If you’re thinking about starting a business, you know you’re going to need financing. Some banks like lending to start ups, some don’t. You’ve heard of the 5 C’s of credit:
- Character
- Cash flow
- Collateral
- Credit
- Conditions
But most banks like to see a balance sheet that is:
- Liquid (plenty of cash)
- Not leveraged (less than $3 of debt to every $1 of equity)
- And three years of profitable operations historically
But you may want to know what are the absolute deal breakers where the banks won’t lend under any circumstances.
As an aside, most start ups are financed through an SBA program (most often the 7a program). So, the SBA has specific guidelines which the bank combines with their own to make the loan.
1) Poor credit– About two thirds of your credit score is based on payment history of your credit obligations. So, if you’ve had a history of slow payments that could be a deal breaker. Also, if you’ve had a prior bankruptcy, liens, garnishments or judgments that will also affect your ability to borrow. Generally, banks are willing to loan to individuals with a credit score of 680 or above. Below that, it becomes increasingly unclear whether a bank will loan or not. If this is you, consider either a co signer or guarantor (with a good credit score) or talk to a professional about what you can do to improve your credit score.
2) Lack of collateral- A little know fact about the SBA 7a program is that the lender has to put forth best efforts to fully secured the loan with margined collateral. If the business doesn’t have sufficient collateral to secure the loan, the bank is required to obtain additional collateral from the owner’s personal assets. For example, if the loan amount is $500,000, then you need between $625,000 and $666,000 of assets with a 20-25% margin to get the loan. Each type of asset has a different margin requirement (SBA has their guidelines and so does each bank). Most banks will loan 75-80% on real estate, accounts receivable or equipment. In rare circumstances, banks do make loans that are slightly undersecured.
3) No business plan or 2 years of projections– About 80% of the businesses started fail in the first five years. The number one reason is that they are undercapitalized. So, a bank is looking for you to do a full business plan explaining the business, the market, the competition, the management team and two years of projections that are based on sound assumptions consistent with the industry performance and trends. Banks are not venture capitalists because they loan their depositors money, not their own. The business plan and projections along with the other factors involved need to show a high likelihood of business success with acceptable risk for the bank.
Lending to start ups is very risky because there is no historical performance of the company. This is not an exhaustive list of deal breakers, but these are three that bankers incur most often. Do your homework before you go see the banker to be sure your request doesn’t have one of these.
