Many business owners approach their banks and the commercial loan process assuming things will be similar to their experiences securing a personal loan for a home or a car. However, that is most often not the case and can cause confusion and lost time.
The commercial lending process differs from most consumer lending, such as residential mortgage lending, in that there are no hard rules or ratios that make a loan either acceptable or unacceptable.
The commercial loan process is a bit more of an art than a science. However, the underwriting process of sound commercial lending is not the mystery it may seem to be. It is simply a process of information gathering (or due diligence), financial analysis, and informed decision-making.
The process described in this article is typical for a new client; an existing client with an established history would most likely encounter a more streamlined process. While the process outlined here may seem rigorous, remember there are many components to consider in the decision-making process and every business has its own unique story that needs to be understood.
All of these factors, coupled with the fact that banks are highly regulated and are lending depositors’ and shareholders’ money, makes it clear that there is little room for wrong loan decisions. That is why there are typically several potential sources of repayment for a commercial loan — cash flow, collateral, and guarantors. To analyze these repayment sources, the bank must first get to know and understand the prospective borrower. The areas of focus include:
- Meeting With Company Management
- Background of Your Company’s Industry
- Company Credit Needs (Current and Proposed)
- Company History
- Company Financials
Details of the bank’s commercial credit analysis on the five items above lead to loan decisions, so it is important for business owners to know how to clearly and concisely represent themselves in the process.
Meeting With Company Management
The bank’s due diligence process begins by meeting with company management. General information about ownership, management, products and markets, finances, and brochures contribute to an understanding of the business. These provide important background information, and give the banker a perspective of management’s understanding of the business.
Financial Information Required In The Commercial Loan Process Includes:
- Year-end balance sheets and income statements for the past three years
- The most recent interim financials along with corresponding statements from the prior year and the annual budget
- Business tax returns (if year-end statements are unaudited)
- Accounts receivable aging and possibly accounts payable aging
- Personal financial statements and personal tax returns because the owner(s) typically personally guarantee the debt for most privately held businesses
The bank is trying to determine, “Does management understand the company’s financial statements, competition, and competitive advantages?”
Ideally, the banker has at least one meeting at the business location to provide a tour of the facilities. This allows the banker to observe the general working environment, equipment quality and upkeep, and inventory control and management. It also provides an insight into management’s understanding of the operations.
The management assessment includes not only the owners but also other key personnel. Relevant information includes individuals’ names, areas of responsibility, tenure with the company, and prior experience. The goal is to get a solid determination of management’s experience level and depth. Some businesses rely heavily on a key individual, and this risk needs to be addressed, possibly with life insurance on the key person.
Who Should You Include In The Company Management Meeting?