Credit Scores and Business Plans
The things that is often brought up to us is whether or not a discussion regarding individual's credit score should be put within the business plan. Usually, when we develop a business plan on a customized basis for a client we do not include information regarding the individuals personal credit. This is primarily due to the fact that the individual bank or financial institution is going to pull all three major credit reports when they are examining the loan application. However, especially for service-based businesses there may be times when it is appropriate to discuss the underlying credit of the individual borrower directly within the business plan. This is especially true if the individual is applying for a small business administration loan given that the credit score is going to be a very important factor when making a lending determination. As a whole, most banks consider three primary factors when developing and reviewing a loan application.
First, they thoroughly review the business plan to ensure that the business is going to be able to remain economically viable in most economic climates. This includes an overview of the anticipated revenues, expenses, and pretax profits. It is important within the business plan to show that the business can satisfy the debt obligation by more than 20% per month within the first years of operation. Most banks and lenders focus substantially on the ability of the individual entrepreneur to make timely monthly principal and interest payments regardless of how the business is doing.
Second, the loan officers or lending committee will look very thoroughly at the individual bar themselves in regards to their experience, educational background, and their ability to effectively operate the business on a day-to-day basis. Most people that seek small business administration loans or conventional business loans are new entrepreneurs. The small business administration programs were developed specifically so that newer and younger entrepreneurs could have access to affordable credit. This is going to be one of the key factors moving forward as it relates to the federal government support of these programs. One of the nice things about getting a small business administration loan is that the terms are flexible especially for an entrepreneur that does not have a substantial amount of experience operating businesses on a day-to-day basis. Most importantly, a full resume and biography should be included within the business plan so that the bank
has an understanding of the individual's ability to effectively bring a new enterprise to profitability with a positive cash flow within the first 24 months of operation. If this is specific for a professional practice, such as a dental practice, then a substantial amount of information regarding the practitioners history and their ability to render services to the public should be included as well.
Third, there is going to be an examination of the collateral that is going to be used for the loan. Most banks and lenders strive to have his much collateral as possible so that in the event of a default they are able to recoup their investment. Common types of collateral include real estate, furniture, fixtures, related equipment, retirement accounts, checking accounts, 401(k) accounts, and any other asset that has a salable value. For SBA loans, most banks want to see that at least 80% of the loan is collateralized. This is why a 20% capital injection is typically needed by the borrower in order to ensure that the bank is comfortable providing this investment to the entrepreneur. Of course, one of the other frequent questions we get is whether or not the individual entrepreneur is going to need to provide a personal guarantee for the loan. The short answer is yes. Almost all banks and lenders require that the individual entrepreneur personally
undersize the loan in conjunction with their company. After the credit crisis of 2008 and spanning through a recession for three years – most banks have implemented much more stringent lending protocols so that in the event of a default the bank is able to recoup a significant portion of the loan. This is one of the things that an entrepreneur should discuss with their certified public accountant given that when a small business administration loan is undertaken - a substantial amount of the individuals personal assets can be put at risk. As such, it is up to the entrepreneur to make an appropriate determination as to what they consider to be a can reasonable risk for their personal assets. Many people have a significant amount of concern specific for their primary residence. This of course could mean that a house could be lost in the event that a business fails. As such, it is important that the entrepreneur determine whether or not they consider this to be acceptable risk.
In closing, lending is a very complicated process especially for small businesses given the high-risk nature of these operations. The small business administration seeks to alleviate some of the risks associated with banks providing small business loans by issuing guarantees. However, it is still very much incumbent upon the entrepreneur to have an airtight business plan that will ensure that even if revenue targets are not met the business is able to satisfy the underlying debt obligation. This is going to be something that we continue to discuss on this website also focusing on how to properly develop a business plan that is specific for a SBA lending bank.