For Small Business Owners & the Self-Employed

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:: Borrowing Money: What Exactly are Banks & Other Lenders Looking for?

Q: I own a small coffee shop business and I'm thinking about expanding my operations by opening up another two locations in neighboring towns. I've run some projections and my proposed expansion will be alot easier on me financially if I could borrow some capital. I really don't need that much, but before I go through the trouble of applying with a bank or finance company, I want to know if I have a shot at qualifying for a loan. My personal credit isn't the greatest. What do you suggest?
                                                                        - Albert K. Whitehall, New York

A: Dear Albert, I assume that since you want to open up another two locations that you've got some pretty decent cash flow, right? If so, good for you. But, whatever you do DO NOT even think about opening up TWO locations at the same time. If that's what you're thinking, forget about it. One location is more than enough to get off the ground at one particular point in time - especially for a smaller business owner such as yourself with limited resources and capital. The proper way (if time and funds permit) is to launch one coffee shop, make it successful, then move on to the next after you're sure it can support itself from its own cash flow.

What exactly are lenders looking for? This is a great question! Every lender wants their loan applicants to meet certain minimum requirements. If you don’t meet these conditions, you will never qualify for the loan. Each lender is different, so make sure you find out all the details before applying.

The first thing to understand is that lenders use both financial and non-financial criteria when making loan decisions. Let’s take a brief look at both types of criteria. (Further explanation of these criteria and strategies for putting your company in the best possible light are available here).

Financial Criteria - These criteria are the main concerns in any credit decision. There’s no question about it: If you want a loan, you’ve got to be prepared with strong financial data. Without strong financial data your approval for a loan will be like fighting an uphill battle. Here are the financial criteria lenders will look at:

1. Comparative Industry Data - Since it makes little sense to compare a small business to a billion dollar public company, a lender will look at information from companies with similar operating characteristics.
   
2. Liquidity - Liquidity is a company’s ability to pay its bills as they become due.
   
3. Financial Health - While it’s extremely important that your company possess sufficient liquidity, a lender will look to your company’s overall financial health too. The principal method used by most lenders to measure financial health is the Debt-to-Equity ratio.
   
4. Consistent Profitability - Having sufficient liquidity says that your business can pay its current debts as they become due. Strong financial health shows that your company has the ability to absorb losses without going broke. However, in order to obtain a loan, your business must show a history of consistent profitability. One of the first things a lender will look for is your company’s ability to repay the loan.

Non-Financial Criteria - While your company’s financial results are the main focus in any loan decision, lenders will evaluate non-financial concerns as well. Many times these non-financial factors are very influential in the credit decision process. The following are some important non-financial criteria that a lender will look at before making a credit decision:

1. Experience & Management Ability
2. Trade Credit History
3. Economic Conditions & Your Industry

With regards to you borrowing money: Even if you have all of your ducks in a row, your less-than-stellar personal credit may be a stumbling block when applying for a loan. This is because lenders will usually ALWAYS look to the personal credit of the business owner when considering a business loan - especially in the case of a newer, smaller business with no credit history to speak of. Unless your business is established and has its own credit history, there's really no sense in applying for a loan if you don't have good credit. Doing so is an exercise in futility. My advice to you is to do everything you possibly can to try and fix and improve your personal credit. Once you do, you'll have a markedly improved chance of qualifying for a loan.

Hope this helps!

Q: I just heard on TV that because of the new Bush tax plan, my business will be able to fully deduct the cost of my SUV (sports utility vehicle)? Is this right?  
                                                     - Jake S. Morgantown, West Virginia

A: Dear Jake, the answer to your question is yes....and no . No, if your SUV weighs less than 6,000 pounds you can't. If it does and you use it for business purposes, then yes you can...well sorta.  Actually this "SUV loophole" was available prior to 2003. The only thing that's changed in 2003 is the IRS Section 179 expensing limit.

Here's the deal: You’re entitled to larger depreciation deductions if you purchase an SUV, pickup or van that weighs over 6,000 pounds. The deduction rules that apply to passenger vehicles weighing less than 6,000 pounds are stingy and extremely limited. According to the IRS, a passenger vehicle will be considered a “truck” for tax purposes if it has a gross vehicle weight rating over 6,000 pounds. If the vehicle qualifies for truck status, there are no depreciation limits. As a result, you can deduct more of the purchase price and save lots of money in taxes.

For example, let’s assume that in 2001 you purchased and used for business a vehicle costing $40,000 and weighing less than 6,000 pounds. Your first year depreciation is limited to $3,060, and this number is further reduced by any personal use. This limit applies even if you qualify to use Section 179 expensing. Depreciation is limited in subsequent years also. If, on the other hand, you spent the same $40,000 on an SUV, pickup or van weighing more than 6,000 pounds you can deduct a whopping $24,000 Section 179 expense in the first year (The $24,000 applies to 2001 or 2002. Beginning in 2003 and thereafter the Section 179 deduction is a whopping $100,000!). Additionally, the remaining balance can be depreciated free from limitations in subsequent years.

What kind of vehicles weigh more than 6,000 pounds? Several popular models weighing more than 6,000 pounds include the Ford Expedition, Chevy Suburban, GMC Yukon and of course, the all monster Hummer. Check with your favorite dealer for additional qualifying vehicles. Hope this helps!