Need a business loan? Think like a lender.

December 20, 2019

Improving Your Farm Profitability: #1

by Craig Chase, FFED program manager

Craig Chase.
Craig Chase

Farmers producing value-added or non-conventional crops often ask me how they could increase their chances of getting a loan from a lender. My answer is simple: you must think like a lender. 

Remember that a lender works for a bank (or other institution). The bank expects each loan processed to be paid back on time and with interest. The lender will evaluate your loan proposal and determine the likelihood of getting paid back. The riskier the loan, the stricter the conditions of the loan. 

You really can’t blame a lender for acting like a lender. Assume you were approached by two different borrowers wanting the same amount of money over the same time period. After reviewing their loan packets, you believed you would get paid back from the first one and the second one you had an 80 percent chance of getting paid. Wouldn’t you expect the higher-risk proposal to have different loan conditions (collateral, insurance, contracts, interest rate, etc.)?  I would. 

The five Cs

How can you minimize the riskiness of your loan proposal? By understanding the five c’s of lending:

  • character
  • capital
  • capacity 
  • collateral
  • conditions

Character is basically about you. What education, training, and experience do you have directly related to your proposal? Secondly, are you conscientious in paying your bills and increasing your credit scores?

Capital refers to the amount of money you are investing in this project, as well as previous projects, compared to what others (bankers and others) have invested. What is the size of the down payment you will be providing, how much current debt do you have, how much cash will be available when things don’t work as planned? 

Capacity reveals whether the debt will be repaid from the business operations outlined in the proposal or from other sources, and what the cashflow from all sources looks like. 

Person holding hundred-dollar bills.

Collateral refers to the assets that will be pledged against the loan. Keep in mind the loan to value (LTV) ratio on collateral varies by the type of asset (short, intermediate, or long-term). It would likely be no higher than 65-75 percent on intermediate and long-term assets.

Conditions are the extras required by the loan. Extras may include appraisals, kinds and level of insurance, loan guarantees, required documentation, contractual and other agreements, and possibly others. The lender will likely score your loan proposal on these five factors. The higher the score, the better the interest rate and conditions.

Improve your chances

How can you enhance your chances of getting your loan?

  • Build a high credit score.
  • Annually update your balance sheet, income statement, and statement of cashflows.
  • Show more than 50 percent equity on your balance sheet.
  • Have net working capital greater than 15 percent of your annual gross revenue.
  • Show that all credit cards used in the business have a zero balance at the end of each month.
  • Have a positive cash flow taking into consideration the new loan payment. 
  • Speaking of cash flow, develop a monthly cash flow projection for more than one year. 
  • Present a clear, concise business plan. 
  • Have detailed, reasonable assumptions for each of the numbers in your financial projections and understand what your financial statements are telling the lender. 
  • Know the amount of the loan you are requesting and explain the intended use for those funds and how they will enhance your farm business.

Deeper understanding

Doing all these things won’t guarantee you get every loan proposed to every lender. But it will increase the likelihood that the lender you do work with will understand your business and what you are proposing. 

Remember—when you want to increase your chances of getting a loan, think like a lender and you should increase your success. And if you follow all these suggestions, you will understand your farm business better too. This should increase the likelihood of your continued financial success. 

Maybe you will get to the point where you could get a loan from a variety of lenders, but you decide not to because of your healthy financial performance and condition.

Questions? Contact me.

Additional resources

Obtaining a Business Loan (AgMRC article)