How Much Can I Borrow?

Every lender probably has experienced some version of the following exchange:

Lender: So, how much are you interested in borrowing?
Borrower: Whatever you want to lend me.

We'll give you a hint: this is the wrong answer. Anytime you approach a lender, you should do so with a plan -- a plan for spending the money and a plan for paying it back. If you have no answer to these questions -- that is, how much you need to borrow and how you will pay it back -- it is unlikely the lender or anyone else will be able to figure it out for you.

We'll assume for the moment that the two questions, "How much can I borrow," and "How much should I borrow?" are the same. While this may not be a safe assumption in these days of rampant credit card debt, we will at least begin with the premise that your lender has your best interests at heart -- that he or she wants to lend you what you need, but not more than you can safely pay back at the agreed upon terms. So how much is that? While there are no widely used credit scoring devices in commercial lending, there are some basic rules.

To take the payback issue first: lenders look at a couple things when judging a borrower's capacity to meet their loan payments. The most important is the debt service coverage ratio. This is a long phrase for the concept, "Do you have enough income to make your loan payments?"

To figure this out, take your monthly average net income and add back noncash expenses (such as depreciation). Then add back any loan interest expense that was included in your operating expenses (because this will be counted again in the loan payment). Take this amended cash flow and divide it by your monthly payment of principal and interest (debt service). This will give you the debt service ratio. Most lenders are looking for a minimum debt service coverage ratio of 1.2 -- that is, you have 20% more money than you need to make the monthly payment. This allows for life's little emergencies. Most lenders will be happier with a ratio of 1.5 or greater.

The other ratio that will certainly interest your lender is the debt to equity ratio of your business -- in lay terms, how much you owe vs. how much you own. Even if your income stream is pretty good, a lender may be reluctant to get involved with a business that already has numerous other creditors, especially if that business is not able to demonstrate significant support from its owners in the form of equity. Lenders will not typically advance an item's entire cost. How much depends on the collateral: 70% is typical for commercial real estate, but on new equipment it may be 80% or more. In any event, lenders will almost always want the borrower to put something into the deal, to demonstrate borrower commitment if nothing else.

In determining the amount of your loan payment, lenders will assume a term. For business loans this is typically 3-7 years for equipment and 10-15 years for commercial real estate. Lenders don't like to lend money for longer than the "useful life" of the collateral, so if you are borrowing for something with a longer useful life (a new freezer), you will likely get a longer term and therefore smaller monthly payments than if you are borrowing for something with a shorter useful life (a computer). This is why it is typically difficult to get bank loans for things like inventory or marketing, because the marketing has no value to the lender and the inventory will be long gone before the loan is repaid.

This is not to say that it is impossible to get loans for items with a brief shelf life or of indeterminate value -- only that it is more difficult. This brings us to the second concept: lenders consider not only how you will pay for the loan, but what it is really for -- not the item so much as the purpose. If a prospective borrower is able to articulate clearly how the loan will help leverage other funds, take advantage of an opportunity, increase revenue, expand market, or anything else that will help increase the capacity of the borrower to repay the funds, the lender is going to listen.

It may also help to remember that most outside lenders are risk-averse. After all, they may not understand what a cooperative is about and how it works, and they tend to look at everything a little skeptically anyway. An outside lender who knows you and your business already or who has some expertise in your industry will most likely be willing to do more for you than one who doesn't have such knowledge. Other potential sources of credit include vendors who have a business interest in selling more inventory to you. Your members also may be more willing to plunk down money for some intangible item, because it may have value for them in a way that it does not for an outside lender. (See article on member loans in this edition.) Thus, part of how much you can borrow will depend on whom you ask, because different parties will simply have different interests in your project.

Let's go back to our little exchange:

Lender: So, how much are you interested in borrowing?
Borrower: About $6,000. I found a great deal on a new freezer for about $8,000, and we have $2,000 saved already. This new freezer will allow us to double our inventory in frozen products, a department that grew by 23% last year. With it, I think we can expand sales to..."
Lender: Now we're talking!

Scott Beers provides accounting and financial planning services to co-ops through Cooperative Development Services. Margaret Lund is managing director of the Northcountry Cooperative Development Fund.