Which product is better -- a Line of Credit or a Term Loan?
The purpose for which the funds will be utilized helps to decide which to choose. For instance, a Line of Credit is a perfect solution for short-term operating needs. A Term Loan or a Lease is much better than a Line of Credit for financing business equipment, computers, machinery, or vehicles.
Lines of Credit are generally available only to borrowers who have been in business for at least 2 years.
Collateral is assets which may be liquidated (sold) by the bank if a loan is not repaid. It is the secondary source of loan payment; the primary source is cash flow from the business.
Collateral can consist of business assets such as inventory, equipment, accounts receivable, BOH savings/time deposit accounts, etc. It can also consist of personal assets pledged by the owners such as real estate.
Collateral is required for all loans and the bank must be in first position on business assets pledged.
This means that if the customer’s business assets are already pledged to another bank, the borrower must request a release from the other bank first.
SBA loans may have additional collateral requirements.
What if the Borrower/Owners have or had personal credit problems?
Lenders prefer applicants who have good credit history. Since owners run the business, lenders assume that there is a direct relationship between the owners’ personal credit history and the business’ credit history. The bank wants to see that payments to other financial institutions, trade suppliers and other business obligations are current. If the owners personally consistently pay late, the business may not qualify for a business loan.
BOH underwriting criteria include some of the following factors:
Business or Owners have had a prior charge-off with BOH.
Business or Owners have filed for Bankruptcy:
Within last 7 years for business
For Owners, filed within last 3 years or discharged within last 3 years.
Foreclosure, unpaid tax liens, collection accounts, repossessions, charge offs by other creditors, delinquencies on credit report.
Serious delinquencies noted on Owner’s credit report.
Delinquent taxes of business or owners.
The best way to re-establish a good credit record is to repay creditors as soon as possible. Sometimes, it is best to seek credit counseling if necessary.
What does the bank look for when it reviews the applicant’s tax returns?
Tax returns validate if the company has previously shown profits. If the company has not been profitable, it may be difficult to make payments on a loan or line.
Cash flow generated by the business is the primary repayment source for the loan or line. A quick way to determine the primary repayment source is to calculate for every $1.00 in debt payments, the business must be able to generate at least $1.50 in cash flow (calculated by adding net profit plus non-cash expenses such as depreciation and amortization).
Accurate recordkeeping is essential for the business owners to properly manage the company, for the IRS and the lender.
A Balance sheet is a snapshot of the company at a point in time. It provides details on how much the company owns and owes and is one aspect in determining creditworthiness.
It also shows how much Capital is in the business which is money that has been personally invested in the business. It is an indication of how much the owner has at risk should the business fail. Lenders expect owners to have a stake in the business.
A separate Balance sheet should be provided if it is not included in the Tax returns.