Friends, family – and your commercial loan officer

The evolution of a new business is fairly standard and it usually proceeds without much thought given to its future need of financial support from a local bank.

Typically, the business operates for several years in a garage or basement while the principals hold their day jobs. It operates as a d.b.a. and all business and personal income and expenses are commingled and run through their individual state and federal tax returns. Then the time finally comes when the business seems to be profitable according to bookkeeper-prepared financials.

But there can be no certainty on profitability until the business has been separated from the individuals and judged in its own right. (This judgment, and the company”™s future prospects, will be made by a bank when it assesses a loan request.)

Armed with encouraging numbers and the business owner”™s decision to move from the garage, hiring employees and consulting with professionals from the legal and financial community is necessary to develop a growth plan.

The final, critical member of the team is the commercial loan officer from the local community bank. Together this group constitutes the financial team. Their goal is to take the business to the next level, ensure that the activities of the business are profitable and that the business is not stifled by a lack of financial resources to support growth.

The business owner must understand that the day has come when family and friends have extended maximum financial support and the resources from a bank will be required. If the business owner waits until outside financial support is immediately required before updating financial reporting, he or she has waited too long.

Ideally, the appropriate contact with the community banker is in the early stages of the business”™ development. At that point, the banker begins to understand the business and becomes familiar with the owner(s), sees the evolution of the business, the multiyear plan, the cash-flow needs and cycle of the business.

The financial team and the business begin to build a financial history from which (taken with other factors) financial projections can be developed. When outside funds are needed, those projections are tested by the community banker, sensitized to risk factors, including interest rate trends and sales projections, which are adjusted as the lender deems appropriate. The most important exercise the lender completes is a computation of the debt-service coverage ratio by overlaying the proposed loan structure, including repayment terms, over the financial projections. To the extent there is seasonality in the financial operations of the business, the banker will typically account for this in the calculation of debt service coverage. The business owner must always recognize that cash flow, not revenue, makes loan payments. As such, the business must provide sufficient information to the lender from which the lender may determine that repayments will be made in accordance with the loan terms.

To secure loan repayment, especially with a relatively young business and short track record, the community bank will typically take a lien on the assets of the business, as well as a guarantee from the owner(s) of the business. Ideally, this collateralization does not come into play at a later date, because the business is operating successfully and meeting all projections.

At the end of the day the business owner must remember that if he or she is successful beyond their wildest dreams, they have the full financial benefit of that success, whereas the lender only has the good fortune of having its principal and interest repaid.

For more information, contact jforgotson@bncfg.com.