I recently read a non-scientific study conducted by Multifunding LLC who surveyed 250 of its own customers to determine what types of business loan they thought they could qualify for and at what interest rate.
While the overall results were not surprising, they did hit on one result that really got me thinking about the reasons that businesses get turned downed for business loans by banks and other lenders.
They found that the average revenue of the businesses surveyed earned annual revenue of $750,000 and that these businesses, on average, requested loan amounts around $325,000.
My first thought was that these businesses are just asking for too much.
It’s not just that many of these businesses cannot service that level of debt (which I think very few of these companies probably could) but that is a high liability for banks who are either unwilling or unable to take that much exposure in just one company.
Might be why 62% of those businesses surveyed were either marginal businesses (meaning that they really don’t have much of a chance for landing a business loan) or just did not qualify outright.
Let’s look at a scenario for one of these companies.
While all businesses and industries earn different margins, a very good goal is to earn about 15% in EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) ‘” usually the amount from your business that you have to service debt with (make loan payments).
For a business earning $750,000 annually ‘” that relates into about $112,500 per year to service any and all debt (provided that the business can earn the 15% of EDITDA).
Now, let’s assume that your $350,000 loan comes with a 10% interest rate (even though the survey mentioned stated an average interest rates ranged from 23% to 31% (comparable to credit card rates) and for a 5 year term.
At 10%, this loan would require that your business pays $89,300 in principal and interest payments annually just to service the loan.
Great, this is below that $112,500 that you have in EBITDA and thus you should qualify.
No ‘” banks and other lenders don’t just require that your cash flow meets the minimum loan payments but they want a cushion as well.
What happens if your business or industry or even the entire market has a slow period, if you can only meet the minimum, one small slide in revenue means you can’t make your payments.
Thus, banks and other lenders require that your cash flow for debt or EDITDA covers at least 1.25X the minimum loan payments ‘” giving your business the ability to see revenues slip some 25% before it can’t make its loan payments.
That would put your required minimum cash flow to be some $111,500 ($89,300 times 1.25) or just $1,000 below what you actually make. Might be a little tight for most banks and other lenders given our current economy.
It gets even worse if your interest rate is anywhere near the 23% to 31% these businesses from the survey are facing or if the loan term was under the five years in our example.
Let’s take a worse case scenario. A $325,000 loan request at say 30% for three years would require your EBITDA to be $222,800 ‘” nearly twice what you really can earn ‘” even with $750,000 in revenue.
Look – the bottom line is that your business might not need all that cash at one time.
Think about how much you actually need immediately, how much you need in the interim and how much you need in the long-run and work on each of those needs separately and only when needed.
Might go a long way to getting that business loan approval. Much easier to qualify for a smaller loan amount now while you build your relationship with your lender than its to ask them to take that much exposure in your business ‘” especially during a time when banks just don’t want to lend to small businesses anyways.