Tips for Getting a Loan in a Tight Credit Market
Gary Desilets, owner of Deckscapes of Virginia, just received a notice from Dun & Bradstreet Credibility Corp. telling him that his commercial credit score dropped from a one to a two.
“Why? Not because I do not pay my bills,” Desilets explained. “My business is up 70% over last year. No, because their models show companies like mine are entering a slower phase of the annual business cycle and are more than likely to pay late. I have not paid a bill late in four years. Last year when this happened, Home Depot cut my credit line from $20,000 to $2,000 because of this change in commercial score.”
This downgrade may hurt Desilet’s chances of securing loans to grow and expand his business down the road. Plus, he uses his personal credit to fund training, advertising and other activities when needed, so when he can’t access that credit, it puts him between a rock and a hard place in the seasonal construction business.
Desilets is not alone in his plight, despite some improvement in the credit markets, many small businesses still face an uphill battle when it comes to landing financing.
Marshall P. Gavin, owner of b. dazzle, an adult and children’s game wholesaler based in Redondo Beach, Calif., says many of his retailers are having a hard time getting credit from their local banks to restock inventory. He added that some have stopped paying on time and using credit cards.
“The economy is teetering and is uncertain and that worries small businesses. It certainly worries their creditors if they’re doing bank financing,” said Grafton “Cap” Willey, managing director in charge of accounting firm CBIZ Tofias' Newport, R.I., office and former president of the National Small Business Association. “That’s aggravating the access to capital issues.”
Willey explained that banks are hesitant in making loans without Small Business Administration (SBA) guarantees; there was a significant drop in SBA lending when the guarantees dropped from 90% to 75% in January. Some states are trying to fill that void by replacing the additional 15% guarantee. He added regulators are putting pressure on banks to reduce risk, which leads to a reduction in lending.
Willey also echoed Desilet’s concern on the over-reliance on collateral and credit scores. Most small businesses do not have much collateral and often rely on those scores.
“During this great recession, personal credit scores have taken a huge hit while the regulators and the lenders have increased their requirements,” Willey said. “It is has squeezed out a lot of opportunities. We are also seeing larger vendors squeezing terms on their small business customers for shorter payment terms, often refusing deliveries unless their bills are very current.”
A January Federal Reserve Board survey of banks found that a modest number eased standards and terms for commercial and industrial (C&I) loans over the fourth quarter of 2010. It also showed banks reported small changes in their lending policies for other types of loans. Banks reported a moderate increase in demand for C&I loans but little change in demand for other types of loans. It was mostly large banks that eased up slightly in their lending, but only to large and middle-market firms; few banks reported changing lending standards on such loans to small firms.
Victoria Williams, an economist with SBA’s Office of Advocacy, recently found that in the first quarter of 2011, small business lending declined even further – another 2.4% from $624.3 billion in December 2010 to $609.4 billion in March 2011. Small business loans by the largest lenders--those with assets of $50 billion or more--declined the most, while lenders with $10 billion to $49 billion in assets actually had a modest increase of 3.1% in lending.
There are many who say banks simply aren’t doing their part to help the economic engine of this country get running again.
“It’s the banks’ lack of comfort,” said Daniel Murphy, vice president of commercial lending for Ocean Capital. “We should be lending, we need to be reinvesting in our communities.”
Murphy offered several tips for small businesses trying to access capital:
1) Look at personal credit report within the past 90 days. Murphy stressed entrepreneurs should know and understand their credit score and shouldn't get distressed if a bank rejects a loan application, just try a different one. Your credit score “is not an end-all, be all, it’s an indicator,” Murphy said. “Your score is just a score; you’re more than a number.”
2) Identify Assets. Whether it's a 401(k) or property, small business owners need to identify what assets they have to leverage. “They need to know their personal, financial situation,” Murphy said. He continued to suggest loan seekers write their financial situation down on paper either as a personal financial statement, balance sheet, or other document that can be easily read and understood by lenders.
3) Be prepared. Entrepreneurs need to organize their documentation, file tax returns (personal and business) and prepare interim financial statements and review them quarterly with your certified public accountant.
4) Take advantage of SBA resources. The agency offers a plethora of loan products to small business owners including: SBA 7(a), 504, express loans, as well as USDA loan programs like the business and industry program, which is committed to small businesses in rural areas with a population of 50,000 or less.
5) Create partnerships with CPAs, attorneys, bankers, and other experts. “You need to rely on these people because those are the ones you’re going to turn to in times of need,” Murphy said. Businesses do not plan to fail, he said, but they fail to plan.
6) Establish and know how to communicate a viable business model. “The thing that most business owners fail to do is stop, pump the breaks and assess the situation,” Murphy said. Business owners need to periodically assess their financial situations and make adjustments – laying off people, for example – as needed to stay fiscally viable. Entrepreneurs need to be confident in their business plan and know how to sell it to potential lenders. For startups, the business plan should be thorough and the projections should be based on actual industry knowledge.
7) Be sure the terms of the loan and interest rates are realistic. Murphy warned, "if it sounds too good to be true, it probably is.” Research potential lending institutions to get their history and reputation. “You have to do your due diligence.”
8) Have Experience Lenders want to know their clients have experience in the industry they are in and want to see how the money will be used. Entrepreneurs that do not have three to five years of prior experience in the industry, Murphy said now may not be the time to seek 95% financing from a bank.“You need to understand your industry, and, more importantly, you need to understand why you’re asking for the money.”