Long Shot
Bank loans are often the most desirable – and the hardest to get.

November 29, 2004; Page R4

After landing her patented infant outfits in hundreds of small boutiques, Jennifer Hughes turned to her bank for a loan. She wanted to expand production and get into more boutiques — and possibly big retailers — as well as consolidate some debt.

But even though her banker said he loved her products — one-piece kids’ outfits designed to look like stylish separates — Ms. Hughes was rejected. Her personal debt was high, and the company’s cash flow wasn’t steady. Now the 38-year-old entrepreneur has given up on a loan and has started looking for an investor to help fund her company, Liloebe LLC of Traverse City, Mich.

For many small-business owners, banks are the lender of choice, for a multitude of reasons. They offer some of the lowest rates on loans. They can provide a small business with invaluable advice. And getting a loan from a bank can be seen by other lenders as a financial seal of approval.

But as Ms. Hughes discovered, small businesses face long odds when seeking out a bank loan. Lenders are reluctant to take a chance on a small or fledgling enterprise unless it can show a steady cash flow, reliable client base and well-developed business plan.

Still, entrepreneurs often approach a bank even if they have no shot at a loan, just to build a relationship that might pay off later. What’s more, there are a number of steps a business can take to burnish its case. The most important: Look stable. Companies must thoroughly detail their business plans, shore up their credit rating and offer any number of guarantees that they can pay off their loan, from putting up collateral to taking out insurance.

Plan Ahead
There’s one big mistake to watch out for at the start. Prospective borrowers often have only a fuzzy notion of the business they’d like to start, or a broad business plan that doesn’t nail down every nickel and dime they will need to spend.

To be sure, any potential backer will ask for a business plan. But plans are particularly important to banks, because they want to ensure that the businesses will last long enough to pay off a loan.

For example, an investor might be willing to back a business with a shaky plan — if its product looked like it could bring a big return. But banks want slam-dunks, not hot prospects. Lenders would much rather deal with a business that has been around 10 years, or one that already has landed a big contract, than take a chance on a start-up that could default.

Entrepreneurs must also take a close look at their credit rating. Even a booming business will have trouble finding capital if its credit rating — or its owner’s — has suffered.

Banks judge credit on “the five C’s”: character, capacity (financial strength), capital, collateral and conditions (the state of the economy and the industry). Banks all have different systems for grading credit, and the three major credit agencies — Experian, Equifax and Trans Union — can come up with different scores for the same company or individual.

There are plenty of factors that can hurt a credit rating. Simply having a lawsuit filed against a company, for example, can knock a credit score. Frequent late or erratic payments also can be damaging.

Many of these payment problems come down to a poor understanding of cash flow. Fabiola Brumley, manager of Bank of America Corp.’s small-business banking in Palm Beach, Fla., says many entrepreneurs fail to properly estimate cost over time — that is, not factoring in the time it takes to get paid. Checks need to clear, and invoices need to be processed, before businesses see their money — but, in the meantime, employees and creditors must be paid.

Shoring Up the Loan
But a solid credit rating often isn’t enough. Keith Leggett, senior economist for the American Bankers Association, says banks also want borrowers to take out ample insurance — to guarantee that they’ll be able to pay back loans even in the worst of times.

Madelyn Flannagan, vice president of education and research for the Independent Insurance Agents & Brokers of America, says most businesses buy an insurance package that includes things like liability, property and business interruption, which covers a company’s costs as it recovers from an unexpected calamity, such as a hurricane.

The cost can vary widely depending on the size and type of business. A business with $15,000 in property and two to three full-time employees might pay $300 to $400 annually; one with 20 employees and $100,000 in property might pay $2,500 to $3,000. These figures exclude workers’ compensation coverage, which can vary even more widely.

Many banks want entrepreneurs to guarantee a loan further by putting up their own assets as collateral — a practice called a personal loan guarantee. Lenders say the guarantees are necessary to protect banks against the prospect of widespread defaults.

Asks Ms. Brumley of Bank of America, “Should we roll back the time to the ’80s when people defaulted and left the burden with the FDIC and the banks?”

The Next Step
So what happens if an entrepreneur has taken all of the recommended steps, and still doesn’t qualify for a loan?

The first lesson: Don’t give up easily. Different banks have different standards and requirements — and some are more willing to deal than others. Borrowers may be able to find a loan by going to another bank, even if it means breaking a longstanding relationship with a lender.

Brad Pittenger, owner and founder of Xiolink, an Internet-infrastructure company in St. Louis, found that he couldn’t get a loan from his regular bank unless he put up a personal guarantee. For him, that was out of the question.

“For one, it’s kind of a principle thing,” he says. “And two, personal guarantees also tie up those assets if I ever want to go sell my home or get a bigger one.”

But with his capital-intensive business, Mr. Pittenger needed a line of credit. So he looked outside his local bank and found a smaller one in Kansas City that didn’t require a guarantee.

Even if a lender says no, it’s important for entrepreneurs to keep the lines of communication open. A bank’s staff can be a valuable resource for small-business information — and they’ll be that much easier to approach when it comes time to find the next loan or line of credit.

“Just pick up the phone and call,” says Ms. Brumley of Bank of America, who says bankers should be ready to chat and give advice to clients on topics ranging from check fraud to the best collection software. “We don’t charge by the hour like accountants or attorneys.”

Businesspeople can also try a personal loan instead of a business loan. The difference? Personal loans are easier to get, even with troubled credit. But they are often unsecured — meaning the borrower puts up no collateral — and therefore carry much higher interest rates.

Greg McBride, senior financial analyst with Bankrate.com, a personal-finance Web site geared toward consumers, says the average interest rate on a personal loan is 14.3%. Meanwhile, rates on commercial loans made by commercial lenders currently can get as low as the 5% range. For a cash-strapped business, that can make a difference: For a $10,000 loan at 14.3% over five years, monthly payments would be $234.24. For the same amount at 5.75%, the monthly payment would be $192.17.

Given the huge potential expense, some entrepreneurs choose to minimize their exposure to debt. Robert Smith, who started his first business when he was 22, was approved for a $20,000 loan for his next endeavor, a public-relations firm in Rockford, Ill. He was planning on spending $12,000 of that on advertising and marketing costs to get the business up and running.

But using connections at his old company, Mr. Smith was able to lock in enough clients to get the business off the ground without advertising. He was able to lower his loan request to $9,000.

“I don’t think most people think that way. They don’t think about ways they can lower what they need,” says Mr. Smith, who is now 30. But “if you want to take a loan, you want something as small as you can handle.”

Mr. Albergotti is a staff reporter in The Wall Street Journal’s New York bureau

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