July 15, 2022

MEMORANDUM

TO: SBDC Network

FROM: MD Austin

SUBJECT: Small Business Lending is a Like a 4-Legged Stool

Over time, this writer developed an outline to help explain to small business borrowers the process lenders use (to varying degrees) to assess loan requests for new and/or growing enterprises.  The analysis tools used include:

  • The background and experience of the owner(s). This is one of the premier factors lenders utilize when assessing business plans and related documentation.  In a best-case scenario, an applicant would have both general business and industry-specific ownership or management experience.  This is critical when assessing a business plan for it permeates all other aspects of the request.  A good way to highlight this factor is to provide a resume or similar document, as well as explain how the background and experience of the business owner will enable them to be successful
  • The character of the borrower. Small business and SBA lending in particular is deemed to be “character” lending.  However, to this writer’s knowledge no lender has ever developed a character test.  To fill this gap, lenders look at the credit of the borrower/individual involved in the ownership of the business.  Some lenders have minimum credit score requirements, while others are more circumspect (i.e., they mention “good” credit).  Even the SBA has embraced personal and business credit scores as a primary approval criterion for their “small” loan program (i.e., loans of $350,000 or less)
  • The amount of cash equity (down payment) available to be injected into the business. A lot of folks get confused with “equity lines” as a form of equity, but in this case, lenders mean cash.  Lenders do not provide 100% financing, nor will the SBA.  Cash equity can range from 10%, up to 50%, depending on the requirements of the lender
  • Collateral is the final general factor that lenders assess. It’s important for borrowers to understand that lenders look at the “liquidation value” of assets pledged, which can range from 10% – 80% of the “face” or purchase value, and the type and value of the collateral provides a secondary repayment source that answers the “what if” a business doesn’t succeed

In addition to an assessment of the overall assessment of the viability of a business plan and/or loan request, lenders then assess how well the request meets these 4 criteria and determine if they can approve or disapprove the loan.  Some lenders might turn to SBA or other guarantee programs as a means of reducing the risk of loss exposure of an application, while others might say “come see us when you’ve been in operation for 2-3 years”.