Attacking a Loan

With his 12 years on the faculty of the University of Chicago's Graduate School of Business, Brad Barbeau, 46, was no stranger to the basics of borrowing money. When he needed growth capital for his Monterey, California-based all-organic soft drink producer, The Monterey Beverage Company, borrowing seemed like the best way to go: Rates were low, his community lender was eager to help him create new jobs, and he qualified for an SBA guarantee.

Barbeau was prepared for some tough terms and conditions from the bank. He wrote a solid business plan to justify the loan amount. He even signed over his own home as collateral. Along the way, though, he learned that negotiating commercial credit is a multistep process that begins well before the application is submitted . . . and never really ends.

Understanding the process as a whole can not only make borrowing easier but can also give you an edge when negotiating with your lender. When there is a large loan hanging in the balance, even a slight edge can save you thousands in the long run. Here's what you should know to keep your lenders happy and to keep the table tilted in your favor:

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Call Early and Often: Like most things in business, negotiating a loan starts with building a strong personal relationship. Start by inviting a banker to your place of business; wow them with product samples; take them to lunch. A little kindness goes a long way.

Bruce Enright, president of Tallgrass Technologies, a computer reseller in Kansas City, Kansas, has always held regular meetings with his banker. They meet as often as once a month, "partially because I want to build his comfort level so his decision-making is not influenced by the element of surprise, and also for his input and experience in a variety of industries," he says. "More formally, I will likely include him in our new board of advisors."

When Enright, 42, needed $400,000 to buy out his business partner, that long-standing relationship was key. Although the bank's loan review committees looked critically at Enright's balance sheet ratios, he had a champion inside the organization who could go to bat for him. "The strength of that relationship," he says, "overcame the weakness of tight leverage and downward-trending profits."

Get the Book: Every banker will tell you business loans are often predicated on meeting and maintaining some well-established operating parameters. Take a glance at the banker's bible for these crucial business metrics: Robert Morris Associates' Annual Statement Studies (The Risk Management Association) or RMA.

This guide to over 600 industries includes common financial ratios and statements culled from a national survey of commercial loan accounts. Get a glimpse into the mind of a banker by picking up a copy of the RMA at a bookstore, library or bank. RMA benchmark ratios can become targets to qualify for, or maintain, commercial credit.

Offer More: If you want to get a loan out of a banker, the best enticement is a hefty portfolio of other banking needs. What most banks want are depository accounts and fee-generating services. If you can't offer more than a monthly loan payment, be prepared for a polite "No, thank you."

The reason is, the margin between what banks pay for money and what they charge for it has been shrinking. Margins are so narrow that loans are only mildly interesting to most bankers.

For Enright, shifting deposit accounts to his ultimate lending institution was all part of the deal. "As they stretched their ability to loan," he says, "the reward was fee-based business including payroll accounts, wire transfers and credit card processing."

Anticipate Failure: It may seem counterintuitive, but a great way to gain a banker's trust is by discussing how your business could fail. Write down 10 things that will challenge your business-and the ways you'll overcome those challenges. This list of potential pitfalls not only shows that you have thought through your business, but also gives your banker great ammunition for the tough questions his loan review committee will ask.

Be sure to include the old standby: key-person risk. If you die tomorrow, how would you repay the bank's money? Key-person risk is present in every business and can best be addressed only by substantial life insurance. Barbeau and his business partner were each required to have life insurance policies that would pay twice the amount of the loan. It's morbid. It's expensive. But it shows you are thinking through all possibilities and helping the bank reduce its exposure to risk.

Plan Pessimistically: When his loan closed, Barbeau's negotiations were just beginning. Spending the money was more arduous than getting it.

"We were granted the SBA loan based on the projected expenses and revenue in our business plan," says Barbeau. When he began using the money, however, the bank expected expenditures to fit the original budgets. "As soon as the ink dried on the business plan, we had to make adjustments," he explains. Each variance meant showing the bank why the costs were necessary. "We had to present receipts for each purchase, which was allocated into buckets. In the end, we drew out only $132,000 of our $165,000 loan because we couldn't spend the money as quickly as budgeted," Barbeau says. The lesson? "I should have gone for more money," he says.

A thorough business plan with clear projections is vital to getting a loan approved. But projections that are too optimistic will get you in trouble. "The glass always looks half full when you are going into these things," Enright advises, "but you want a good cushion."

Negotiate Smartly: Barbeau and Enright say careful planning and good relationships earned them rates and terms that saved them thousands in the long run.

Start negotiations with what's most important to you. For Enright, that was some protection from risk; he made it clear his home and retirement savings were off-limits as collateral. The bank agreed-and crafted special terms that protected him in a worst-case scenario.

Stay Vigilant: Although Enright negotiated a five-year loan amortization schedule, his bank is not going to close the deal quite yet. The loan's covenants can change every quarter, and the whole loan is reviewed every year. Based on early discussions with his lender, Enright is confident he can keep the loan renewing annually. But any policy change at the bank could make the terms of his loan unworkable.

Once you put together all the pieces-a great relationship, a solid business plan, risk coverage, and upside for the bank-you're ready to negotiate a generous loan package. For a well-prepared borrower, everything is negotiable.

David Worrell is a partner at Monterey Venture Partners, helping emerging companies with strategic and financial planning. You can reach him at david@plan2ipo.com