Why Women Entrepreneurs Face Bank Lending Obstacles

When I started my journey as an entrepreneur and CPA nearly three decades ago, it was commonplace for women entrepreneurs to experience a disadvantage versus their male peers when applying for a bank loan. Usually that disadvantage came in the form of a caveat requiring a husband’s co-signature. Conversely it was rare for a male business owner to find it was necessary to involve his spouse when securing a bank loan for his business. During those years I observed first-hand the inequities experienced by female loan applicants and found myself at odds with many bankers as I fought for the rights of my women business owner clients.

Today circumstances are different. The gender bias in securing a business bank loan has largely disappeared. In its place is a tough new regulatory environment and much stricter underwriting criteria which have combined to make it more difficult for all business owners – male and female alike – to obtain bank financing.

Both female and male business owners alike should understand how their business and personal circumstances are viewed by a lender before they make an application. And knowing when it is necessary to involve a business owner’s spouse—and when it is not—is key to the successful completion of the loan application process . That understanding begins with a thorough grasp of the criteria used in bank loan underwriting. These criteria include a measurement of the applicant’s ability to repay a loan or line of credit.

Cash Flow, Collateral and Credit History

When applying for a bank loan, the number one concern a lender has is whether the business or its owners will be able to pay the principle and interest charged by the bank for the loan. The bank uses three criteria to determine the likelihood its loan will be repaid: Cash Flow, Collateral, and Credit History.

Cash Flow produced by the business and its owners is measured first. Assets owned by the business and its owners are reviewed as well to determine if they are sufficient and available to be pledged as collateral against the loan. And last, but certainly not least, is a careful review of the business’s credit history and the business owner’s personal credit score.

Cash Flow Measures Recent Ability To Produce Income

To measure a borrower’s ability to repay, generally speaking a bank will first determine if the business generates sufficient cash flow generated from ongoing operations to meet the required monthly loan payments. Most banks want to see a business producing at least enough cash each year to meet 120% of the annual loan payments. More conservative banks will expect the business to generate a cash flow equal to 125% (or more) of the annual loan payments (or total debt service). The term banks use to describe this measurement is called the “Debt Service Coverage Ratio” or “DSCR”.

To illustrate how the Cash Flow criteria works, let’s look at this example: If a business is producing cash flow equal to $12,000.00 per year, a bank would not consider lending a business money if the annual loan principal and interest payments required to service the amount borrowed exceeded $10,000.00 per year (or $833.33 per month).

It’s important to note that banks look at both the business’s cash flow as well as the business owner’s cash flow. The banks favor making loans to businesses whose owners have sufficient or healthy amounts of personal income. In certain cases, the business owner’s spouse may (or may not) need to come into the loan application process. If the business owner’s spouse’s income is significant, including them in the application and guarantee process may be helpful (or necessary) in securing a bank loan if the business’s cash flow alone is insufficient to meet the lender’s DSCR.

Collateral Is The Bank’s Backup Plan If Cash Flow Dries Up

Banks will look to the business and the business owner’s balance sheet to determine if there are suitable and sufficient assets which may be used as security against the loan until it is paid back to the bank.

Similar to the cash flow criteria, the bank will review the business’s assets first and then the personal assets of the owner(s). Again with respect to collateral, the decision whether to involve the business owner’s spouse in the lending process should be considered carefully.

Every bank has its own ratios to cover the collateral criteria and generally the greater the strength of the business and personal cash flow criteria, the less concerned the bank is about collateral. That said, virtually all banks want assets pledged against the loan to serve as the bank’s back up plan.

Credit Score and History Seals The Deal

Banks that extend loans to businesses look carefully at the business’ credit history and the personal credit score of its owners. If either the cash flow or the collateral criteria are weak, the way in which the business and its owners (and spouse if they are co-applicants) paid their bills in the past will either help the business owner close the loan or send them out the door looking for another source of business capital.

Interestingly enough, the credit score criteria may be where women have an advantage over their male counterparts. According to Experian, women are better at managing their money and debt.