Lending More Than a Hand
Pet product retailers know that expansion often is key to growth and continued success, but sometimes they lack the capital to build. This can represent a significant investment, some or all of which might require financing.
Lending and borrowing is no trifling matter, whether it be personal or business. To make the smartest, most sound decision, retailers must know what to look for and what to look out for when considering taking on a business loan. The most common mistake proprietors make when applying for a loan is “not being prepared,” said Ken Paton, a consultant and financial adviser in Portland, Ore., who has worked with small businesses as either an accountant or consultant since 1969.
“The business should be worthy of the loan and be able to demonstrate it,” Paton said. “Good financial statements, consistently prepared, are needed. Tax returns are required by the [Federal Deposit Insurance Corp.], so banks will ask for them. The best preparation is to have accurate books and tax returns. The building also should be well maintained.”
Benjamin R. Jones, specialist at Live Oak Bank in Wilmington, N.C., said,“The information we like to review includes a business plan, three years of business and personal tax returns, a current profit and loss statement, and a summary of what the loan proceeds will be used for.”
“Interview your potential lender,” Jones said. “Find a loan officer who will get to know you and wants to understand your business. There are brokers who charge upfront fees and then don’t deliver the loan and cannot be found to get a refund. Working directly with a bank eliminates that risk but might require that you explain the pet industry to someone who doesn’t have any idea of how it works.
“You don’t need a down payment or collateral to expand, start construction or renovate,” Jones continued. “If you have cash flow, good credit and a strong business plan, we’ll help you achieve your goals. Also, borrowers overlook the importance of valuation. Valuation is not just about your collateral; revenues, cash flows, business and marketing plans all are components of value. Character and management also are components of value, and this is where my expertise is key to the evaluation and lending process.”
Store owners must be diligent against later problems that can arise in the lending process.
“Balloon payments run the risk of coming due when the economy is down,” Paton said. “Adjustable-rate loans are often more risky than fixed rate, but fixed-rate commercial loans are hard to find and generally only available to the strongest borrowers. Separating real estate and equipment into two different loans can raise the payments well above a loan that includes both, but some banks just want the real estate and want someone else to finance the equipment.”
“Live Oak Bank offers several features that traditional lenders do not, including little to no equity requirements, no minimum collateral coverage requirements, and up to 25 years for loans involving real estate, 10 or more years for loans involving equipment, lease hold, renovations or new spaces,” Jones said. “All of our loans are fully amortizing with no calls or balloon payments.
“[Small Business Administration] (SBA) loans tend to be borrower friendly,” Jones continued. “They have longer terms, no balloons and few covenants. For example, a conventional loan might have a 10-year amortization with a balloon in three to five years, while an SBA loan will have an amortization and term of 10 to 25 years. This is a huge difference and real benefit to our customers.”
Jones cited the factors that are considered when deciding whether or not to approve a loan.
“As an SBA lender we, are looking at the 5 C’s: credit, character, capacity (cash flow), collateral and condition of the business,” he said. “At Live Oak, we don’t focus on collateral as a means of security and repayment; we look at the business, management and the track record. These are what I refer to as the ‘elements of success,’ and they tell the story of long-term prosperity.”
Proprietors considering financing for construction also should consider the costs of insurance, equipment and working capital.
“Having sufficient funds to market, promote, train staff and cover short-term operating expenses is key,” Jones said.
A business plan will identify various factors in preparing an analysis, including competition, age and demographics of the market, and the market’s size, Paton said.
Private money is another option.
“Private money is best for a bridge situation such as a startup or turnaround, where conventional financing is not available and the business will be much stronger in a fairly short period,” Paton said. “Private money is for a high-risk/high-reward investment. Special-purpose buildings are always a bigger challenge than general-purpose buildings, which are easier to sell if the borrower fails to pay.”
So how does a retailer decide if they can or should finance?
“Part of this answer is personal experience, trends and market factors,” Jones said. “ I enjoy talking with proprietors and working with them to uncover solutions for their goals.”
According to Patton, “Lenders look for good cash flow, collateral, good personal credit, experience and a solid balance sheet. If not all of those are available, an SBA-guaranteed loan can be used to support some weaknesses. If all of these are present, a well-priced loan should be available. If one or two are missing, and the loan can solve the problem, many banks will be interested in looking.”
Factors that lenders consider when deciding whether to approve a loan are the ability and willingness to repay the debt, Paton said.
“After you go through all of the numbers, it always comes down to the integrity of the borrower,” he said. “How hard will he/she work to meet all of their obligations on time?”
“Most banks want to have $1.35 of cash flow (before depreciation, debt service, rent paid to the owner and one-time expenses) for each $1 in proposed debt service,” Paton said. “With an SBA program, it can be as low as $1.25. Cash flow normally is the limiting factor.”
Jones said, “The loan amount should be based on cash flow and debt coverage. I like to see a debt coverage ratio of 1.5 to 1.75 times the cash flow.”
The best way for a proprietor to present their idea and close the deal is “to be yourself and not try to provide answers that you think the banker wants to hear,” Paton said.
“Advanced planning and due diligence are key,” Jones said. “Anticipate what your lender might request. Have a successful strategy to compete in your marketplace. Demonstrate what your point of differentiation will be. Ultimately, if you have cash flow, good credit and a strong business plan, most banks will look favorably at your proposal.”
This article originally appeared in the March 2016 issue of Pet Product News.