by Carolyn M. Brown
When Robert Joseph opened R J Construction Co. Inc. in 1993, he capitalized the business using $20,000 in personal savings. Three investors (relatives and former co-workers he has since bought out) also had an equity stake in the company. At the time, Joseph did his personal banking with Wells Fargo, so he opened up his business account there as well.
R J Construction, in Missouri City, Texas, is a general contractor/commercial construction company that works on projects such as industrial wastewater treatment plants and sanitary pump stations. “We were five years into the business before we were profitable, generating $1 million in revenues,” says the 49-year-old civil engineer. “That’s when we established an initial line of credit with Wells Fargo for $100,000.” For most construction companies, winning a bid on a contract is just the beginning, since capital is needed up front to purchase materials. Joseph used the credit line as working capital so he could meet his contractual obligations.
Today, R J Construction’s largest client is the nearby City of Houston. For the past eight or nine years the company has carried a workload of about $7 million a year and completes about $4 million of that. “What we do is specialized, so there’s always been work,” Joseph says. R J Construction taps its revolving line of credit—now $350,000—roughly three times a year, but the funds get paid back within three to six months. “Some projects are more equipment intensive than others,” says Joseph, whose company employs 12 full-time workers including his wife of 27 years, Barbara, who works as the office manager. “We also like to make sure our vendors get paid up front,” Joseph adds.
As Joseph’s example illustrates, businesses typically use a line of credit to maintain or expand a business—not start a new one. A line of credit provides business owners much-needed short-term working capital to meet payroll, pay vendors, or purchase raw materials. According to the National Federation of Independent Business, 86% of small businesses use some type of credit from a financial institution—76% possess a credit card, 47% a credit line, and 31% a business loan. Failure to obtain credit is associated with having low credit scores, a large number of mortgages outstanding, fewer unencumbered assets, and being located in states hit hardest by the housing bubble.
Loan officers need to understand the condition of the business and its prospects, says Bank of America small business executive Robb Hilson. Shaun Coard, senior vice president and business banking manager at Wells Fargo, says the owner’s financial information is used to determine his or her net worth; the company’s is used to analyze trends in annual sales, net income, and equity in the company.
Coard says the basics consist of three years’ of business tax returns and the business owner’s personal tax returns; three years’ of financial statements, including balance sheets (listing the company’s assets and liabilities); and income statements (listing revenues minus expenses to determine profit or loss). Some lenders will also request a statement of cash flow (charting movement of funds in and out).
What can business owners do to improve their chances? “Present a logical business plan that demonstrates their ability to repay the obligation,” says Hilson. “Maintain good financial controls, and don’t try to completely kill profits to manage taxes. Banks can’t lend on cash flows that don’t get formally reported.”
Here are five key areas loan officers will examine before granting you a line of credit.
How will a credit line help your business?
Lenders look at how the funds will be used, says Hilson. The most common uses include funding inventory, accounts receivable, and capital equipment. They’ll also look at what the business does—who does it sell to and buy from—as well as ask general questions about the company’s business model.
What are your annual net revenues?
You must prove that the business has lasting earning power, which means you’re generating net income. Yearlong monthly cash-flow statements will reflect this net income. Lenders like to see enough ongoing cash flow to cover all expenses, including the proposed loan payments, says Hilson. A seasonal lull can be reconciled, but a drastic drop in revenues year after year would cause concern.
How far out are your receivables?
Typically, a credit line is secured with accounts receivables. “We want to see current, detailed accounts receivable aging—a report listing accounts receivable owed from each of the company’s customers that indicate the number of days outstanding categorized as current, more than 30 days, 60 days, and 90 days,” says Coard. Based on eligible collateral, this report is often used to determine the limit of the line of credit. She says that most financial institutions will not include accounts receivable that are more than 90 days past due when determining the line of credit. In addition, if the company’s accounts receivable include what’s known as a concentration, meaning more than 20% of the total accounts receivable balance is due from one customer, the amount of the concentration may either be discounted or excluded from the eligible accounts receivable.
What’s your debt–service coverage ratio?
Coard notes, “We look for 1.25 to 1 debt–service coverage ratio. This means for every dollar of debt that you owe or you want to finance, we want you to have $1.25 of income.” Coard adds that the business owner’s financial net worth and liquidity are important when the lender is looking for a secondary source of repayment. “We analyze your assets and liabilities to help determine if borrowing additional financing is or isn’t going to be a problem for you.”
What’s your personal credit history?
Yes, banks review your company’s performance, but businesses don’t pay the bank back, people do. “The business owner’s credit score and payment history are indicators of the business owner’s reliability,” says Coard. If you make consistently late payments that can’t be reasonably justified, then chances are your loan request will get denied. Coard acknowledges that the past few years have been difficult for business owners. She advises business owners to always communicate with their lenders to inform them of both positive and negative events that affect their business.
Build A Rapport
One way entrepreneurs can ease the pain of poor credit is to establish a rapport with a banker long before they apply for a loan. This isn’t the teller whose kids’ names you know when you deposit your checks. This is a business banker who understands your industry—a trusted adviser on par with your accountant or lawyer. Ask a branch manager for a referral. Then tell the business banker who you are, what you do, and ask how he or she can help grow your company. You should meet with this person regularly.
It was a long-term relationship with Liberty Bank & Trust Co. (No. 5 on the be banks list with $464 million in assets) president Alden J. McDonald Jr. that enabled Norm and Michelle Gobert to acquire financing for their business, Signs Now New Orleans. Located downtown near the Mercedes-Benz Superdome, Signs Now New Orleans produces promotional banners for events and advertising vehicle wraps for buses and streetcars. The Goberts recently obtained a $300,000 bank loan to boost their business’ sign-making capabilities. They bought equipment to produce signage and displays that had previously been outsourced and to make their production processes more efficient. But beyond the owners’ ongoing personal relationship with their banker, Signs Now New Orleans has a history of profitability that spans more than 20 years, even during tough times that included a storefront rebuild after Hurricane Katrina.