Whenever I explain the SBA and small business loan application process, I like to remind listeners that: (a) every small business loan application is evaluated according to five basic criteria, and (b) each loan application exhibits strengths and weaknesses which must be evaluated in the underwriting and loan approval process. The five criteria being evaluated include:
(1) Personal investment by the loan applicant compared to the amount of debt being requested,
(2) Cash flow and repayment ability of the applicant for the proposed loan amount,
(3) Business ownership and management credentials of the applicant,
(4) Credit history of the applicant with other lenders, and
(5) Collateral offered for the loan in case of inability to continue making payments on the loan.
A good reason for a small business owner to think he can find a compatible lender would be if all five criteria have strong characteristics which can be documented by the lender.
The world, however, is not perfect, and neither are most business loan applications. Just remember, personal guaranties never come without a cost to the primary business owner(s). Arms-length transactions usually require some ownership in the business by the personal guarantor in exchange for the favor of facilitating a loan approval with their guaranty. In the case of friends and family members, personal disputes can arise from business relationships, and that is a risk the primary business owner must contemplate when accepting their offer to guarantee his business loan. How, then, can a small business owner obtain the necessary credit to grow his business? What if the business took on too much credit card debt, because it could not borrow sufficient capital from traditional resources to take advantage of growth opportunities? What if they have wonderful prospects to take on new customers, but they don’t have enough of their own investment to be matched in a favorable debt-to-equity percentage by the lender? What if the owner(s) and the business do not have assets which make good business loan collateral? How about a business with unproven management and very little track record to demonstrate successful business results? These are not reasons to give up. The reason is that any of the five criteria displaying weakness, can be offset by other criteria displaying offsetting strengths. This is where a personal guarantor on the loan might be one resource for strengthening the small business loan application.
Who is the ideal business loan guarantor prospect? Oftentimes, small business owners turn to friends and family for assistance. A family member with a solid personal financial statement and an excellent credit history might be a prospect to personally guarantee the loan and strengthen the loan application. This could be because they are older, wiser, more experienced, and/or have just had the chance to accumulate more personal wealth. Statistically speaking, this type of individual has more to lose from defaulting on a loan, and they are much less likely to do so, because they have reserves for financial emergencies. An even better loan guarantor prospect is a person that has business expertise that is unique to the loan applicant’s industry. They are not just guaranteeing the loan because they are a friend or family member with financial means, but they are supporting the business because they understand its potential, and they can offer expertise to help make sure it is successful.
With all things considered, a business loan personal guarantor could have the qualifications to enhance a weakness in any one of the five areas of underwriting analysis for the small business loan application. Poor historical business cash flow could be offset by the personal guarantor’s other sources of income. Inadequate personal credit scores of primary owners could be compensated for with exemplary credit of a personal guarantor. Sometimes a personal guarantor bolsters a company’s inadequate equity investment by taking a small ownership percentage of the company in exchange for their personal guaranty. A primary owner without enough business management or ownership success could be assisted with a personal guarantor who is a proven expert in the industry. Finally, sometimes a personal guarantor has personal assets that can be added as collateral for the loan to further strengthen his personal guaranty. Just remember, personal guaranties never come without a cost to the primary business owner(s). Arms-length transactions usually require some ownership in the business by the personal guarantor in exchange for the favor of facilitating a loan approval with their guaranty. In the case of friends and family members, personal disputes can arise from business relationships, and that is a risk the primary business owner must contemplate when accepting their offer to guarantee his business loan.
Written by: Bruce Hurta, VP of Business Lending
For more information, or if you have questions, please contact Bruce Hurta, VP of Business Lending at Members Choice Credit Union. You can see other educational articles about SBA financing at Bruce Hurta’s blog http://brucehurta.wordpress.com/.