Financial guide: Credit check

Credit check

by Sarah Brouillard   Maia Haag has written a children's book that she personalizes and sells as a keepsake to thousands of customers each year.

If Haag wanted to, she also could write a book about how to finance a small business. Her self-owned retail and e-commerce company, I See Me Inc., has run the gamut of credit line options available through Haag's bank, Wells Fargo. As her business is cyclical, with 60 percent of volume occurring the two months before Christmas, Haag has used various credit lines to stock up on inventory for the seasonal uptick.

Here's a brief history: After initially financing her company through personal assets, in 2002 Haag obtained a Wells Fargo BusinessLine, which lends up to $100,000 without collateral. She was approved for $50,000, at an interest rate of 7.5 percent, based on Haag's excellent personal credit score. Haag also began to tap into a home equity credit line to help fund the business.

The following year, armed with some ambitious revenue forecasts, Haag applied for a dramatic increase in her credit limit. Not willing to take on so much risk, the bank lowballed her at $70,000, “which I knew wouldn't be enough,” Haag says. Her banker instead suggested she pursue a line through the more risk-tolerant Small Business Administration (SBA).

Haag applied for a government-backed SBAExpress line of credit through Wells Fargo. Although she had to pay closing fees, and had to use her personal assets as collateral, Haag was approved for a $250,000 line — the maximum allowed — at 5.75 percent.

In 2004, after Haag paid off her SBA-backed credit line and exceeded I See Me's revenue projections, Wells Fargo approved a new $250,000 line with a variable interest rate (prime plus one, which puts her at 5 percent currently). Because of the large debt amount, the bank has secured as collateral her accounts receivable.

‘A big Visa’
Lines of credit are especially helpful to businesses, such as Haag's I See Me Inc., that experience periodically inconsistent cash flow. Through banks, owners can use available funds to buy extra inventory and to hire more employees during high-demand months. During down periods, a line of credit can pay for payroll and other day-to-day expenses.

“I look at it as kind of having a big Visa,” says Lee LaMere, an assistant vice president with Bremer Bank. Bankers typically expect borrowers to pay down the credit line near the peak of a business's cycle.

An alternative, of course, is to seek private investors. But Haag says she prefers debt. “Ultimately, it's a more expensive way to finance your business,” says Haag, who's debated the equity-versus-debt issue with a number of fellow small-business owners over the years. “But I've come to the conclusion that financing through the bank for as long as possible, for me, has been the right choice because I've been able to keep that control and ownership.”

Also, it's helpful to have another pair of eyes take a hard look at the business. It forces her to analyze her business needs objectively and with restraint: “A bank only loans you what they think you can borrow,” she says.

Lines of credit are offered through virtually every bank, big or small, though each bank has its advantages and disadvantages. Bigger banks pride themselves on their speedy approval rates and extensive menus of products and services. The Twin Cities' two biggest banks — U.S. Bank and Wells Fargo — offer unsecured lines of credit (meaning they don't require collateral) up to a certain limit. But they are often criticized by their smaller competitors and some customers for their lack of personal relationships and high bank-officer turnover.

Small community bankers hold up their on-call availability and “partnering” of customers, yet they may not be able to tolerate very much risk with their tiny portfolios, say large banks.

Other differences: Larger banks tend to use an in-house calculus, entering personal credit scores, age of business, and other financial data, to determine whether to give a loan or line of credit. Smaller banks, in comparison, often practice “character lending,” largely based on the subjectivity of individual banking officers. Some of their customers say small banks are more willing to take chances on small businesses.

A ‘no-brainer’
Haag picked Wells Fargo for her business line of credit because it was first and foremost her personal banking institution. Kelly Dietz, another small-business manager, says, “We wouldn't have necessarily gone there” either, meaning to a large bank, but had already hit several dead-ends with other banks.

As secretary and treasurer of Northstar Pet Supply, her husband Kirk's $5 million pet-supply distributing company, Dietz says she witnessed three big banks in 1991 all pass up the opportunity to provide Kirk his first line of credit. Although the company had an operating history of four years, none of the “big guys” took them seriously.

“They just laughed,” says Dietz, adding, “bigger branches are overly cautious; they don't speculate.”

The couple then noticed a new Firstar branch going up near their home. The branch manager, it turned out, was well-versed in the business of distribution. When approached with the Dietzes' request, he responded, “this is a no-brainer,” says Dietz. Within weeks the Dietzes had their line of credit.

Like many other small businesses, Northstar Pet Supply was a tiny boat briefly adrift in the Twin Cities' sea of bank mergers and acquisitions in the early 2000s. A cap on the amount of stores U.S. Bank could operate after its 2001 merger with Firstar left several former Firstar branches, including the Dietzes', up for grabs. Bremer Bank bought the Dietzes' branch, picking up with them where Firstar left off.

The new relationship at first, however, had its share of bumps. The Dietzes' original loan officer left the company. Then, Bremer assigned the couple a new officer who “didn't know our account, and wasn't hands-on,” says Dietz. Eventually, corporate powers-that-be moved the Dietzes to Lee LaMere, who has been their loan officer for two years.

Bremer separates its lenders into two groups: mid-market commercial lenders, who can provide credit lines of more than $500,000; and community bankers, such as LaMere, who can provide credit lines under $500.000.

Through LaMere, the Dietzes use a revolving line of credit to help Northstar Pet Supply's fluctuating cash flow. They borrow funds to pay their 60-some manufacturers for inventory — pet-related consumables such as food, litter and bedding — until their customers' cash comes in. Their customers are independent, locally owned pet stores.

The 80/50 rule
The line of credit has expanded as Northstar Pet Supply has grown, says Dietz. She won't give specific financial information, but says the current line is more than $200,000. Right now, the Dietzes' interest rate is a variable 5.5 percent.

Like all Bremer credit-line customers, the Dietzes' business assets are used as collateral. LaMere says the bank determines the amount it lends and collateral by taking 80 percent of a customer's eligible accounts receivables (less than 90 days old), or 50 percent of inventory or equipment.

Not all small businesses that walk through Bremer's doors are eligible for a line of credit, however. Potential borrowers need to show an operating history of three years or longer; younger companies are usually referred to an SBA officer. And as with any bank loan, personal credit plays a huge role in who gets accepted for a line of credit.

Bremer looks at the personal financial statements of those who own 20 percent or more of the business. Owners' recent tax returns, as well as those of the previous three to four years of the company, are also sought by Bremer bankers. Like some of its larger competitors, Bremer uses a credit scoring system that churns all this financial data, and spits out a number that ultimately spells approval or rejection.

“The strength of that lies on the borrower. If the borrower has really good personal credit, the models have shown us those individuals will pay us back,” says LaMere. “Those with poor or below-average personal credit will struggle and probably will not pay us.”

Larger lines of credit, above $250,000, require even more number crunching, says LaMere, as a company's cash-flow and net profit are scrutinized.

Yearly renewals often hinge on whether borrowers successfully paid down their previous line of credit. Their balance should be down to zero at some point during the year, typically for at least three to four weeks, says LaMere.

Sizing up customers
Other local banks abide by a similar process as Bremer's when sizing up customers and approving lines.

TCF Bank looks at credit-worthiness and financial stability when approving a line of credit, says Todd Olson, vice president of business banking in Wayzata. A strong record of paying off debts in a timely manner — on both the borrower's business and personal financial statements — is crucial.

Besides credit scores, TCF looks for a good resume among owners: “We look for a track record of either ownership in their business or a similar one, or management experience in their line of business where the responsibilities included an active role in the financial operation of the business,” says Olson.

Generally, lenders like to see a two-year track record of business profitability, a positive cash flow with increasing sales, and a satisfactory Better Business Bureau record. Lines of credit range between $10,000 and $50,000; larger lines up to $100,000 are usually SBAExpress.

At Wells Fargo, approval for an unsecured BusinessLine up to $100,000 is most likely among those companies that have been established for at least three years. Existing Wells Fargo customers need only a two-year business history.

Lenders also look for a satisfactory business and personal credit history — “as far back as TransUnion, Equifax and Experion produce,” says small-business banking specialist Matt Clark, referring to the credit-reporting agencies. The last 10 years must be bankruptcy-free.

Customers with some past credit troubles can obtain a secured BusinessLine up to $100,000. Lines of credit for companies that don't fit Wells Fargo's risk profile are usually referred for an SBAExpress line, or a home equity line of credit.

Highland Bank, based in St. Paul, typically handles all the lending and leasing needs of its small-business customers, so it's common for the bank to have a blanket lien on a given company's assets. To support a line of credit, Highland may require a borrowing-base certificate, in which borrowers report their liquid assets — accounts receivable and inventory — monthly, quarterly or annually.

Those numbers are put into a template to determine a borrowing base or collateral equivalent. The borrowing base stays in sync with the business: as receivables go up, or inventory goes down, Highland adjusts the amount it lends.

As with other banks, Highland looks at personal credit scores and management skills of owners. Age of business doesn't matter: “We'll work with someone who just walks in with a business plan, has no revenue or anything,” says Rick Wall, CEO. In those cases, Highland will look for collateral outside of the business, such as personal assets. 

[contact] Matt Clark, Wells Fargo: 612.667.7594; ma*************@********go.com; www.wellsfargo.com. Kelly Dietz, Northstar Pet Supply: 763.535.4663. Maia Haag, I See Me: 507.263.8406; mh***@***si.com; www.iseeme.com. Lee LaMere, Bremer Bank: 612.781.6991; www.bremer.com. Todd Olson, TCF Bank: 952.848.2373; to****@*****nk.com; www.tcfbank.com. Rick Wall, Highland Bank: 651.698.2471; ri*******@***********ks.com; www.highlandbanks.com.