire to make SBA financing very challenging for even the most savvy business borrower.

Contrary to popular belief, the Small Business Administration is not a direct lender and does not lend money. The SBA’s cornerstone financing program, the so-called “7(a)” program, provides a guarantee to banks that make loans to small businesses on a portion of the principal. If the borrower defaults, the government will repay the bank. This guarantee, or protection of principal, motivates lending that might not otherwise occur. As a result, the SBA funnels much-needed debt capital to small businesses that otherwise might not be able to borrow money.

While the economics of this arrangement make sense, they result in a two-tiered application process. The first application is made to the lending institution, typically a bank (though not always). Another application is made to the Small Business Administration for the guarantee. Of course, a two-tiered application process naturally results in a two-tiered approval process. While both parties work hard to respond fast, the reality is that two approvals often take longer than one. For businesses with fleeting opportunities, there can be a real cost associated with any delay.

In addition to potential delays with the approval process, the disbursement processes associated with SBA-guaranteed loans can result in further delays and additional documentation. Specifically, in most instances the agency requires lenders to make loan proceed checks co-payable to the borrower and the borrower’s payees. While this represents prudent processing on the part of the SBA, for borrowers trying to fund a project where costs may be constantly changing, specifying costs at a particular moment in time can become a complex and time consuming challenge.

Next, there is a common misconception that the SBA will finance projects or businesses that are very risky and considered not fundable by traditional lenders because the government can afford to lose money. While the concept of entitlements has significant currency inside of the federal government at large, it has almost none inside of the Small Business Administration.

Because of the public policy constraints faced by the SBA, the underwriting standards look very much like those of a conventional lender. First, SBA lenders, and by extension, the SBA itself, are not collateral lenders, but cash flow lenders. Repayment from the cash flow of the business is a primary consideration in the SBA loan decision process. Like any other lender, if cash flow dries up, the SBA is looking for appropriate collateral behind the loan. Though the agency can often work with situations where collateral might be thin, SBA loans require a guarantee from all principals with a stake of more than 20% in the business enterprise. In addition, this guarantee carries a lien on the borrower’s property. Translation: If you default and the SBA pays the guaranteed portion of your loan principal, the agency can go after your personal property and assets to make it whole again.

The fact is that the SBA is not in business to assume a great deal of risk. In truth it can’t, because the agency wasn’t built that way. It is for this reason that the Small Business Administration has often turned-down guarantees on loans that lenders have approved.

Finally, SBA-guaranteed loans are not cheap. While the federal government subsidizes a wide range of activities and constituencies, small businesses are not one of them. The Small Business Administration charges its lenders a guarantee fee, which the lenders can, and often do, pass onto the borrowers. For loans of more than $150,000, up to and including $700,000, a 2.5% guaranty is charged. For loans greater than $700,000, the guaranty is 3.5 percent. For loans greater than $1,000,000, there is an additional upfront guarantee fee equal to 0.25% of the amount by which the guaranteed portion of the loan exceeds $1,000,000. In addition, if a commercial loan in a combination financing has a senior credit position to the 7(a) loan, a one-time fee equal to 0.7% of the amount of the commercial loan is charged to the borrower.

In addition to guaranty and servicing fees, the Small Business Administration charges a so-called “subsidy recoupment fee” for prepayments of more than 25% during the first three years of loans with 15-year maturities or more. These “subsidy recoupment fees” range from 5% of the prepayment and fall to 1% over time. These fees, in addition to an annual servicing fee of 36 basis points, can have a material impact on a borrower’s effective interest rate on the loan, and in some instances, the company’s overall cost of capital.

It is important to point-out that none of the requirements or underwriting standards established by the Small Business Administration are unreasonable. They are established to protect taxpayer dollars: a must. However, they should very reasonably cause borrowers with fundable deals to carefully consider their sources. While the SBA may offer an alternative, lenders that do not offer SBA- guaranteed loans are unencumbered by the constraints of a federal agency. As a result, they may be better positioned and more nimble in servicing your unique borrowing needs