Multiple studies have proven that black and minority entrepreneurs face an uphill battle attaining finance from traditional banks when compared to their white contemporaries.
As a black owned enterprise, we fully empathize with the struggle. We also feel compelled to offer insights and actionable solutions to business owners and aspiring entrepreneurs.
As it pertains to this article, the phrase “Come Correct & They Can’t Stop You” encourages you, the business owner to prepare your business and necessary lending requirements in order to stack the odds of securing bank finance in your favor. This article will discuss three core elements that will guide your process and provide actionable insight:
- Understand your business needs
- Understand the requirements of the bank
- Establish a relationship with your banker
Before we address what business owners can do to increase their chances of obtaining bank finance, let’s take a look at some of the challenges many black and minority business owners are experiencing:
Four statistics highlighting the challenge
- According to data released by the Federal Reserve in 2020, the percentage of white business owners that receive at least a percentage of the funding they requested from a bank is 80.2%. In contrast, only 60.9% of Black business owners say the same, along with 69.5% for Hispanic business owners and 77.1% for Asian business owners.
- The audit study “Impacts of Owner Race and Geographic Context on Access to Small-Business Financing;” found that in comparison to white applicants, black and minorities applying for bank loans were more often asked to show business financial statements (50% vs. 83%), income tax returns (52% vs. 86%), bank account information (0% vs. 25%), personal financial asset details (22% vs. 60%), and credit card debt(13% vs. 42%); they were also offered less frequent assistance in filling out loan applications (59% vs. 18%).
- According to the Federal Reserve, 9% of black business owners were found to be “discouraged” from even applying for loans, meaning they did not apply due to an expectation of rejection. Compare that to just 12.7% of white business owners who felt the same.
Even black business owners that were equally creditworthy to white business owners applied less frequently than their white counterparts.
- The latest Report on Employer Firms based on the Fed’s 2019 Small Business Credit Survey, found that fewer than 1 in 4 Black-owned employer firms has a recent borrowing relationship with a bank. This number drops to 1 in 10 among Black non-employer firms, compared with 1 in 4 white-owned non-employers.
These studies and others show that even when controlling factors such as creditworthiness, size and age of the business; black and minority entrepreneurs are less likely than white entrepreneurs to secure a loan, they typically pay higher interest rates, and they are more likely to find the application process more challenging than white entrepreneurs.
As a result, many black and minority entrepreneurs have become discouraged in the process and fail to establish valuable relationships with their banker.
What the statistics add up to
An article published by the MIT Press “Discrimination In The Small Business Credit Market” noted, not only does this place a burden on black communities that persists through generations, the full economic impact is enormous.
According to a report put out by Mckinsey.com, The racial wealth gap will cost between $1 trillion and $1.5 trillion by 2028, or 4% to 6% of US GDP.
The following four stats developed by the Brookings Institute are mind blowing! What if?
- There are 124,004 Black businesses, accounting for 2.2% of employer businesses. If Black businesses accounted for 14.2% employer firms(equivalent to the Black population), there would be 806,218 more Black businesses.
- Currently, Black businesses bring in average revenues of $1,031,021, compared to $6,485,334 for non-Black businesses. If Black businesses increased their average revenue to the level of non-Black businesses, it would increase total revenue in Black businesses by $676,356,621,618.
- Black businesses create an average of 10 jobs per firm, compared to 23 for non-Black businesses. If the average employees per Black business increased to 23, it would create approximately 1.6 million jobs (1,583,268).
- Black businesses pay their employees an average of $29,882, compared to non-Black businesses’ average pay of $51,357. If Black businesses paid as much as non-Black businesses, then those employees would see an increase in pay by approximately $25 billion ($25,947,313,541).
The reality is that there is more in play than racial inequality and fairness, the missed opportunity is considerable. According to the Selig Center for Economic Growth, Black buying power was $1.4 trillion in 2019. It’s projected to grow to $1.8 trillion by 2024.
Despite the challenges facing black and minority entrepreneurs there has never been as much opportunity to build and grown a business in America.
So what can business owners do to increase loan approval rates?
1. Understand Your Business Needs
Do you need to purchase new equipment, add inventory, or maybe you’re ready to hire additional staff? These are examples of potential needs that many business owners come across. Before seeking a loan, make sure you understand the nature of your need.
Ask yourself these five questions:
- How urgent is your need?
- How will you deploy the funds?
- How will the funds help you grow your business?
- How will you repay the loan?
- Is your business seasonal or cyclical?
It’s easier to secure funding when you know what to expect and are prepared before you apply. Understanding your business needs and answering these questions will help you determine which loan (if any) is best for your business.
Do you understand the economics of your need? Let’s say you want to apply for a loan in order to purchase a new piece of equipment that will double the productivity of your business. You need to know how your new level of productivity will impact your cash flow.
Cash flow or Coverage is the most important metric to understand about your business when seeking finance. Lenders will want to know your Debt Service Coverage Ratio (DSCR) which is a measure of cash flow available to pay your current debt obligations.
Lets use the example above and say your new piece of equipment would increase your Net income to $500,000; and your Debt Service or the amount of money needed to cover your loan payments would increase to $400,000. Your DSCR would now equal 1.25.
Most lenders would be happy with this number but it is important to note that DSCR is up to the discretion of the lender based on the type of business, condition of the market and the risk appetite of the lender. Typically, 1.2 DSCR or higher is good and 1.5 DSCR is considered very good and in most instances will help you negotiate lower interest rates.
2. Understand The Lenders Requirements
There are many different types of loans: business lines of credit, SBA loans, short term loans, business term loans, merchant cash advance, equipment financing loans, commercial mortgage loans, and business credit cards just to name a few.
Depending on the lender, each product comes with its own requirements and qualifications.
The following seven requirements can be found in the majority of loan products:
1.Personal and Business Credit
Banks will check both your personal and business credit score in order to better understand how you manage debt.
They want to see that you are paying debt on time, and that you have no collections or judgments. Good credit scores can grant you access to financial support, low interest rates, and favorable trade credit.
Most business loans will require you to have a personal credit score of 700 or above. You can check your personal credit reports once a year for free at AnnualCreditReport.com.
Three tips to improve your personal credit:
- Dispute inaccuracies, delinquencies, derogatory accounts, or collections in your report.
- Never carry a balance over 7% of your overall credit limit.
- Pay bills on time and in full.
Business credit scores depend on the reporting entity or bureau that conducts the assessment. It is important to know which of the reporting entities lenders, suppliers, and manufactures work with in your industry, and which metrics the reporting entities use to rank your business.
The four major reporting entities and their metrics include:
Dun & Bradstreet Paydex:
Learn More: Dun & Bradstreet
Experian Intelliscore Plus:
Learn More: Experian Business Credit
Equifax Business Credit Report:
Learn More: Equifax Business Credit Report
FICO SBSS (Small Business Scoring Service):
FICO SBSS differs from the other business credit report entities because it combines both personal and business credit scores to arrive at your FICO SBSS score.
Learn More: FICO SBSS
2.Business Financial Statements ( 3yrs.)
Financial statements allow the bank to investigate your business and its financial health. It may be worth working with an accountant to ensure your documents are accurate.
You will need the following four documents:
- Balance Sheets
- Income Statements
- Cash Flow Statements
- Interim Financial Statement (current yr.)
3.Bank Account History (last 3mos.)
Banks want to see your bank account statements for these four reasons:
- To verify your business name and trading name (if applicable).
- Review your account activity over the past few months which is an indicator of your financial health.
- Confirm a stable and positive average daily balance, daily deposits, and recurring payments.
- Ensure bank statements prove your deposits or revenue are more than your payments or expenses.
4.Business and Personal Tax Returns (last 3yrs if applicable)
The most important part of your tax returns is your income. Lenders want to make sure that you’ll be able to make your payments on time without a problem for the length of the loan, which requires solid revenue and cash flow.
If you are behind on filing returns or your documentation is inaccurate, you will need to sort that out before applying.
Also, if you have business partners, members or owners, make sure they have filed their personal returns for the last three years.
5.Professional Business Plan
Formulating a Business Plan is not only a necessary requirement when seeking funding from institutional investors and lenders, a professional business plan can help you identify three key pieces of information:
- The appropriate course of action for your business
- The amount of financial capital you will need to execute your plan
- Any potential weaknesses in your plan
Your plan needs to be backed up with research, financial data, and a clear strategy.
With a well-constructed plan, lenders will be able to evaluate the health and potential of your business. Lenders will also be able to match your business with the right loan for your needs.
Lenders will be looking for the following five documents:
- Profit and Loss Statement
- Business Cash Flow Statement
- Balance Sheet
- Sales Forecast
- Breakeven analysis
Working with an Accountant on preparing financial documents can not only save you time and ensure accuracy, but accountants can also help you understand what the numbers in your financial documents say about your business health.
Before approving your loan request, lenders will want to make sure you understand your numbers.
6.Collateral (Personal or Business)
Collateral is defined as an asset a borrower pledges to a lender for the life of the loan. In the event the borrower defaults on the loan, the lender can seize the collateral in order to recoup its losses.
Collateral is used by lenders to reduce the risk of losing money on a loan. The amount of collateral required will vary depending on factors such as, credit rating, the type of lender, and the nature of the collateral.
Cash and securities (Treasury Stocks, Bonds, Corporate Bonds, Certificates of Deposit) are the best form of collateral for lenders because they can liquidate or convert to cash quickly.
Hard assets like, real estate, equipment, and inventory can take longer to liquidate so they are considered less valuable than cash and securities.
When dealing with collateral, Loan-to-Value Ratio (LTV) is a key metric lenders use to determine how much they will lend based on the value of your collateral.
For example, a lender may offer 75% LTV if you pledge real estate as collateral; If your real estate is worth $100,000 the lender will lend you $75,000.
Unsecured loans do not require collateral, but they do require excellent credit.
7.Years in Business
For loan approval, lenders will consider how long you have been operating your business.
Most online lenders will require one year while banks generally look for at least two years in business.
3. Establish a Relationship with Your Banker
Data from the Small Business Credit Survey conducted in 2018 indicates, minority owned firms more frequently lack networks and relations with small banks that could help in the loan approval process. Furthermore, according to statistics, minority owned firms are less likely to have an existing relationship at an institution before applying for a loan.
This is a huge problem because establishing a relationship with your banker is vital and key to running a successful business.
Five Reasons Why Establishing a Relationship with Your Banker is Necessary:
- Its all about establishing familiarity and trust. Banks value long-term, profitable business banking relationships.
- If your Banker or Relationship Manager has confidence in you and your business, they will go to bat for you and figure out creative solutions for your business.
- In addition, when you have a history and working relationship with your bank, your business will be perceived as less risky when compared to a new business with similar credentials.
- From the banker’s standpoint, being invested in a client over time allows the banker to learn about the company from inside out and develop an understanding of a companies management style.
- Banks can apply their experience and knowledge to serve as a key sounding board for your business when critical decisions need to be made.
Seven benefits of a good banking relationship:
- Help securing financing.
- Access to crucial insight on the local economy and business environment.
- Ability to negotiate better interest rates and lower fees.
- Thoughtful recommendations for products and services.
- Access to your bankers network, Including industry contacts and the local business community.
- An advocate for your business to the banks Executive Management team.
- A trusted third party, providing valuable feedback, advice, and perspective.
How to Cultivate a Relationship Wih Your Banker
No matter how big or small your business is, it is important to start building a relationship with your banker as soon as possible.
Weather you bank with a Branch Manager, Business Banker or Commercial Banker, a business relationship with your banker is similar to any personal relationship, a good banking relationship is a two-way street, it needs to be beneficial for both sides.
Six actions to consider taking with your banker:
- Try to connect in person when possible.
- Explain your business plan.
- Make sure your banker understands your business, industry, industry position, and value proposition.
- Make sure your banker understands your vision and how you intend to grow your business.
- Schedule quarterly meetings to update your banker on new developments.
- Be honest and share information. If you have cashflow problems or financial difficulties, let them know. Transparency goes a long way in developing trust.
Racial inequalities surrounding access to capital for business owners is an undeniable reality and problem in America.
We believe more productive conversations, education, and political action are necessary in order to close the racial funding gap.
Come Correct and They Can’t Stop you is a call to black and minority business owners to educate and prepare themselves for success and access to capital.
Understanding your business, banks requirements, and building relationships with your banker can go a long way towards higher approval rates among Black and Minority business owners.