From the Inside Out: What They Don’t Tell You About Commercial Loans
Chances are the corner bakery or the service station on the main boulevard of your town opened its doors on the heels of a commercial loan. If so, the funds would have helped pay for equipment, tenant improvements, beginning inventory, signage, and other typical inputs to a thriving business venture.
Most of the entrepreneurs would have submitted a detailed loan package, complete with a business plan and historical financial information. These are the basic hallmarks of a commercial application. And last year, according to the SBA, more than 103,000 enterprises cleared the approval process, receiving $19.8 billion in commercial credit. But behind the approval is a hidden phase that few entrepreneurs know about. There resides the horror stories endured silently by the “fortunate” few who capitalized their dreams with a business loan, but in the aftermath, faced unexpected challenges surrounding the structure of the loan. This article is written to help navigate around a few of the nasty pitfalls and maximize the funds once approved. Half the battle is knowing key bits of information in time, and the other half is taking defensive steps to protect against them.
Due diligence should be a dance between two partners, but too often it is skewed towards the lender. The lender thoroughly checks out the borrower, but the borrower, generally uninitiated in the commercial lending process, does not appropriately check out the lender. Due diligence from the borrower’s perspective must be an ongoing dialogue of defining and redefining how the credit will result in a successful launch or expansion of the business. When this does not happen, the borrower is left searching for ways to recover from severe miscommunication.
Here are a few rules of thumb for conducting borrower’s due diligence
Assume nothing. Don’t assume the initial conversations about the possibility of receiving a loan are written in stone. Lenders may present the marketing version of their programs during initial conversations and act on the customary practices at the time the package is presented to the loan committee. Your interest rate, collateral requirements, and loan amount may be very different from what you expected.
Understand the relationship between you and the loan officer. Your biggest advocate will be the loan officer who pitches your credit to the loan committee. Two things are important here: 1. Pick his/her brains constantly. They know exactly what the loan committee is likely to approve, but they may not volunteer the information. You also want to make sure they are on your side. 2. Give him/her the tools to make a compelling case for your business and for the terms you request. Use awards and visuals to help make the case for why you need a certain interest rate, or payback period, or loan amount.
Leave no room for surprises. Find our early in the process what the terms of the loan will be. Left alone, the interest rate may not be revealed to you until the day you arrive for the signing ceremony. At that point your negotiating leverage is gone. All of the documents have been drawn up to reflect that rate. Be sure to discuss terms with your loan officer before the committee meets so that you understand what is being presented and what will likely be approved. Use this information to adjust your projections before you are thrust in the middle of opening your business. Some potential surprises:
o Payback may begin before you open your business. Some loan programs require that loan payments begin 30 days after closing, regardless of whether or not your business is open and generating revenue. If possible, negotiate these terms ahead of time. If the lender is inflexible about the start date, at least know this before the signing ceremony. You will need to adjust your projections and make provisions to make the payments on time.
o The lender may dole out the loan proceeds in order to assure that expenditures are consistent with approved uses. If construction is involved, they will also want to limit other expenditures in order to complete the project.
Protect you working capital line item. Working capital is not a luxury. It is essential to your success. If you find that your other costs are going up, do not sacrifice working capital. Adjust your loan request to make sure you have sufficient reserves to meet your obligations before you open and after you open when sales are building up to their expected level. Keep discussing these matters with your loan officer as part of your due diligence.
Two important antidotes for unexpected surprises: 1) Ask specific questions ahead of time (before loan committee considers your loan application). Ask early and ask often because the approval process is extremely dynamic. Things are changing rapidly, especially as your project moves from loan officer review and packaging to loan committee decision. The committee may change the structure of your loan and it may be unpredictable to the loan officer who may not share the information with you right away. 2) Create a detailed action plan for what you will do once your loan is funded, then visually walk through that action plan. Pick it apart at every step by imagining what could go wrong.
Receiving a commercial loan to open the business of your dreams can be an exciting time! It signifies that someone else believes in your concept and its potential to generate a profit and create jobs for the local economy. Before you get to the point of signing the loan documents, however, it is essential to conduct your own borrower’s due diligence. Your goal is to open a dialogue about the specific ways the loan proceeds will help your dream succeed. Make no assumptions, understand the importance of the relationship between you and the loan officer, leave no room for surprises, and protect the working capital in your formula. If you do these things, it will help assure a positive launch from day one.