For most small businesses, banks remain the fundamental source of capital to finance current operations and future expansion. Because banks have something businesses want, namely money, businesses believe they have no leverage when negotiating loan agreements. However, this is not the case. If business owners understand and implement the right approach to obtaining a loan, it can obtain favorable loan terms.

The following are general principles that a business owner should keep in mind when attempting to obtain a loan from a bank:

1. Undertake significant research into the loan process to gain a complete understanding of it. If you do not have a high comfort level negotiating the loan, seek assistance from accountants, attorneys, and other business advisors.
   
   
2. View the loan agreement with a long-term perspective. The terms and provisions contained in the agreement could apply over a five year period when business and economic conditions can change.
   
   
3. Make sure any restrictions or covenants do not impair the flexibility of the business, the ability to take advantage of new business opportunities, and the ability to compete.
   
   
4. Most bankers will not have as much experience in your industry as you. Therefore, you must educate the banker on industry practices, so loan terms do not put you at a competitive disadvantage.
   
   
5. Arrange for bank financing before needing it. Don’t go to the bank when you need your money the most. The old adage “Those who don’t need the money can get it, and those who need it, can’t get it” is, unfortunately, true.
   
   
6. Remember, banks make money by lending money. As much as you want to borrow to expand your business, banks wants to lend so they can make money.

1. Basic financial and business information must be presented. This includes interim financial statements not more than 90 days old as well as financial statements and tax returns for the prior 3 years. Additional information may include income and expense projections for the next 3 years, a schedule of existing business debt, accounts receivable aging, and a listing of fixed assets.
   
   
2. Present a financial forecast showing the debt repayment plan as well as a balance sheet reflecting the value of the collateral to be pledged as security for the borrowing.
   
   
3. The assumptions underlying the presented financial statements must be clearly stated. Make sure these assumptions are realistic as this will preempt questions a banker may have. Unrealistic assumptions could cause loss of credibility with the bank. Further, because these assumptions will form the basis for the actual loan documents; unrealistic assumptions will lead to unrealistic loan terms.
   
   
4. The requested loan must be based on the use for which the proceeds will be utilized. For example, a business owner should finance short-term needs with short-term money and long-term needs with long-term money. An attempt to finance long-term projects over too short a period of time; could result in insufficient cash flow to keep the business in operation.
   
   
5. Show the bank that as your business grows you may be able to provide additional collateral, or at least different types of collateral, as security for the bank’s loan.
   
   
6. Review, and review again, and have your financial advisors review, your financial goals and plans. Make sure your plan can withstand the scrutiny of a “devil’s advocate.”

1. Arrange for a limited review of the financial statements of the business, as opposed to a full audit. Reviews are cheaper and may provide just as much assurance to the bank as an audit.
   
   
2. Limit the required deposits on account with the lending institution. This limits the assets the bank can seize in the event of a default.
   
   
3. Negotiate “interest only” or skip payments provisions in the event your business encounters unexpected financial difficulties.
   
   
4. Make sure the bank is required to notify you if you breach loan term and demand the bank give you adequate time to cure the breach before declaring you to be in default.
   
   
5. In the event of destruction of collateral, the business owner should have the right to utilize insurance proceeds to replace the collateral; the bank should not have the right to merely collect the insurance proceeds in satisfaction of the loan.
   
   
6. Make sure that whenever the bank’s consent for an action is required, it “cannot be unreasonably withheld.”
   
   
7. The business owner should not be required to pay a pre-payment penalty for early payoff of the loan.
   
   
8. In many loans, the borrower is required to pay the legal and other fees of the bank, including discretionary actions of the bank (i.e. obtaining an appraisal of the borrower’s assets). The borrower should only have to pay for reasonable fees incurred by the bank, not all fees. Further, the borrower should limit the number of times a discretionary act can occur.
   
   
9. Negotiate to permit the loan documents to be assumed by another party in the event of a merger or reorganization of the business.
   
   
10. Make sure the loan terms do not hamper your ability to undertake personal tax planning. For instance, loan terms could prohibit an S corporation from distributing cash to a shareholder to pay tax on the shareholder’s share of corporate income.
    
    
11. For estate planning purposes, a business owner should be able to transfer any portion of his business, provided he retains control of the enterprise. Further, a business owner should be permitted to transfer his interest in the business to another individual in the event of his death or mental incapacity.
    
    
12. Obtain the bank’s pre-approval to certain acts of the business. For instance, if you foresee a change in ownership with a child or sibling becoming an owner, obtain the consent up-front.
    
    
13. In the event the bank desires a personal guarantee, limit the assets to which the bank can go against. Additionally, attempt to have a sunset provision providing for a specific date or event after which a personal guaranty will not be required.
    
    
14. Many times, a business owner, as guarantor of corporate loan obligations, will be required to give personal financial statements to the bank. Attempt to limit this to merely the tax return; personal financial statements are very expensive to have prepared and may provide the banker with no true additional assurances.
    
    
15. The lender will require the business owner maintain certain financial ratios. Further, the lender may require different ratios at different times during the year and over the course of the loan itself. The business owner must be sure these ratio requirements do not impair the flexibility needed to operate the business. Further, the business owner must be sure that as capital needs vary during the course of the year (and during the course of the loan term), the ratios are not violated.
    
    
16. Banks may require the borrower maintain key-man and business interruption insurance. The borrower should be able to decrease the level of coverage (and thus the cost of the insurance) as the loan is paid off.
    
    
17. The bank may prohibit borrowers from undertaking additional debt without the lender’s consent. Borrowers should negotiate to limit this consent requirement for loans “not in the ordinary course of business,” or that exceed a certain amount (which will vary depending on the type and size of the business). This “consent” requirement should be eliminated as long as the borrower agrees that any subsequent lender is subordinated to the current lender.
    
    
18. The bank may restrict the borrower from selling any assets that secure the loan obligation. The borrower should have the ability to sell these assets as long as the newly acquired assets (or other assets it owns), are granted to the bank as security for the loan. This will give flexibility to the borrower to buy and sell assets that can be utilized to obtain the highest financial return, without impairing the lender’s security.
    
    
19. Banks will generally prohibit the merger or other reorganization of the borrower without its consent. The borrower should be able to undertake these types of transactions as long as it maintains majority ownership interests in the new entity or if the new entity is more creditworthy then the original borrower itself.
    
    
20. Banks will generally require the borrower to indemnify it for any losses sustained as a result of environmental contamination. However, the borrower should only agree to indemnify the bank to the extent the environmental contamination is the result of its own actions. The borrower should not be held responsible for the acts of the prior business owner.
    
    
21. The bank may desire any dispute be settled by arbitration. As a borrower, you may be able to obtain a more sympathetic hearing from a jury of peers instead of from an arbitration panel that may be made up of the bank’s peers.
    
    
22. Evaluate everything towards long range goals. This includes paying close attention to loan covenants and restrictions which could impair the ability to raise capital for future growth or undertake additional loans.
    
    
23. Finally, never ever agree on any provision that allows the bank to act “in its discretion,” or based on a subjective standard. The banks actions should be clearly governed by objective criteria. Specifically, the borrower should demand to be eliminated any provision that provides the banker with discretion to declare a breach/default. The business should only be in default as a result of the breach of specific provisions. This will protect the borrower from being subject to indiscriminate acts by any person within the bank and will also allow the borrower to operate its business with the certainty that its loan will not be called.

1. The strong balance sheet of a business shows there is adequate collateral for the bank to go against in the event earnings of the company decline.
   
   
2. Although the balance sheet may be weak, the industry and the economic forecast indicate increasing earnings for the business; this will provide an adequate source of funds to repay the debt service.
   
   
3. Even if the restrictions imposed by the bank are eliminated, the banker will still achieve its objectives through the use of other provisions (in essence, the loan documents contain duplicative provisions).
   
   
4. No business can anticipate every possible business or economic scenario that could impair its ability to repay the loan. Thus, the borrower needs a flexibility to adjust to unforeseen conditions to avoid defaulting of the loan. This is a view that also has significant benefits for the lender. By providing the borrower with flexibility in the face of unforeseen circumstances, the bank is giving itself some breathing room to work with the lender in case of financial hardship. The bank will not be forced to declare a default and thus lose a significant portion of its investment.

For further information regarding these matters, please contact Mr. Goldberg at 248.740.5664 or click here to send an email.