WhatYouShouldKnowBEFOREYouApplyforaSmallBusinessLoan

©2018

AboutWacif

• TheWashingtonAreaCommunityInvestmentFund Wacif isaCommunityDevelopmentFinancialInstitute CDFI andnonprofitloanfundbasedinWashington,D.C.

• Since1987,WacifhasempoweredunderservedcommunitiesintheWashington,D.C.metropolitanareabyprovidingaccesstocapitalandexpertisetoentrepreneursandcommunityorganizations.

• Ourmissionistobuildinclusiveentrepreneurialecosystems,pursueequitableeconomicdevelopment,andsupportcommunitywealthbuildingthroughourinvestmentactivitiestostrengthenourregion’seconomiesandcommunities.

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WorkshopOverview&Goals

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5StagesofBusiness–AdaptedfromtheHarvardBusinessReviewStage1.Existence(a.k.a.“StartUp”)

• Themainconcernsofthebusinessareobtainingcustomersanddeliveringcontractedproductand/orservice.• Doesthebusinesshaveenoughmoneytocover theconsiderablecashdemandsofthisstart‐up phase?

Stage2.Survival(“CostofStayinginBusiness”)• Thebusinesshasdemonstratedthatitisaworkablebusinessentity.Themainconcernshiftsfrommereexistencetotherelationshipbetweenrevenuesandexpenses.• Canwe,ataminimum,generateenoughcashflowtostayinbusinessandtofinancegrowthtoasizethatissufficientlylarge,givenourindustryandmarketniche,to earnaneconomicreturnonourassetsandlabor?

Courtesy:HarvardBusinessReview:TheFiveStagesofSmallBusinessGrowth,NeilC.ChurchillandVirginiaL.Lewis,May1983Issue.https://hbr.org/1983/05/the‐five‐stages‐of‐small‐business‐growth

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5StagesofBusiness–AdaptedfromtheHarvardBusinessReview

Stage3.SuccessStory(“StayorGrow”)• Thedecisionfacingownersatthisstageiswhethertoexploitthecompany’saccomplishments,expandorkeepthecompanystableandprofitable providingabaseforalternativeowneractivities.

• Whatarethebusiness’salesprojections?Howlongwillittakeforyoursalestomeetyourcosts?

Stage4.TakeOff(“HowQuicklyCanandShouldWeGrow?”)• Inthisstage,themainconcernsarehowtogrowrapidlyandhowtofinancethatgrowth.Amongthekeyquestionsare:

• Willtherebeenoughtosatisfythegreatdemandsgrowthbrings[…]andacashflowthatisnoterodedbyinadequateexpensecontrolsorill‐advisedinvestments broughtaboutbyownerimpatience?

Courtesy:HarvardBusinessReview:TheFiveStagesofSmallBusinessGrowth,NeilC.ChurchillandVirginiaL.Lewis,May1983Issue.

https://hbr.org/1983/05/the‐five‐stages‐of‐small‐business‐growth5

5StagesofBusiness–AdaptedfromtheHarvardBusinessReview

Stage5.Maturity(“WeHaveArrived.”)

• Inthisstage,themainconcernsare:(1)toconsolidateandcontrolthefinancialgainsbroughtonbyrapidgrowthand(2)toretaintheadvantagesofsmallsize,includingflexibilityofresponseandtheentrepreneurialspirit.• Ismanagementisdecentralized,adequatelystaffed,and experienced?• Aretheowner(s)andthebusiness clearlyseparate,bothfinanciallyandoperationally?

Courtesy:HarvardBusinessReview:TheFiveStagesofSmallBusinessGrowth,NeilC.ChurchillandVirginiaL.Lewis,May1983Issue.https://hbr.org/1983/05/the‐five‐stages‐of‐small‐business‐growth

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UseofFunds

EnsureSurvival

PayBills MeetObligations

DebtService

PurchaseInventory,Equipment

AccountReceivableSupport

Workingcapital

MakeaProfit

PurchaseBuilding,Land,Machinery

LongTermGrowth

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DebtFinancing‐ Forms Traditional

Self‐Financing aka“bootstrapping” 401k,HomeEquityLoans,etc.

Banks&OtherConventionalLenders:

TermLoans withorwithoutSBA7aorSBA504program guaranty

LineofCredit

Alternative

AssetBasedLoans

Purchaseorderfinancing

AccountsReceivablefinancing

Factoring*‐ Thepracticeinvolvesafinancingcompany,or"factor,"advancingyoumoneybasedonitsbuyingyourreceivablesatadiscount;yourcustomerspaythefactorthefullvaluelater,whenthebillisdue.Factoringgetsyoucashinhandimmediately‐‐butatasteepprice.

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DebtFinancing‐TypesTermLoan

Fixedmonthlypaymentforasetterm/period.(Principalandinterest)

Usuallyforrealestateacquisitions,leaseholdimprovements,furniture,fixtures&equipmentpurchases,oracquisitionofabusiness.

LineofCredit

Monthlyinterestpaymentdueonoutstandingprincipalbalance.Generally6‐12monthtenor.PrincipaldueinfullatmaturityoratLender’sdemand.

Useforworkingcapitalneedssuchasaccountsreceivable,payrollandinventory.

Mayincludeamandatorywithcleanupprovision.

BridgeLoanAtypeofshort‐termloan,typicallytakenoutforaperiodof2weeksto3years,pendingthearrangementoflargerorlonger‐termfinancing.

Equipment/InventoryLoans

ShareholderLoans

BusinessCreditCards

HomeEquityLoan,401K,CashSurrenderValueofLifeInsurance

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WhyUseDebt?

Bestfor: Companieswithdefinedcashflowcycle,butcanbeattainedinstart‐upphase

Upside Avarietyofdebtinstrumentsexisttomeetspecificfinancingneeds

Assistsbusinessestomaintaincontrol

Unlikeinvestors,lenderscannotdirecthowyourunyourbusiness.

Accessibilityandflexibilitytonegotiatetermandpaymentstructure

Downside Requiressoundmanagementofcashflowacrossseasonsandcycles

Challengingforstartups,seasonal

businesses,andhighriskindustries

Repaymenttermsarenotflexible.

Debthastoberepaideverymonth, regardless ofhowwellyourbusinessisoperating

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The5C’sofCredit– Lending&Credit

Whetheryouareseekingfinancingfromabank,nonprofitloanfund,alocalcommunitydevelopmentcorporationorafamilymember,alllenderswillanalyzeyourcreditworthiness.The“5C's"arethebasicelementsofcreditanalysis.

1.Character – “Areyoutrustworthytorepaytheloan?”

Considers:Creditreports personalandbusiness ,References,Work/Industryexperience,Publicrecords,Digitalfootprint

2.Capital – “Personalinvestmentintothebusiness”Considers:Haveyoucontributedfromyourownassetsandassumedpersonalfinancialrisktoestablishthebusiness? Before youseekanyfinancing

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The5C’sofCredit

3.Capacity – “Abilitytorepay”Considers:thecashflowfromthebusiness,thetimingoftherepayment,otherpossiblesourcesofrepayment,andtheprobabilityofsuccessfulrepayment.Paymenthistoryonexistingpersonalandbusinesscreditrelationships

4.Collateral– “Home,InvestmentProperty,Contracts,Inventory,Equipment”

Considers:Pledgeofpersonaland/orbusinesspropertyorassetstoLenderintheeventofadefault

5.Conditions – “LoanPurposeandEconomicLandscape”

Considers:Sectorofbusiness,Competitivelandscape,Growthandattractivenessofindustry,Economicconditionsofthemarket

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FinancialStatements

Therearethreemainfinancialstatementsusedtounderstandyourbusiness:

1. BalanceSheet

2. ProfitandLossStatement(IncomeStatement)

3. CashFlowStatement

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BalanceSheettellsaboutyourbusiness

Itisasnapshotatonepointintimeandtells:

Whatyourbusinessowns(Assets)?

Whatyouowetoothers(Liabilities)?

Whatyourbusinessisworth(Equity)?

Howassetsareusedtooperatethebusiness?

Howliabilitiesareusedtofinancetheassets?

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HowtheBalanceSheetWorks

Thebalancesheetisdividedintotwopartsthat,basedonthefollowingequation,mustequaleachotherorbalanceeachotherout.

Assets=Liabilities+Shareholders'Equity

Thismeansthatassets,orthemeansusedtooperatethecompany,arebalancedbyacompany'sfinancialobligations,alongwiththeequityinvestmentbroughtintothecompanyanditsretainedearnings. 15

BalanceSheetAnalysis– Lenderwantstoknow:

1. Whattypeofassets doesthecompanyhave?Whatisitsvalue?

2. Lookingatitsaccountsreceivables reported,doesthebusinesscollect/getpaid foritsservices?

3. Howdoesthecompanycontrolinventory?

4. Doesthecompanypayitsbills?

5. Howmuchofyourloandebtiscurrentduein12monthsorless ,andhowmuchislong‐term greaterthan1yearmaturity ?

6. Whatis netvalue ofthebusiness?7. Lookingyear‐by‐year,howhasthe

businessperformed?Hasitsvalueincreased/decreased?Diditexperienceslossesthataffecteditsretainedearnings?

8. Hastheownertakenmoneyoutofthebusiness?

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IncomeStatementorProfitandLoss(P&L)Statement

Itisarecordofacompany’soperationsRevenuesandExpenses .

Willtellhowthebusinessperformedduringacertainperiod.

Itisanindicatorofacompany’sability tobuyandsellinventory/servicestomakeaprofit.

Willtellifthebusinessisearningasufficientmargin?

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P&LAnalysis:TheLenderWantsToKnow

1. Aresales aregoingupordown?

2. Whatitcosts toproduceorpurchasetheproduct?

3. Whatarethebusiness’expenses?

4. Netprofit— Howmuchmoneyisleftafterallexpensesarepaid?

5. Isthereanymoneyleft togrow/investthebusiness?

6. Howmuchmoneyisavailabletopaydebt existingandrequested ?

7.Howmuchmoneydoestheownerreceivefromthebusiness?

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CashFlowStatement

Demonstrateshowmuchcashflowsinorout ofthebusinessoveraperiodoftime.

Doesthebusinesshaveenoughcashtopayday‐to‐dayexpenses?

Paybillsontime?

Showsseasonalityortemporaryshortfallsand/orsurpluses.

ReconcilestheP&Landbalancesheet.

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CashFlowAnalysis– TheLenderWantstoKnow

1. Doesthebusinesshasenoughmoney tocoverday‐to‐dayactivities?paydebtsontime?maintainandgrowthe

businesswithoutanegativecashflow?

2. Thebreakdownofprincipalandinterestonyourloanpayments. Note:theIncomeStatementonlyshowsinterest‐ notprincipal.

3. Businessand/orownerweaknesses aninabilitytokeepandgeneratecash .

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WhatisthePurposeofFinancialProjections?

• FinancialStatementsdealwith presentandpastfinancialinformation.Projectionshelpyousetsalestargets,pricingandappropriatelyplanforthefuture.

• Throughforecastsorprojections,youcanexaminevarious“what‐ if”scenariostoensurethatyourcompanywillhavetherequiredcashflowtoachieveyourbusinessgoals.

• Toprovetoinvestors,potentiallenders andyourself ,thatthebusinessmakessensefromafinancialstandpoint andthatyouunderstandyourfinancialneed.

• Projectionsprovideamethodoftranslatingyourmarketopportunityandoperationsintocash flows,incomeandexpenses.

• Todeterminethefinancialresourcesneedtogrow yourbusiness.

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Projections:LenderWantsToKnow1. Atwhatpoint,willthe

businessstartoperatingintheblack (positivenetincome)?

2. Accordingtotheprojectedincomestatement,whenwillitbeprofitable duringYear1,Year2,etc.?

3. Whatwillbethe growthrateofsalesforYears1,2,3,andbeyond?Onwhatisthisbased?

4. Whatwillbethegrowthinnetincome profit ?

5. Howwill loanfundsbeallocated?

6. Howwillthesefundsberepaid?

7. Howlongwillittakepaybacktheloaninfull?

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YourCredit:CreditScore

• Creditscoresrangefrom350‐850,generally• Banksseek700 ,generally• Non‐traditionallendersseek600 ,generally

Source: www.truecredit.com

350 450 550 650 750 850

Highest

VeryPoor

Poor Fair Good Excellent

Lowest

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YourCreditReport:WhatLendersWantToKnow

Typesofnegativeinformation Maximumtimeoncreditreport

Generalciviljudgments 7yearsfromthedatefiled7yearsfromthedatepaid Iftaxlienisnotpaid,itwillremainonfileindefinitely.7years

Taxliens

Chapter13bankruptciesthathavebeendismissedordischarged

AllotherbankruptciessuchasChapter7

10years

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Summary&Takeaways– WhattheLenderWantstoKnow

Cashflowfordebtservice

Strongfinancialmanagement

Documentedfinancialcontrols

Processforbudgetingandprojections

Financiallysustainablebusinesslines

Diversifiedrevenue

Staffresources

Businessrisk

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LoanApplicationProcessGenerallyRequiredDocumentsChecklist

CompletedLoanApplication(withapplicationfee)

Businessplan(orExecutiveSummary)

BusinessTaxReturns(atleast3years)

PersonalTaxReturns(atleast3years)

FinancialStatements(P&LandBalancesheet,atminimum)

Copyofcurrentlease

Project/ContractmanagementReport

CreditReport(Personaland/orBusiness)

CorporateDocuments

EvidenceofInsurance,BusinessLicense

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GovernmentFinancing

Mobilization WorkingCapital

• NotificationtoProceed• Generallyupto30%Mobilizationor$350,000• TermofProject• AbilitytoPerform• InterestOnly&PrincipalRepaymentStructure

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ConcludingTips

Howmuchmoneywillyouneed?

Howwillthemoneybeused?

Whatisthelengthoftimethatyouneedthemoney?

Whattypeofrepaymentstructureare

yourrequesting?

Doyouhaveotherresourcesorassetsyoucanusetoreducetheloan

amount?

Doyouhavecollateral?

1.Knowyourrevenuestream s andcostdrivers.2.Bepreparedtoanswerthefollowingquestions:

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