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How Commercial Lenders Went Wrong With Small Business Financing

Small business owners will be more likely to avoid serious future business finance problems with working capital management and commercial real estate loans by exploring what went wrong with business financing and commercial lending. This is not a hypothetical issue for most commercial borrowers, particularly if they need help with determining practical small business financing choices that are available to them. The bankers and banks responsible for the recent financial meltdown seem to be saying that even if anything actually went wrong, everything is fine now in the world of commercial lending. Nothing could be further from the truth. Commercial lenders made serious mistakes, and according to a popular phrase, if business lenders and business owners forget these mistakes, they are doomed to repeat them in the future.

Greed seems to be a common theme for several of the most serious business finance mistakes made by many lending institutions. Unsurprising negative results were produced by the attempt to produce quick profits and higher-than-normal returns. The bankers themselves seem to be the only ones surprised by the devastating losses that they produced. The largest small business lender in the United States (CIT Group) declared bankruptcy after two years of attempting to get someone else to pay for their mistakes. We are already seeing a record level of bank failures, and by most accounts many of the largest banks should have been allowed to fail but were instead supported by artificial government funding.

When making loans or buying securities such as those now referred to as toxic assets, there were many instances in which banks failed to look at cash flow. For some small business finance programs, a stated income commercial loan underwriting process was used in which commercial borrower tax returns were not even requested or reviewed. One of the most prominent business lenders aggressively using this approach was Lehman Brothers (which filed for bankruptcy due to a number of questionable financial dealings).

Bankers obsessed with generating quick profits frequently lost sight of a basic investment principle that asset valuations can decrease quickly and do not always increase. Many business loans were finalized in which the commercial borrower had little or no equity at risk. Banks invested almost nothing in cash (as little as three cents on the dollar) when buying future toxic assets. The apparent assumption was that if any downward fluctuation in value occurred, it would be a token three to five percent. In fact we have now seen many commercial real estate values decrease by 40 to 50 percent during the past two years. Commercial real estate is proving to be the next toxic asset on their balance sheets for the many banks which made the original commercial mortgages on such business properties. While there were huge government bailouts to banks which have toxic assets based on residential mortgages, it is not likely that banks will receive financial assistance to cover commercial real estate loan losses. As a result, a realistic expectation is that such commercial finance losses could produce serious problems for many banks and other lenders over the next several years. As noted in the following paragraph, many lenders have already drastically reduced their small business finance programs.

Inaccurate and misleading statements by commercial lenders about their lending activities for business finance programs to small business owners is an ongoing problem. Although banks have typically been reporting that they are lending normally with their small business financing, the actual results indicate something very different by any objective standard. It is obvious that lenders would rather not admit publicly that they are not lending normally because of the negative public relations impact this would cause. Business owners will need to be skeptical and cautious in their efforts to secure small business financing because of this particular issue alone.

There are practical and realistic small business finance solutions available to business owners in spite of the inappropriate commercial lending practices just described. The emphasis here is focusing on the problems rather than the solutions primarily because of the lingering notion by some that there are not significant current commercial lending problems. Despite contrary views from bankers and politicians, collectively most observers would agree that the multiple mistakes made by banks and other commercial lenders were serious and are likely to have long-lasting effects for commercial borrowers.

Commercial Loans And Small Business Financing – What To Avoid

It is always advisable to have a detailed understanding of what can go wrong with commercial loans and working capital financing. The five factors described can have negative and long-lasting financial results for small business loans and commercial real estate loans. Business owners should be prepared for these real possibilities.

Most commercial borrowers do not want to experience a worst case for commercial real estate loans and small business loans. When present simultaneously, there are five particular factors which will usually result in a serious outcome that is nevertheless avoidable. Understanding each of the issues should enable borrowers to avoid a potentially devastating working capital financing outcome.

Here are the issues which we believe will usually result in a worst case scenario for commercial loans if all five are present: (1) Dealing with an inexperienced commercial finance advisor; (2) Using a lender which historically has an unacceptable track record for successfully completing commercial loans; (3) Obtaining business financing that includes a recall option for the lender; (4) Inappropriate and non-competitive business loan terms; and (5) Short-term financing in which a borrower is not also offered the opportunity to lengthen to a longer-term period.

Our primary advice is to totally avoid circumstances where all five factors exist at the same time. A secondary recommendation is to also seek alternative financing for commercial loans when either of the first two elements are present. There are likely to be many working capital management scenarios where it will be impractical to avoid all of the issues described in the preceding paragraph.

It is important for business owners to secure commercial financing which is not impacted by the worst case conditions. Business owners will subject themselves to inappropriate business financing terms for a very long time if they do not take appropriate action before they finalize commercial loans. There are two points which should be emphasized.

Our first point is that business loans are probably more complicated than realized by most commercial borrowers. There are a number of additional serious commercial funding obstacles beyond those noted in this brief article. Because of this, it is important for commercial borrowers not to narrowly focus on the factors included in the worst case scenario discussed here and simply avoid these specific issues.

A balanced analysis of both the worst case aspects and other critical business finance terms is essential for comprehensive working capital financing. The importance of this overall perspective is why we emphasized the critical nature of avoiding both inexperienced brokers and lenders.

Second, the worst case scenario for business loans described above is totally avoidable. But to avoid an obstacle, it is critical that you have a working understanding of what you are avoiding, what it looks like and any special techniques required to evade it. For example, if you are driving a car, it is common sense that you will not intentionally drive your vehicle over sharp pointed objects that are likely to puncture your tires.

With commercial loans and commercial real estate loans, the combination of the five factors noted previously in this article will typically produce an impact for small business funding that is equivalent to much worse than simply puncturing a tire. Unfortunately, without proper advice and knowledge, most business owners will not be prepared to recognize the appropriate warning signs for avoiding business financing hazards.

In this article we focused on problems with small business financing that will almost always have long-lasting and immediate negative results for business owners. Commercial borrowers should not overlook the multitude of other serious problems with commercial loans beyond those described. As with the circumstances noted above, most of the other potential difficulties with business loans can also be avoided.

Expanding Small Business Financing Opportunities For Your Business

Small business financing is often the only way for some businesses to get the capital they need to open their doors, expand operations, or develop new services and products. However, the Great Recession created some significant hurdles for personal and business loan applicants who boasted less-than-perfect credit scores.

However, recent investigations suggest that banks are starting to open their doors to business owners in greater numbers. Although credit requirements remain above what they were before the recession, lending has indeed warmed up for many business owners. Where many businesses were just “treading water,” they’ve now entered an era of cautious and optimistic growth.

Another positive sign in small business financing is the improved cash flow in the nation’s major banks, which has led to increased lending activity and an overall reduction in average commercial loan rates. With the recession fading into the background of the economy, small businesses that have been waiting for an improved economy are finding that banks are willing to deal with businesses that might have had budget shortfalls a few years ago. Small businesses and fledgling companies that have been conservative in hiring and expansion efforts post-recession have finally become eligible for loans.

According to data compiled by the federal government, one of the major sources of small business financing today has been loans through the Small Business Administration (SBA). One of the reasons why looking at banks that provide loans that are guaranteed by the SBA is a savvy way of obtaining a business loan is because the government’s list of banks represents lenders who are already interested in making loans to small entities. Looking at these banks reduces the time a business owner might need to spend to find commercial lending opportunities. It’s also a good idea to locate a bank with loan officers who have prior experience with SBA loans.

However, getting business and commercial loans still requires a solid application. In small business financing, one of the most powerful features of a loan application is the business plan. Banks are much less likely to hand over a check if the business plan isn’t fleshed out, accurate, and professionally written. A business plan with typos or a lack of information on cash flow, budget, and fiscal projections won’t impress a loan officer. Some small business experts advocate hiring a business plan writer to ensure the final document is as professional as it can be when it’s sent to the bank.

The government has taken an interesting step in encouraging growth of small business by reducing the fees associated with SBA loans. Borrowers already enjoy SBA loan rates that tend to sit below traditional loan rates, but low fees on certain SBA loans may make these small business financing methods even more cost-effective than they were in the past. For example, loans under $150,000 no longer have fees and short-term loans guaranteed by the SBA also feature rates lower than many standard bank loans. This means that brand new start-ups or businesses that are nothing more than an idea in a garage are possible for new borrowers.

Small business loan applicants should remember that the interest rates on SBA loans aren’t set by the government, but are part of a negotiation between the bank and the applicant. However, there are maximum rates set in place so the interest on business and commercial loans will never exceed a certain amount. Since the bank has some leeway in setting an interest rate, it’s worth it for a small business owner to come to the table with a credit rating that’s as high as possible. Small business financing today isn’t a cakewalk, but getting a loan as a brand new business is possible in today’s lending environment.