LOANOLOGY
LOAN QUALIFICATION
Understanding Acquisition Cash Flow
For banks, cash flow is king. It tells them if your business can generate enough income to cover ongoing expenses, debt payments, and still have enough leftover to support the acquisition.
Personal
Of course different entity models are addressed differently but the bottom line from a cash flow perspective is what is your business DSC. What margin percentage and total dollars are we looking at? Regardless of sole prop or S corp, when your business overhead which includes your personal income, is accounted for what is your NOI (net operating income)?
Business
Your Business Cash Flow: This includes your revenue, expenses, and net operating income (NOI).
Can you have a great business but be so out of line in your personal finances that you can't get your acquisition loan approved? Both SBA and conventional lenders will factor your personal cash flow ratios into their approval. SBA loans require a personal DSCR of minimum 1 to 1 and conventional lenders will have a 30% to 40% maximum personal debt to income maximum.
Seller
Seller's Business Cash Flow: The seller's financial health impacts the overall deal's profitability.
When purchasing a book, or only client assets and no overhead, the cash flow is easy because 100% of it flows to the buyer's financials for calculations. If purchasing a practice where you will be taking on additional overhead then the EBOC or earnings before owner compensation is the primary focus as well as any add-backs (amounts logged as expenses which would not be an ongoing expense of the new owner) to put back into the cash flow.
Combined
Combined Pro Forma Cash Flow: This projects the combined cash flow of your and the seller's business after the acquisition.
The lender is going to take the buyer and seller's combined EBIT and subtract the annual debt service from the loan and look at the DSCR for the previous tax year, the year before that, the interim YTD, and projected year.
Calculating Cash Flow
The minimum DSC ratio required, when and if a policy exception can be made, and exactly how the DSC is calculated will all vary by lender.
Many acquisition deals cash flow high enough that these variances won’t make a difference for acquisition loan approval.
However, when cash flow is tight and every dollar counts, the lender’s minimum DSC requirement can make a difference between qualifying with one lender but not another.
Most conventional lenders will have a minimum of 1.25 to 1.75 DSCR (Debt Service Coverage Ratio) minimum depending on the industry and collateral. The SBA mandates a 1.15 business DSCR minimum but most SBA lenders will have a higher minimum ranging from 1.25 to 1.75 DSCR.
Lenders will calculate DSC for both the acquisition deal and for the borrower personally. Unfortunately the ways cash flow is calculated is not an exact uniform policy across the board with all lenders, even with SBA lenders.
To calculate EBITDA for acquisition loans, the bank will typically take the combined buyer and seller net operating income (earnings) and add to it any interest, income tax, depreciation, and/or amortization expenses.
They add the new acquisition loan debt and then look both forward a year and backward a year (often two years) to see if the deal cash flows above their minimum DSCR on a projected and historical basis.
Sometimes it isn’t only what the minimum debt service coverage ratio is but also how the DSCR is calculated.
Most owners who have not acquired before will not have significant interest, depreciation or amortization add-backs.
However an owner who purchased a $2M business a few years ago may be amortizing $250,000 a year and have a $100,000 a year in an interest add-back which would make a significant difference in how cash flow is calculated. You wouldn’t want to use a lender that calculates DSC from EBIT instead of EBITDA in this case.
For personal cash flow ratios some lenders will use the same calculation as they do with the business DSC and may or may not have the same minimum ratio, or have a minimum combined (personal and business) which is called a “global” DSC.
SBA requires a 1.1 personal DSC. Conventional lenders differ on personal cash flow and debt requirements but all of them look at personal as well as business DSC.
A conventional lender can also look at personal debt to income (Personal Annual Debt Service / Total Personal Income) and require a maximum of 30%-40% debt for example.
What is the minimum credit score needed for a business loan?
The minimum credit score needed for a franchise business loan relies primarily on the lender's own credit risk assessment criteria. While minimum score requirements can vary significantly between lenders and loan products, generally, a score of 700 or above is considered favorable for securing competitive rates and terms for most all business loan products. Most conventional loans will require at least north of a 680 and most SBA lenders will require a 625 (many a 640) credit score for loans over $500,000.
800 to 850 - Outstanding
740 to 799 - Very Good
670 to 739 - Good
580 to 669 - Fair
300 to 579 - Poor
While there isn't an industry-wide, universally agreed upon minimum credit score for business loans, a majority of lenders typically look for a score of at least 640—classified as a "fair" level of credit. If your credit score dips below 670, regarded as a "good" level, you'll likely need to have been operating your business for a specified duration and generate a minimum annual revenue.
When is my credit score pulled?
Preferred lenders do not do a hard pull credit score until the loan proposal is executed.
How can I increase my score?
FICO credit scores range from 300 to 850 points and can be obtained from any of the three national credit data reporting agencies (TransUnion, Equifax, and Experian). Each agency gathers information on millions of individual consumers and uses complex proprietary algorithms to determine credit behavior patterns and forecast the likelihood that a particular loan will be repaid.
The data used in determining an individual’s credit score is based on all credit related data. Under guidelines imposed by FCRA, an individual’s credit score does not contain any information pertaining to age, race, gender, or geographical location (zip code).
Why is the lender's score pull different than mine?
Between all three bureaus, there are multiple FICO® Score versions out there being used.
Many SBA lenders are using the TransUnion FICO 4 version but several others are used by different lenders.
Many credit reporting services you might be seeing your FICO score use different FICO Score versions. Common versions used are FICO Score 2, FICO Score 5, FICO Score 8, FICO Score 9…you get the picture.
The TransUnion FICO 4 version isn’t a popular version used outside of banks. It’s not unusual for the TransUnion FICO 4 version to have a lower score (even up to 40-50 points lower) than more widely used versions. This can make a difference and cause alarm when you think you have a 720 score and then the bank pulls your credit and it’s 685.
SBA Loan Credit Scores
The SBA does not have a minimum credit score requirement and defers to the SBA lenders standard credit score policy for loans over $500K. SBA lender credit score minimums vary, but typically range from 625 to 680. For loans under $500K the SBA utilizes the SBBS score.
SBA borrowers for loans up to $500K will begin with a screening for a FICO® Small Business Scoring ServiceSM Score (SBSS Score).
The SBSS Score is calculated based on a combination of consumer credit bureau data, business bureau data, Borrower financials, and application data (The SBSS Score is not to be confused with the Small Business Predictive Score (SBPS) used by SBA’s Office of Credit Risk Management).
The minimum acceptable SBSS score is 155, but that score may be adjusted up or down from time to time.
Why is the lender's score pull different than mine?
Between all three bureaus, there are multiple FICO® Score versions out there being used.
Many SBA lenders are using the TransUnion FICO 4 version but several others are used by different lenders.
Many credit reporting services you might be seeing your FICO score use different FICO Score versions. Common versions used are FICO Score 2, FICO Score 5, FICO Score 8, FICO Score 9…you get the picture.
The TransUnion FICO 4 version isn’t a popular version used outside of banks. It’s not unusual for the TransUnion FICO 4 version to have a lower score (even up to 40-50 points lower) than more widely used versions. This can make a difference and cause alarm when you think you have a 720 score and then the bank pulls your credit and it’s 685.
35% - Payment History
The first and most important variable of the FICO score is the “payment history.” An individual consumer’s payment history accounts for 35% of the score. This variable is fairly intuitive for most consumers. In essence, it looks at whether the consumer has paid past credit accounts on time.
A few late payments will not drastically hurt a FICO score. On the contrary, making every single payment on time will not lead to a perfect score. Payment history is simply one piece of information used to calculate the score.
All types of credit lines are included. Namely revolving credit (i.e. credit cards, home equity lines of credit, etc.), installment loans (i.e. mortgage, vehicle loans, etc.), and open accounts (i.e. company charge cards, utility accounts, etc.).
FICO scores consider how late a payment was made (number of days), how much was owed (for that particular payment as well as the balance of the loan), how many payments were made late (number of missed or late payments), and how recently each of these instances occurred.
Payment History also factors in derogatory public information such as bankruptcies, foreclosures, civil law suits, wage garnishments, liens, and judgements. The above outlined derogatory items are quite serious and can potentially have a very drastic effect on the payment history variable of the FICO score. Older entries and entries pertaining to smaller dollar amounts have less impact than newer derogatory entries or entries with larger dollar amounts.
10% - Types of Credit In Use
The fourth factor which makes up a FICO score is “types of credit in use.” This accounts for 10% of the overall score. “Types of credit in use” analyzes the specific types of ac- counts associated with a credit profile. Examples include credit cards, mortgage, vehicle loans, retail accounts, and finance company accounts among others. It is not necessary to have every type of credit account in order to have a good FICO score.
However, having a healthy mix of account types in good standing is a positive indicator. Nonetheless, it is generally not a good idea to open unnecessary credit lines in an attempt to boost the score. It is also important to note, this score factors into the total number of accounts. Therefore, having too many accounts could be detrimental to the FICO score. Despite a common misconception to the contrary, closing an account does not remove it from a credit profile.
30% - Amounts Owed
The second most important variable of a FICO score is the “amounts owed on credit accounts”. This variable makes up 30% of the score. Owing a large amount of money is not necessarily a bad thing and will not have a negative impact on your score in and of itself. Credit reporting agencies look at several categories including the amount owed on all accounts, different types of credit accounts associated with a credit profile, number of accounts with balances, percentage of the available credit being used on revolving credit lines, and how much of the principal balance is outstanding on installment credit lines.
The purpose of this variable is to determine the overall financial health of an individual consumer. In other words, the lender uses this category to determine whether or not the consumer is overextended and the likelihood that the individual will make the payment past the due date or miss a payment entirely.
15% - Length of Credit History
The third component, “length of credit history”, accounts for 15% of a FICO score. As a general rule, a longer credit history with a good track record will increase a FICO score. However, since this variable only accounts for a small percentage of a FICO score, some people with shorter credit histories may have a high FICO score depending on the entirety of the credit profile. This portion of a FICO score accounts for the age of the oldest active credit account, age of the newest credit account, average age of all accounts, amount of time since credit accounts have been established, and frequency of use of revolving credit accounts.
The purpose of this variable is to establish a pattern of predictive behavior of the individual consumer based on their past use of credit accounts. A longer credit history is more beneficial than a shorter one due to the fact that the credit reporting agency has more information to predict the future use of credit and the likelihood of repayment or delinquency and default.
10% - New Credit
The final factor in determining the overall FICO score is “new credit.” This accounts for the remaining 10% of the FICO score. Opening a number of new credit lines in a short period of time could potentially be a red flag to lenders due to a perception that the individual consumer poses a greater risk. The negative impact may be more significant for individuals with shorter credit histories as it can potentially represent a negative event in a consumer’s financial health.
Common examples of negative events include loss of employment, unexpected medical expenses, or other unexpected significant financial burden(s). Although individuals with a well established credit history will not see as significant of an impact on his or her FICO score, it is generally a good idea to open new credit accounts only as needed. Along with new credit accounts, the second aspect of this category is the number of credit inquiries associated with a credit profile.
FINANCE
YOUR WAY
DO-IT-YOURSELF BUSINESS LOANS
Complete application and loan package
See matching lenders
Select one or all matching lenders to access your loan package
Receive loan proposals from interested lenders
Select the winning lender and e-sign their loan proposal
Use the tools and intel available, follow the process, receive alerts at every stage along the way, and utilize LoanBox human support as needed.
LOANBOX ADVISOR SUPPORTED LOANS
Complete applicant summary form
Have consultation
Upload the docs requested
Receive, discuss, and approve your LoanBox Advisor plan
Provide needed docs as requested as your Advisor navigates everything for you
Your loan is still managed on the LoanBox platform, so you still have access to the same lenders and receives the same alerts.