One of the most interesting relationships in the Main Street economy is the one between business owners and their banks. It is at once powerful and essential. Let me tell you a short story about where this dynamic has been in order to explain where it’s going.
Unlike our big business cousins, small firms have limited capital sources. Indeed, the lion’s share of our growth funds come from a bank loan, with almost 60% being made by a community bank (ICBA). Yet, since 2008, more than half of small business CEOs have consistently reported not needing to borrow money (NFIB).
A dozen years ago, a kind of perfect storm began for Main Street businesses: the 2007-09 recession was made “Great” by the Wall Street-induced financial collapse, which was followed by our economic lost decade during the Obama administration. In survival response, small businesses tightened their belts and deleveraged on a scale not seen in generations.
This deleveraging phenomenon resulted in small businesses retaining more earnings which, by definition, produces stronger balance sheets and reduces loan demand. And it produced a silver lining we didn’t know we had or needed – until last year.
When the global pandemic hit, COVID-19 threatened our lives, while the political lockdown responses threatened our livelihoods. But as bad as 2020 was, it would have been worse without that decade of belt-tightening and deleveraging. It’s just math: in a pinch, you can last longer on your own when you have reserves. We’ve lost too many small businesses since April 2020, but without those stronger balance sheets, there would have been more failures.
Unlike most other countries, the U.S. government stepped up with centralized, small business funding in the form of the Paycheck Protection Program (PPP), now in round two, executed 100% by banks. And in 2020, six million small business CEOs, most of who had reported earlier that they didn’t need bank money, went to a bank and signed PPP loan forms.
In the history of Main Street businesses, there’s never been such compression of contacts between small firms and the banking industry. And going forward, with hundreds of billions in SBA-guaranteed bank loans (PPP1 & 2), these small business CEOs either have or will repeat that bank contact to comply with the unprecedented loan forgiveness process.
One thing about reserves is they’re not unlimited. So as small businesses respond to evolving post-pandemic customer expectations, there will be more bank contacts. But these post-PPP transactions will likely not come with a government guarantee, which means we’ll be back to tried-and-true business loan underwriting fundamentals. Of course, on our side of the desk, we call those hoops. You know – the kind you have to jump through. But here’s the successful way to think about the hoops: get over it and get good at it.
After customers, bankers are among my favorite people in the marketplace. But there are two things you need to know about them: they’re kind of lazy and are easily spooked. So, if you help your banker not work too hard on your proposal by delivering your part of the fundamental underwriting elements every banker uses, such attention to detail will calm their nerves and increase your chances of approval.
So, now, business CEO, meet the “Six Cs Of Credit”
Character
What’s the character of the borrower? To big banks, character is a digital credit score number spit out by a computer. To a community bank, character is their neighbor sitting in front of them with a pulse, a plan, and a promise. The appraisal of your character is huge in the loan approval process. Guard it well.
Capacity
What’s the ability (read: cash flow) of the company to repay the loan? A banker once told me if I could only bring him one document it should be my cash flow projection that demonstrates my plan for paying him back. Remember, profit is an accounting and tax concept. Bank payments are made with cash, not concepts.
Capital
Is the loan amount justified by the financial strength of the borrower? For example, sales volume, profitability, cash flow, retained earnings, the underlying value of the asset being purchased, etc. Bankers like road trips and they like to eat. If you’re unsure about your capital, invite your banker to your business to talk about it over lunch – pre-proposal.
Collateral
This is the bank’s fallback position. Collateral is whatever a banker can get you to pledge as their Plan B in case you default. But remember: Once you give a banker collateral, getting a partial release prior to full payoff is like getting a she-bear to hand over her cub. By the way, bankers like serial numbers, and they lu-uh-uv real estate deeds.
Coverage
Bankers are prepared to take certain risks, which they handicap in the underwriting process with the interest rate and terms, including other risk-lessening elements like covenants, various kinds of insurance, etc. Be prepared to deal with whatever makes your banker less jumpy. A little bit of negotiating is possible, but don’t die on this hill.
Conditions
Bankers ask themselves questions like, “Does it work?” and “Do we like this deal?” You can improve your chances by telling your story (at that lunch). Explain how you’ll use the money, how it will help you grow your business, create more jobs, strengthen your market position, make more money, etc. Bankers don’t get excited on their own – you have to help them. Practice your pitch on someone before you go “live” with your banker.
Remember what I’ve taught you: The title of the shortest book in the world is “Loan Officer Courage.” No one ever got any help from a scared banker. Improve your loan chances by understanding the Six Cs of Credit.
Write this on a rock … Make your bank your business’s best friend by showing them you understand and support what they have to do to help you.