Your business might be eligible for a loan based on SBA regulations, but it still must qualify for a loan with a particular lender and perhaps also with the local SBA office. When you submit your application package to a lender, it does not pass behind a mysterious veil where secretive actions take place. Rather, approval can usually be predicted if you understand how lenders qualify you. This page explains exactly how lenders do this.

How Lenders Decide

Lenders guess! They might not like to say that, but every loan decision is based on their best conjecture on whether or not a borrower will pay the requested loan back. They don’t know the future, so they inform themselves about the situation (called “underwriting”) and make their best prediction about the outcome.

In the absence of a crystal ball telling the future, lenders look at the only thing they can know – the past. SBA lending is based on this fundamental principal: what happened in the past will probably continue in the future. In other words, the past is the best predictor of the future.

Lenders use their years of lending experience to figure out statistical probabilities. They look for common characteristics in borrowers that succeeded and those that defaulted. They try not to make the same mistakes in the future.

Start Up Businesses

Lenders seldom make loans to new businesses that have not filed a full year tax return. Without a past, lenders have nothing on which to predict success. The unfortunate fact is that most start up businesses fail, and they fail rather quickly. With failure a probability, the SBA does not want the limited dollars available to suffer this risk. Do not confuse SBA lending with venture capital funding.

What Lenders Look For

When lenders look at your company and personal history, they will consider the following items most critical.

Two Good Years. If your business could have made the new loan payments this year and last year, most lenders would probably say yes. Because SBA loans are backed by the federal government, the past refers to what is presented on your business’s federal tax returns.

Cushions. Obviously your company needs to earn enough for the new loan payment, but lenders want you to make more than enough. They want a cushion of excess earnings of about 25% of your total loan payments. Lenders refer to this cushion as a 1.25 debt coverage ratio.

Trends. Lenders want a business to have positive trends. They will look at four years of financials side by side: your last three fiscal years and your current year. Positive trends mean your sales and your bottom line increase each year. If you had a bad year but bounced back, you will need to explain what happened. If the trends have been downward to the present, a lender may decline your loan, assuming the trend will continue until you have zero income and zero profit.

Cash Flow. The key financial figure for SBA lenders is not the bottom line net income on your tax return. We have done very large SBA loans to companies that show a loss. How can this be? SBA lenders adjust your bottom line number with “add backs” and allowances to find out how much cash you have left over to pay loans with.

Personal Credit Scores. Credit scores tell lenders how you have handled credit in the past. Most lenders consider the FICO scores (credit report scores) of everyone who will guarantee the loan (20% owners of the business or the property). A good score exceeds 700. Some lenders will decline you if your score is below 670. Other lenders will accept very low scores. If your scores are low, HBS Finance will help you find a lender that does not emphasize them.

Business Credit. Most lenders will run a Dunn & Bradstreet or other similar report on your business. If problems show up there, you might be declined.

Projection Loans

Under certain conditions, a lender may want to know what you believe will happen in the future. In this case, they will ask you prepare projections. These line item financial reports give you a chance to guess. Lenders will then apply the above cash flow analysis to determine if you project enough cash flow to provide the required debt coverage ratio. (Yes, we have received projections before that showed a borrower could not make the payments!)

You may be asked for projections when expanding to additional locations (rather than relocating), when you buy a business or in the rare case a lender will consider financing a new business.

What Lenders Do Not Look For

Personal Net Worth. SBA lenders will not approve a loan based on personal net worth alone. It has been said that the richest man in the world would not qualify for a SBA loan if his business did not have enough historic cash flow.

Let us put our experience and expertise to work for you. Call us (310) 356-6500