How to secure a line of credit for your business.
The breakup, however, didn't spell the end of business for the hair-care guru, who three years later founded McBride Research Laboratories in Decatur, Ga. Today, his popular lines, Wave By Design and Design Essentials, are sold at hair salons nationwide.
Despite his 20-year intimacy with the industry (he is also a licensed pharmacist), McBride had a tough time getting back into business. What he needed most was money - specifically, a $600,000 line of credit - which he hoped to obtain by putting up $2 million worth of land as collateral. To his surprise, five lenders deep-sixed his application, and even his long-standing personal and business banker said no.
After months on the chase, McBride finally scored at black-owned First Southern Bank, based in Lithonia, Ga. "First Southern believed in us. They were willing to give us a chance to live up to our experience," recalls McBride, who eventually managed to get a $300,000 line of credit.
THE HARD LINE ON LENDING
Today, with sales increasing by more than 20% annually, McBride woeful tale is just an unsettling memory. But a full three years after the height of recession, many other entrepreneurs are facing the exact same barriers. The hard reality: Banks are not willing to take on a lot of risk. In fact, since McBride's struggle in 1990, business lending is down by 16%, according to the American Bankers Association. As for start-ups like McBride's? They have the slimmest chance of obtaining a loan. Due to high risks and failure rates, commercial lenders rarely fund new businesses.
"Bankers aren't in a financial position to do (what amounts to) venture capital lending," explains Ellis Gordon Jr., chief credit officer at Los Angeles-based Founders National Bank (No. 18 on the BE Financials List). Indeed, the SBA discovered that equity for 70% of black-owned start-ups come from friends, relatives or personal savings - not banks.
Some business owners argue that if the banks truly want to reach minority communities, then they need to be more sensitive to African-American entrepreneurs. Maybe so. After all, business lending is a highly subjective process. For better or worse, loan officers exercise a great deal of individual leverage in granting or denying credit.
How, then, can you improve your chances of qualifying for a line of credit for your business? First, make sure you understand how business credit lines work - whether or not they suit your special needs. If it makes sense for your company, you'll want to read on and follow the guidelines we set forth.
THE LOWDOWN ON CREDIT LINES
A line of credit can potentially open a huge door for entrepreneurs. With a revolving line, the most common type of credit line, one can borrow as little as $5,000 or as much as $1 million, drawing on, and replacing, the funds as needed. At the end of the year, the credit may be renewed. (A regular term loan, conversely, is a one-time deal with a set payout period of, say, one or five years.)
A line of credit offers another advantage: Unlike term loans, which require repayment of both interest and principal, borrowers pay interest charges only.
This type of loan also allows businesses to take advantage of special discounts offered by suppliers or to gear up for a special sales effort, such as a seasonal line of credit. Or it can tide the firm over until deadbeat customers pay up.
According to a survey by the Washington, D.C.-based National Federation of Independent Business (NFIB), roughly three-quarters of business owners use lines of credit for working capital. Granted, these firms aren't small potatoes: The NFIB found that businesses with $750,000 and above in gross receipts were most likely to have a line of credit.
As McBride's case demonstrates, a line of credit is generally used to maintain or expand a business - not to start a new one. There are exceptions, though, as James W. Hammersley, deputy director in the SBA office of financing, explains. "An entrepreneurs who has been in business for only a short time could go to a lender and say, |I produce lawn chairs and I need to buy 1,000 pounds of aluminum. But it will take two months to build the chairs. I already have a contract to sell them, but I need money to purchase raw materials.'" Hammersley says the SBA loan officer would probably review such application favorably.
But nothing is that simple. Just ask John L. Sims, president of Philadelphia-based Tri-State Marketing Corp. He has spent the past two years searching for a $25,000 line of credit for his company, which supplies uniforms and other career apparel to Playtex, Du Pont, Rite Aid and similar large companies.
"The business is there; the orders are there; we just need short-term money to fill them," explains Sims, who expects Tri-State to gross $500,000 in revenues this year.
Sims' hunt for the elusive loan is especially frustrating, given that the company has about 22 arrangements with suppliers worth a total of $200,000 in lines of credit. The problem: his business partner has a blot on his personal credit report - two late bill payments within the last 24 months.
"We really thought the banks would judge us based on the corporation's performance," gripes Sims, "not on an individual stock owner's credit history."
On the other hand, "businesses don't pay the bank back, people do," points out Founders National Bank's Ellis Gordon. "The only way bankers can assess the character of a potential borrower is to look at his or her credit report. If that's flawed, the chances of getting a loan are probably shot."
One way entrepreneurs can ease the sting of poor personal credit is to establish a rapport with the bank long before they apply for a loan. "Ideally, you should build a relationship with banker prior to submitting your loan request," advises Lissa Foster, community development specialist at Integra Financial Corp. in Pittsburgh.
THE BUSINESS PLAN
You're too busy doing real work of running a business to spend months writing or improving your business plan. Right? Wrong. To be successful borrower, you need an airtight business plan, emphasizes Joseph Mancuso, president of the Center For Entrepreneurial Management in New York City. He stresses that walking into the bank and handling in an abriged version or mediocre plan simply won't cut it.
The basic components of a winning business plan are a one-to three-page summary of the company's objectives, history, management and finances; market analysis; financial statements; and extensive bios on the management team. (See "A Good Plan Is Key To Business Success," November 1991.)
Carol Columbus-Green is one entrepreneur who, when applying for a line in 1990, was asked to bare all. "The business plan was the first thing may banker asked to see," says the Chicago business-owner, whose three-year-old company, Laracris Inc., produces a line of ladie's intimate apparel called Aubergine. "You have to sell the idea of your company," she adds.
Columbus-Green's plan - enhanced by $1,200 worth of market research - was solid enough to help her get an $80,000 line of credit in 1990 from her personal banker, North Bank of Chicago.
"I really spent the first year researching the industry and prototyping the garment," says Columbus-Green, whose husband helped with the $200,000 in personal savings used to bankroll the fledgling company "I didn't even approach the bank until the product was in the first store." In 1992, with products in 800 stores such as Marshall Field's, Nordstrom and Saks Fifth Avenue, Aubergine posted $2 million in revenues.
THE FINANCIAL REPORT CARD
Financial statements are the report card for any business. And whether or not you make the grade with a loan officer depends on how well you prepare these documents, explains John W. Nelson III, vice president of commercial lending at Citizens Bank Rhode Island. Every lender needs to understand the condition of the business and its prospects. Hence the importance of submitting several financial statements.
In addition to the business' tax returns, the most crucial financial records are the balance sheet (listing a company's assets and liabilities), income statement (showing profit and loss) and cash-flow projections (charting the movement of funds in and out of your business). The loan officer will use this information to determine the net worth of the company, to examine how funds are used and to analyze trends in sales or revenues.
What does a banker want to see for existing businesses? According to Nelson, the basics consist of three years worth of balance sheets and income/expense statements, a projected balance for the upcoming fiscal year and a month-to-month projected cash-flow analysis for one year. Also, the banker will want to see estimated operating statements for three years.
For start-ups, it's a lot more tricky. The entrepreneur must produce projected operating and cash-flow statements for three years. He or she also needs an opening balance sheet, a break-even analysis (which shows when income equals outgo), capital equipment list (cost or value), appraisals on real estate and equipment and personal financial statements form the last three years.
Such rigors mean that no business owner, whether novice or veteran, can do a half-baked job of financial reporting. But many do. Citing high costs, they try to shortchange on the paperwork, says Robyn Elliott, a Culver City, Calif., CPA.
But guess what? Bankers spend a great deal of time doing their own in-house number-crunching and analysis of a borrower's financial statements. If you're shaky in this area, take a crash course at a local college, or attend seminars sponsored by the AMA (American Management Association) or SCORE (Service Corps of Retired Executives Association). A general rule: It helps if you show statements prepared by an accounting firm or a CPA.
SURVIVING THE INQUISITION
Bankers ask five key questions when a loan application hits their desks. How you answer them can make or break your request:
1. How much money do you want? Never ask how much the banker is willing to lend. If you need to borrow $50,000, then hold firm to that request - and don't ask for more. Present the most precise calculations you can assemble to explain why you need that amount.
2. How will the loan help your business? The banker wants to know the loan will result in something positive, say, additional cash flow, higher sales or cost reductions - not pay you a higher salary. Be as specific as possible.
3. How will you pay the money back? The primary sources of repayment are business proceeds, conversion of assets or cash flow. You must prove the business has lasting earning power, which is reflected by a year-long monthly cash-flow statements and quarterly projections for the term of the loan.
Nelson tells business owners to go to the marketing section of the business plan. "I want to know who their customers are, how they're going to reach the market, how competitive they are and how they price their products." Lenders want proof of revenue figures, so they scrutinize projections. "Many owners know exactly what their fixed expenses are, but they have a pie-in-the-sky idea of how much revenue the business can generate."
4. How will you repay us if things don't pan out? The typical response is collateral. And yes, bankers do look at what the property is worth at liquidation value, how salable it is, etc. But be warned: Bankers are not keen about liens. "We like to see the loan repaid from the ongoing cash flow. It is also helpful to show a contingency plan for situations you may not be able to control," notes Debra Pickens, vice president and trust officer at National Bank in Charlotte, N.C.
5. What's your personal stake in the business? A bank will want to know the answer, since this indicates how much faith you have in your own project. Unfortunately, "a lot of business owners fail to bring some cash to the table," says Integra's Lissa Foster. Banks like to see you foot at least 20% of the total cost. And rightly so. As the owner, you may have an emotional attachment to the business, but the bank won't.
Even if you can satisfy all these questions, a bank can still turn down your loan. But don't walk away with your head hanging down in defeat. Find out specifically why the loan was denied and improve upon any weaknesses in your application. Remember: Persistence is crucial to the success of any business.
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|Author:||Brown, Carolyn M.|
|Date:||Jan 1, 1994|
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