Real Small Business Loans for Real Small Businesses

If you were looking for a $300,000 business loan, would you pay and additional $67,000 over three years in order to get a two percentage point reduction in the interest rate?

Unlikely.

But that's what plenty of small business owners do because they seek bank financing with seemingly low rates of interest, versus a so-called stated income/asset loan that carries an apparently higher interest rate.

How can this be?

Simple. The low rate loan is a full documentation, conventional loan. The seemingly higher rate loan, the stated income/asset loan, requires limited documentation and no income verification. For small business owners, there is a world of difference. The reason is because the owner of a small and or cash based business may have a very low salary, but quite legitimately derive economic value from the business in excess of $100,000. But stating this to satisfy a bank can at the same time provoke tax authorities, and generate significantly more taxes well into the future.

Thus the savings from the apparently lower rate of interest are illusory. Worse, because of potential tax liabilities, low rate loans may result in an effective interest rate that is much, much higher.

We are all brought up to believe that banks finance businesses. And there is a myth that small banks and small businesses fit hand and glove with one another. But the truth is that banks and small businesses are actually a tough fit.

The bankers aren't bad guys. It's simply that banks - even regional and community banks that have a vested interested in funding businesses where they operate - are structurally incapable of serving the needs of small and or cash based businesses. Banks need plenty of hard assets to collateralize loans. In addition, they are subject to scrutiny by federal regulators on their underwriting policies and practices, and have an expensive monitoring process that favor larger borrowers - those that need to borrow $500,000 to $1 million or more.

By contrast, smaller, cash based businesses typically do not possess a lot of hard assets, may have uneven financial performance that make regulators wince, and typically require loans of less than $1 million. The reality of this "structural mismatch" can be vexing and frustrating for small business owners who often diligently visit every bank in town only to get turned down by each one.

For these reasons, non bank lenders and stated income/asset programs can be a viable alternative for cash businesses, 'mom and pop' shops, self employed individuals, businesses with environmentally sensitive properties (i.e. auto repair shops, dry cleaners) as well as property owners that want to cash out, or leverage up to purchase additional properties. In the highly regulated environment of a conventional bank, these borrowers present insurmountable obstacles. In the more entrepreneurially driven non bank lender environment, these borrowers present a myriad of opportunities for which creative solutions can be developed.

What is the secret of non bank lenders that offer stated income/asset loans? First, they operate in an underserved market: small businesses seeking loans of less than $1 million. By virtue of this, non bank lenders can identify promising businesses that traditional banks would not even see. Second, non bank lenders are not regulated. This means they can adopt policies that while sound, would nonetheless go against the grain of federal regulators provoking questions and inquiries that bank executives would like to avoid altogether. Finally, non bank lenders believe in the value of real property as collateral. By lending prudently against the value of real property, non bank lenders need go no further in assuring the safety of their capital. Putting all these factors together means that non bank lenders offering stated income/asset programs can provide small businesses with solutions that are more consistent with the challenges they face.

For example, many traditional lenders require cross collateral agreements. These are agreements in which the borrower, after pledging all of the businesses' assets and real property as collateral, pledge their personal property as well. This arrangement can complicate loans, especially when there are multiple business owners whose active participation in the business may vary. Because stated income lenders focus on the underlying value of the businesses' real estate, in addition to its cashflow, they generally do not require cross collateral agreements.

Stated income/asset lenders are also more comfortable with so called cash out loans. For example, suppose you own a property that houses your business, and you want to leverage the value of your equity, and take cash out. Perhaps this cash will be used to expand the business. Or perhaps you might view this cash as a just reward for years of carefully managing the business and the property.

Traditional bank lenders are uncomfortable with cash out loans. They often feel that such arrangements leave them vulnerable. By contrast, stated income/asset lenders, which again place an emphasis not only on the business's cash flow but the underlying property as well, actively seek such loans. Their appetite for these loans is a valuable source of liquidity for small business owners.

As one more example of how stated income/asset lenders are more geared to the needs of small businesses, consider typical loan covenants. Traditional lenders often seek the right to audit the books of the borrower and have the borrower issue a covenant pledging that the business will perform at its current level or better. A breach of this covenant, over which the small business owner may not have complete control, can result in the borrower being in default, and the lender initiating foreclosure proceedings.

Again, there is nothing wrong with this per se. After all because banks are the stewards of consumer deposits that are insured by federal funds, i.e. taxpayer dollars, they must avoid risk at all costs. This is why banks operate in what is often characterized as 'an abundance of caution mode,' and adds bulk to the explanation of why banks are not built for the kinds of risks that small businesses typically present.

It also explains why there is such a void in the market for loan and credit services to small businesses. However, stated income/asset lenders have stepped into this void and are actively seeking out companies to provide loan solutions to help businesses maintain their track record of success, or take a giant step forward to the next level.

Easy Bake Commercial Loan Dictionary!!

EASY BAKE COMMERCIAL LOAN DICTIONARY

When its time to go talk to the bank do bad memories or nightmares come to mind. They asked you questions with words and terms that sound from a far, far away land. Well, I’ve compiled a list of the most important and interesting terms for the next time you talk to a bank or more importantly to help better you understand before signing that loan!

Advance Rates: This rate expressed as a percentage determines how much the Bank will lend on certain assets. For example, accounts receivable typically carries an 80% advance rate. So if your company had $100,000 in account receivable, the bank would lend you $80,000. Machinery and equipment and inventory are typically margined by advance rates. Real Property typically is valued at 80% of the appraised value.

Affirmative Covenants: Affirmative covenants are the contractual provisions in a loan that the company and its management agree to fulfill after the loan is complete. In other words, this is what you PROMISE TO MAINTAIN OR DUE POST CLOSING. Common affirmative covenants include:
· Access to records. The company will give the investor or bank and its representative’s reasonable access to company records and personnel.
· Financial reports. The company will furnish the bank with regular financial reports on the status of the company. Balance sheets, profit and loss statements, and cash flow statements are usually provided monthly, quarterly, and annually. Audited annual statements are often required. Sometimes a short "state of the company" statement is also required from the company president on a monthly basis.
· Budgets. The company will prepare annual budgets which must be approved by the board of directors.
· Existence and maintenance of property. The company will preserve its corporate existence and all rights necessary to conducts its business and own its properties. The company will keep its properties in good repair.
· Insurance. The company will maintain adequate insurance. Often, the company also agrees to purchase key man insurance on the lives of management.
· Payment of debts and taxes. The company will pay its debts and taxes in accordance with normal terms.
· Compliance with laws and agreements. The company will comply with all laws applicable to it and perform its obligations under its agreements.
· Litigation and other notices. The bank will be promptly notified of any lawsuit, default under a major agreement, or other event that could have a material adverse effect on the company or its operations.
· Proprietary rights protection. The company will take reasonable steps to protect its patents, trade secrets and copyrights. These steps may include securing secrecy or non-competition agreements from company employees.
· Use of proceeds. The company will use the funds provided by the investor or in the manner described typically in the loan application.
· Accounting system. The company will maintain its current accounting system.

Borrowing Base: A borrowing base typically a monthly calculation that is attached to a line of credit or revolver. The borrowing base is the total amount of lendable assets – after the application of an advance rate. This number represents the total amount a bank will lend you for that month. If your borrowing base falls below the amount borrowed the bank will seek a reduction on the line of credit balance to below the new borrowing base.

Capitalization Rate or Cap Rate:
The capitalization rate is a measure of a property’s performance without considering any mortgage financing. If you paid all cash for the investment, how much money would it make? What’s the return on your cash outlay? Cap rate is a standard used industry wide.

Cap Rate = net operating income / sales price

Since a cap rate measures the property’s profitability it can also help you determine the appropriate sales price for the property. For example, let’s say you want to earn at least 10% on your property investments. The property you are currently evaluating is listed at $2,750,000 and has a $250,000 NOI. Well for you to earn 10% on your money, you would want to negotiate a purchase price of $2,500,000 ($250,000 / 10%).

Cash-on cash Return:

The cash-on-cash return measures how long it takes for your down payment to come back to you. For example, if your down payment was $20,000 on a property how soon would your monthly cash flow (NOI – Debt Payments) takes to add up to $20,000. General real estate guidelines suggest that a 10% or greater cash-on-cash return is preferred.


Defaults or Events of Default: This is here as a reminder that you and your attorney need to understand what triggers a default in your loan. A default can result in higher fees, higher interest rate, and even an acceleration of the loan – meaning the bank wants the entire loan paid back today. Other defined terms in this dictionary are triggers for default such as affirmative and negative covenants.


LIBOR Rate: LIBOR stands for the London Interbank Offering Rate. It is the basic short-term rate of interest in the Eurodollar market and the rate to which many Eurodollar loans and deposits are tied. The LIBOR is similar in concept to that of the prime rate in the United States except that it is less subject to individual bank management.


Loan to Value: The ratio of money borrowed on a property to the property's fair market value. On a purchase contract, the bank will use the lesser of the appraised value or the purchase price of the property. Most commercial banks advance 80% on the appraised value of the property.

Interest Rate Swap: A deal between banks or companies where borrowers switch floating-rate loans for fixed rate loans. These can be either the same or different currencies. The advantage to this is that one company may have access to lower fixed rates and another company may have access to lower floating rates... so they trade.

Prime Rate: The interest rate that commercial banks charge their most credit-worthy customers. Generally a bank's best customers consist of large corporations. Default risk is the main determiner of the interest rate a bank will charge a borrower. Because a bank's best customers have little chance of defaulting, the bank can charge them a rate that is lower than the rate that would be charged to a customer who has a higher likelihood of defaulting on a loan.

Material Adverse Change: While this might seem obvious, but this provision in a loan agreement can give the bank substantial room to call a loan. Essentially, this provision protects the bank in the event a negative event happens to the borrower that would impair the borrower’s ability to pay back the loan. Examples might include the loss of a big customer, a substantial lawsuit, loss of a key owner/manager. Many borrowers don’t try to limit the range of this provision – What is Material? If its not changed then the definition is defined by how the bank wants to define it. Make sure you and your lawyer look at this provision and are comfortable with its range.

Negative Covenants:
Think of a negative covenant as a promise not to do something. Usually, negative covenants limit the amount of dividends a firm can pay to shareholders and restrict the ability of the firm to issue additional debt. Generally, the more negative covenants exist in a loan, the lower the interest rate on the debt will be since the restrictive covenants make the loan safer in the eyes of bank. This is very important aspect of the loan agreement. For example, let's say you bought a property for its net monthly cash flow. If your loan agreemetn prevents dividends or distriubtions then any payment of the net monthly cash flow would be a violation of the loan agreement.

Net Operating Income:
The net operating income or NOI is the dollar amount that’s left over after you collect all your income (rent) and pay out you operating expenses. This amount is what is used to pay the mortgage, and what’s left after the mortgage payment goes into your pocket! Here is the equation:

Net Operating Income = effective gross income – operating expenses

What is effective gross income? Your effective gross income is the net amount of income after vacancies with the property.
What are operating expenses? Your operating expenses of the property include taxes, insurance, utilities, management fees, payroll, landscaping, maintenance, supplies, and repairs.

Top Ten Red Flags your lender doesn't want to see and hear!

Today, I'm going to focus on post loan closing aspects of your relationship with your lender - that's right you still have to deal with your lender after the money is in your account. This post might be more pointent to a business loan, but some red flags are not exclusive to only business loans and apply to real estate loans. Here are the top ten Red Flags your lender never wants to see our hear!!!

1. Late Payments. While one or so per year might not raise the hair on the back of your loan officer, a series of late payments will prompt a phone call by your lender to you asking if everything is ok. Why? Usually after a payment is five days late, the late payment shows up on your loan officer's boss's desk!! Remember everything falls downhill.
2. Overdrafts. There are two types of overdrafts a lender sees when he drinks his coffee in the morning. Uncollected Funds or just a plain old overdraft where there is not money in the account and no deposit in the system. Uncollected funds are deposits made to your company's DDA and are in the process of being cleared (this can take 3 to 7 business days). Uncollected funds overdraft are still bad, but not as significant as a bare naked overdraft. A banker will probably pay on the presented checks in a uncollected funds situation, but not on a true overdraft. A series of overdrafts are a serious problem that will need to be addresses by the Bank and you. An overdraft report and the number of days the acount has been overdrawn can go to the highest level of the bank.
3. Late Financial Statements. Late finanacial statemetns can be an alarm to the bank that there might be serious problems at your company. Loan agreements provide a period of time to get financial statements completed and submitted to the bank. Many borrowers don't even know that they owe the bank information, because at closing they are mostly worried that the rate and term is correct on the note. Create a tracking list of all documents required by the bank, seperated by monthly items, quarterly and annually. This may sound crazy but late statements is a default of your loan agreement and the Bank could call the loan.
4. No Communication with the Bank - No Returned Phone Calls. A series of phone calls not returned to your banker sends up a red flag that something is going on. The bank debt on your balance sheet is probably over 90% of your total funded liabilities. So this important creditor needs to keep in constant communication. Silence is worrisome for a banker. The banker could be thinking that your losing money, lost a key customer, or what ever else might pop up in their mind.
5. Frequent covenant defaults. Records are meant to be broken, but not loan covenants. A loan officer has to get waivers approved internally and face hundreds of questions about the state of your company and frankly your lack of respect to the loan agreement signed at the closing table.
6. Rumors. This one is harder to control but you must be aware of the impact of rumors about your company getting to your bank. Your bank might lend to your competitor, customers, and might even know your accountant and lawyer. A comment like "Hey, Tim Banker you might want to get over to Joe's Machine Shop ASAP! from your accountant might create a red flag.
7. Borrowing Base Over Advances. For those with lines of credit tied to borrowing bases - an overadvance sitiuation is an immediate alarm to a banker. An overadvance occurrs when you revolver balance exceeds the assets used to collaterialize your line of credit. If it can be cleared up quickly (days) then its not so bad, but if its a long term issues then there will be problems. See if your line balance, which should rise and fall with your current assets, exeeds you current assets, then most likely your losing money or the quality of your assets might be question - accounts receivable collectability for example.
8. That new beach house and Mercedes that you just bought. Believe it or not a dramatic change in your lifestyle would peak the interest of your banker. Your banker would begin to question you commitment to the business, would wonder if the loan proceeds when to buy the car and beach house, and if any other debt was issues to the owner to acquire such cool things.
9. The loss of a key employee, partner, or customer. This is an obvious one, but one aspect of this might lose your bankers trust. If you delay in telling your banker and worse your banker finds out from someone else would be disastorous.
10. We don't have money to fund payroll! This is one of the most debilitating call a banker can receive from a company - short of a call to let your banker your filing for bankcruptcy. Payroll is the most sensitive expenses a company faces each week or every other week. It also quickly sends a message that things are not right at your company. You also forced your banker into a corner - which no loan officer wants to be in. Avoid this one at all costs.