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Introduction to Conventional Financing

Money and graphs

Conventional financing involves a private sector loan that is not guaranteed or insured by the U.S. government.

A conventional loan is not an SBA loan - it's a straightforward private loan from a lending institution, typically a bank or credit union. In the simplest terms, with a conventional loan you go to your bank and apply for a loan. If you are approved for the loan then you pay it back over a number of years.

At the risk of grossly exaggerating things, conventional loans are the holy grail of business financing. This is because everything has to be nearly perfect in order to obtain them. However, once conventional financing is obtained, things tend to move relatively smoothly and quickly, if - and that's a big if - everything, and I mean everything, is in order.

To obtain conventional financing both you and the business have to qualify for the loan. You will have to personally guarantee a business loan in almost every single case. In many ways, conventional financing is relatively simple - you and the business must be perfect in every way.  If you and the business are not perfect, then you should not bother to look for conventional financing.

You might think the business is a sound proposition and that you have a pretty high credit score and the loan should be funded.  But remember: it does not matter what you think, it matters what the lender thinks. You're not the one lending the money. Lenders more, now then ever, are highly averse to risk. You ought to look at a loan as if you were lending the money yourself and think about what you would demand of a borrower.

THE THREE Cs: CASH FLOW, COLLATERAL AND CREDIT

Loan officers regularly recite the mantra that lenders crave the three Cs:

  1. cash flow
  2. credit, and
  3. collateral

CASH FLOW - The business that you want to buy should have more than enough cash flow to service the debt. The cash flow must be shown by objectively verifiable documents for at least the last 18 months, preferably three years or more. Objectively verifiable documents should consist of tax returns, bank statements and profit and loss statements. In other words, the company must have a clear record of profitability.

CREDIT - Both you and the business must have stellar, not just above average, credit. This means a high credit score, no bankruptcies, judgments, etc - even a divorce will work against you.
 
COLLATERAL - The business should have enough collateral to cover the loan if you default on the loan. Typically a business has very little collateral unless it owns real estate. The rest of the business property - equipment, accounts receivable - usually is not worth enough to cover a loan, or is already pledged to another lender. If the business lacks collateral, then your collateral, typically your house, must be pledged. 

OTHER CONSIDERATIONS:  PROPERTY LEASES, FINANCIAL STATEMENTS

In addition to the three Cs, there are many other things to consider when looking for conventional financing. Everything you need to know about conventional business financing cannot be covered in one article. Therefore, I will just say a few more things.

LOAN REQUEST PACKAGE

First of all you should assemble a complete, thorough and accurate package of documents which can be presented to a lender, preferably in the form of a PDF document. The package should consist of:

  1. your last three years' tax returns
  2. your current credit report from one of the major reporting companies
  3. your financial statement
  4. financial statements of your partners or guarantors
  5. your resume (ideally you have experience in the business you want to buy, otherwise the project probably will not get conventional funding unless it is a franchise)
  6. a business plan
  7. three years' tax returns from the business you want to buy; and
  8. year to date profit and loss statement from the business you want to buy

THE LEASE

If the business involves renting space instead of buying the real estate, make sure the landlord will approve you as a tenant and you know the terms of the lease. For example, if there are only 30 months left on the lease and you need 60 months to repay a loan, then you won't get financing.

CONCLUSION

A bank vice-president once told me that "the loan has to make sense". If the loan makes sense from every aspect, then conventional financing can be quite easy to obtain. In a major metropolitan area there are national, international and local lenders, all of whom want to give out conventional loans. If you have a perfectly packaged situation, you can probably walk into any bank and get a loan approved in less than a week with an experienced loan officer. The loan will also get funded quickly. However, if you and the business are not in the perfect situation then the loan will probably never get funded and you'll be wasting everyone's time.

Justin McInerny is also a lawyer who ran his own private practice for 13 years before taking over as vice-president of Beltway Business Brokerage in 2007. He is based in the Washington, DC suburb of Beltsville, Maryland where he helps his clients to buy and sell privately held companies. 

By Justin McInerny

Justin McInerny is also a lawyer who ran his own private practice for 13 years before taking over as vice-president of Beltway Business Brokerage in 2007. He is based in the Washington, DC suburb of Beltsville, Maryland where he helps his clients to buy and sell privately held companies.  

Click here to contact Beltway Business Brokerage >>
 


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