It’s no secret that acquiring debt should generally be avoided. But the way Scott Swenson tells it, not all debt is necessarily bad. And he should know—as the market president for Home Federal Savings Bank in Eagan, Minn., Swenson has handled more loans than he can count. Throughout his 25-year banking career, he’s also developed a knack for the auto service industry, thanks to his work with several repair shop clients.
Swenson recently took the time to explain best practices for taking out loans, the tricky balancing act of good and bad debt and why current loan rates are some of the best he’s ever seen.
How can repair shops plan proactively for getting loans?
To help shop owners understand what banks are looking at, I break it down into the Four C’s:
The first C is cash flow. A rough cash flow calculation is the income or loss from the business, with depreciation and interest expenses added back in. Cash flow is king. The banks are making sure that your business has the ability to pay the loans back comfortably. We like to see what’s called the 125 percent factor. If you have debt of $100 a month, we’d like to see your cash flow at $125 a month.
The second C is capital, or equity. That’s how much the owner has invested in the business versus how much they’re expecting to finance. The more the owner is willing to invest, the easier it is to get financing. But this is where leverage also comes into play. We don’t want your leverage—comparing the amount of debt versus the amount of capital—to be too high. In the auto service industry, that number tends to be fairly high. You want the owners to have some equity in the business, but you don’t want it all to be financed by debt.
The third C is credit. The banks typically look at the owner’s credit score, too. If the owner’s personal credit scores are poor or if they’re really good, that’s typically a reflection of how they operate their business in terms of paying their bills.
The fourth C is collateral. In the old days, collateral was the most important consideration. Now it’s usually the last thing the bank looks at. They don’t really want the equipment or the facility back that’s been acting as collateral; they want to make sure you have the cash flow to pay the loan back. On the other hand, if there’s no collateral value in the shop because the equipment is effectively depreciated, for example, that’s a factor that might limit how much you can borrow.
How does the loan process change for expansions?
Expansions or adding locations are harder to get loans for because they don’t have a track record. If your business model is changing drastically, you’ll be relying on projections to show your ability to pay back the loan. That takes more evaluation from the bank because they’ll be analyzing projections versus historical data. The bank will consider the assumptions and may require more capital or collateral. This is a situation in which it would be good to meet with a banker regularly.
In what kind of situations would shop owners want debt?
The reason you would want to have debt is because it allows you to leverage up. It may allow you to buy additional equipment, another piece of property, or to invest in an asset that will allow you to operate your business more effectively.
It’s good to have a built-up cash reserve in case you have a bad couple of months. I wouldn’t go out and get debt for the sake of having debt, but if you think of a balance sheet, there are some assets that are short term (like cash and inventory), and there are some assets that are long term (like tooling or equipment). If you have longer-term equipment, it makes sense to have some debt affiliated with that because a lot of the equipment in the back of the shop is going to be good for years. It doesn’t do any good to have a bunch of equipment in the back of the shop that’s all paid for if your checking account is at zero.
But you also need to be able to assign a number value to demonstrate how the debt is going to pay for itself. Say you’ve got an opportunity to buy a piece of equipment that allows you to turn around vehicles that much quicker; you should be able to show on a piece of paper how that’s going to impact your profitability. You have to be able to understand its value first and then you can decide whether to finance it or pay cash for it.
What kind of interest rates should shops look for?
We’re seeing rates in the high threes up to the 6-percent range within the banking world. What’s great about these rates is that it allows shop owners to access financing at an all-time low. If they already have debt, this allows them to refinance it and save some interest rate. It could allow them to invest in some equipment that could generate more revenue.
When should shops refinance?
If you can refinance your debt and see an improvement in your cash flow, that’s a good reason to refinance. If your rates are above 6 or 7 percent, find out if there’s an opportunity to look again at your current rates. Keep in mind, however, that the improvement in your interest rate can be deceiving. If your loan amount is fairly small, sometimes refinancing doesn’t produce a material change. If you only owe $10,000, the change in 1 or 2 percent may not be that much over the course of a year.
How much debt is too much debt?
They’ve got to be able to survive any bad months. If the shop is so tight with their cash flow that they can’t handle a bad week or month, their debt or expenses are too high. You have to have room to breathe. The businesses that survived this last economic down cycle were ones that had lots of capital and little debt. If you’ve been able to control your debt and your expenses, you can manage a downturn in revenue without feeling too much pressure.
You have emphasized the importance of a good banker, which can be tough to find. What are some ways to find a good banker?
When I’m out visiting with businesses, I always ask if they know the name of their banker. If they don’t, that’s a problem. I think it’s a good idea to go in on a quarterly basis to talk with your banker, go over your financials, and build that relationship.
When you’re trying to find a banker to work with, I would recommend asking the following questions: Do you have experience in my industry? How long have you been in banking? How long have you been in this office? Are you involved with underwriting and structuring my loan? What is the approval process? What’s the bank lending limit? Are you a preferred Small Business Administration lender?
What kind of documentation needs to be prepared for a loan meeting?
They’re going to want a current financial statement, three years of personal tax returns, three years of business tax returns, an equipment and inventory list, payables and receivable aging. If you’ve got a complete package, the loan process could be as quick as two or three weeks.
What are the basic financial documents that every shop owner should be paying attention to?
I think paying attention to your income statement and the trends in your income statement is really important. How are you doing this month compared to last month? How are you doing now compared to a year ago? Look at any trends in your revenue or expenses that you might want to make adjustments to. You really want to pay attention to that income statement and ask questions about what’s changed, what’s higher or lower, and why that is. You can also look at the seasonality, which is especially important for auto repair. What’s going on with the winter? Is it especially busy or slow? There’s great information in there regarding trends.
Your balance sheet and payables are also important to look at, but those don’t fluctuate as much on a month-to-month or year-to-year basis. If you take the time to really pay attention to those, it will pay off in a lot of ways.
How do you ensure you’re getting the best deal for your shop?
You want to make certain you’re getting a fair deal, so it could be worth talking to two or three banks. You also have to decide what’s most important to you. In some cases, money is a commodity. Are you looking for expertise? Are you looking for a resource in a banker? Or, bottom line, are you just looking for the lowest price? That might influence how much shopping you want to do.
Banks tend to be the most conservative source of financing. Where you run into rate issues is at a leasing company, asset-based lender, equity partner, or if you start using credit cards. If you get into those other sources of funding—which sometimes people have to do because those Four C’s don’t line up—then you can get into some crazy pricing scenarios.
What are the biggest mistakes you’ve seen shop owners make when taking out loans?
Don’t surprise the banker. Sometimes shop owners aren’t up front with all the facts because some details are unfavorable. But bankers can handle good news and bad news. The banker is in a better position to help you out if they have all of the information. Even if you think the bank won’t be able to get it done, they should be able to give you some good tips or suggestions.
