Office of Capital Access | Resources

The Loan Application Process is very critical for lenders. Lenders will evaluate potential borrowers based on a variety of factors including:

Equity Investment
Business loan applicants must have a reasonable amount of capital invested in their business. This ensures that, when combined with borrowed funds, the business can operate on a sound basis. Lenders will expect you to contribute your own assets and to undertake personal financial risk to establish the business before asking them to commit any funding. If you have a significant personal investment in the business, you are more likely to do everything in your power to make the business successful.

A lender will make a careful examination of the debt-to-worth ratio of the applicant to determine how much money it is being asked to loan (debt) in relation to how much the owner(s) have invested (worth). Owners invest either assets that are applicable to the operation of the business and/or cash that can be used to acquire such assets. The value of your invested assets should be substantiated by either invoices or appraisals (for start-up businesses) or current financial statements (for existing businesses).

Positive equity with a manageable level of debt provide financial resilience to help a firm weather periods of operational adversity. Positive equity also ensures that the owner(s) remains committed to the business. Minimal or non-existent equity makes a business susceptible to miscalculation, and increases the risk of default (failing to repay) on borrowed funds.

Sufficient equity is particularly important for new businesses. Weak equity makes a lender more hesitant to provide any financial assistance. However, low (but not non-existent) equity in relation to existing and projected debt—the loan—can be overcome with a strong showing in all the other credit factors.

Determining whether a company's level of debt is appropriate in relation to its equity requires analysis of the company's expected earnings and the viability and variability of these earnings. The stronger the support for projected profits, the greater the likelihood the loan will be approved. Applications with high debt, low equity, and unsupported projections are prime candidates for loan denial.

Earnings Requirements
Financial obligations are paid with cash, not profits. When cash outflow exceeds cash inflow for an extended period of time, a business cannot continue to operate. As a result, cash management is extremely important. In order to adequately support a company's operation, cash must be at the right place, at the right time and in the right amount.

A company must be able to meet all its debt payments, not just its loan payments, as they come due. All SBA loans require that the borrower be able to reasonably demonstrate the ability to repay the intended obligation from the business operation. The lender will consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships (personal and commercial) is considered an indicator of future payment performance. Lenders will also want to know about your contingent sources of repayment.

Applicants are generally required to provide a report on when their income will become cash and when their expenses must be paid. This report is usually in the form of a cash flow projection, broken down on a monthly basis, and covering the first annual period after the loan is received. When the projections are for a new business or an expanding business with anticipated revenues and expenses exceeding past performance by a significant amount (20 percent plus), a critical factor in loan approval is having the lender understand all the assumptions on how these revenues will be generated.

Working Capital
Working capital is defined as the excess of current assets over current liabilities.

Of all assets, current assets are the most liquid and most easily convertible to cash. Current liabilities are obligations due within one year. Therefore, working capital measures what is available to pay a company's current debts. It also represents the cushion or margin of protection a company can give their short-term creditors.

Working capital is essential for a company to meet its continuous operational needs. The availability of working capital influences the firm's ability to meet its trade and short-term debt obligations, as well as to remain financially viable.

Collateral
To the extent that worthwhile assets are available, adequate collateral is required as security on all SBA loans. However, SBA will generally not decline a loan where inadequacy of collateral is the only unfavorable factor.

Collateral is an additional form of security to show a lender that you have a second source of loan repayment. Assets such as equipment, buildings, accounts receivable, and in some cases, inventory, are considered possible sources of repayment if they are sold by the bank for cash. Collateral can consist of assets that are usable in the business as well as personal assets that remain outside the business. This collateral table [link to collateral table in Understanding the Basics/Collateral) shows how different forms of collateral are valued by a typical lender and SBA.

Borrowers can assume that all assets financed with borrowed funds will collateralize the loan. Depending on how much equity was contributed toward the acquisition of these assets, the lender is likely to require other business assets as collateral.

For all SBA loans, personal guaranties are required of every owner of 20 percent or more of the business, plus other individuals who hold key management positions. Whether a guaranty will be secured by personal assets is based on the value of the assets already pledged and the value of the assets personally owned compared to the amount borrowed.

Certified appraisals are required for loans greater than $250,000 secured by commercial real estate. SBA may require professional appraisals of both business and personal assets, plus any necessary survey and/or feasibility study. When real estate is being used as collateral, banks and other regulated lenders are required by law to obtain third-party valuation on transactions of $50,000 or more.

Owner-occupied residences generally become collateral when:

  • The lender requires the residence as collateral;
  • The equity in the residence is substantial and other credit factors are weak;
  • Such collateral is necessary to assure that the principal(s) remain committed to the success of the venture for which the loan is being made;
  • The applicant operates the business out of the residence or other buildings located on the same parcel of land.

Resource Management
The proven positive ability of individuals to manage the resources of their business is a prime consideration when determining whether or not a loan will be made.

Character and Managerial Capacity
Character is the personal impression you make on the potential lender or investor. The lender decides subjectively whether or not you are sufficiently trustworthy to repay the loan or generate a return on funds invested in your company.

Managerial capacity is an important factor, and your educational background and experience in business and in your industry will be reviewed. The quality of your references and the background and experience of your employees will also be considered.

Key Ratios
Mathematical calculations on historical and projected financial statements form ratios that provide insight into how resources have been managed in the past. It is important to understand that no single ratio provides all this insight, but the use of several ratios in conjunction with one another can give an overall picture of management performance. Some key ratios all lenders review are:

  • Debt to worth;
  • Working capital;
  • The rate at which income is received after it is earned;
  • The rate at which debt is paid after becoming due;
  • The rate at which the service or product moves from the business to the customer.