A variety of resources are available to aid the aspiring entrepreneur in starting a new business, or help an established business owner improve or expand his enterprise. Often, the chief reason for the failure of a new business venture is a lack of proper funding at the outset, causing a long, uphill struggle that can be very difficult to win. Knowing where to find financial resources and how to take advantage of them is crucial to success in today’s highly competitive market. Combined with a realistic and effective business plan, adequate funding can be the foundation upon which a solid business can grow and thrive.
Prepare Before You Apply for the Loan
Preparation is essential when approaching a lender. Showing a strong commitment to your business and confidence in its success is important, as well as a firm grasp on the facts and figures. Make sure you know exactly how much funding you will need and detail how it will be spent to make your business profitable. Good preparation can go a long way towards avoiding a denial that will be noted in your credit report, making the next application more difficult.
Among the first steps to take when seeking a business loan is formulating or reviewing your business plan, ensuring it provides an accurate reflection of the structure of your business and your plans for its future. Be prepared to present clear and realistic goals for your business to the potential lender, and a detailed outline of the steps you will take to achieve them. A solid business plan is very important in the approval process, helping the lender evaluate the ability of your business to generate the necessary revenue to repay the loan.
When it comes to cash flow, most business bankers look for what's called a “one-to-one” ratio, which means you are generating from personal income sources or have cash reserves of one dollar for every dollar of loan request. If you are requesting a $50,000 loan the bank will look for at least $50,000 of yearly gross income or $50,000 in reserves like a 401k, IRA, or CD. To prove income and reserves the banker will ask for the following documentation:
- Tax returns / W-2's or 1099's
- Employment contracts
- Social security card
- Sales contracts
- Business Entity documentation (articles of formation or incorporation or EIN # for sole proprietors)
- Current bank statements
- Personal budget and list of personal expenses
What the bank is trying to determine is your cash flow position and it will do this by performing a global underwriting analysis. This analysis takes your income and reserves and subtracts your expenses. Positive cash flow means you have money left over after expenses. This is good because it shows the bank you have resources in case an emergency arises. Negative cash flow will almost always cause the bank to deny your small business loan application, unless of course you have excellent credit scores.
In the absence of strong positive cash flow, excellent credit scores may help you get a loan approval. Excellent credit, in the world of small business lending, means a credit score of 700 or higher. A credit score below 700 will not help much, and derogatory items like judgments, liens, and late payments may also disqualify you even if credit is excellent. Before applying for a business loan with a personal guarantee make sure to run your credit from every reporting bureau and clean up any inaccurate derogatory items in your credit files.
The Personal Guarantee
New businesses pose the most risk for lenders. Knowing this, most banks will require you to sign personally for any loan it makes to your business. Signing personally means that you will personally be responsible for the debts incurred by the business. It is not the preferable way of getting a loan, but if this is your only option for a business loan, better to start there and re-negotiate as your cash flow improves. It is possible to drop the personal guarantee once your business reaches a certain cash threshold. make sure to discuss this option with your banker during the loan application process. Again, your goal is to make the business itself the only guarantor for the loan. That way, if the business fails the bank will not be able to come after you personally to repay the debt.
Choosing the Right Funding Option for Your Business
The best business loan for your needs depends upon a number of factors. Business funding options include traditional long term secured loans, lines of credit, federal loans and grants, or short term loans, among many others. Determining the right funding choices for your business will require a bit of research according to your particular type of business and its financial circumstances.
For the business or startup that requires a large amount of funding, secured business loans are available from virtually any bank that offers business accounts and services. These business loans can be used for working capital, refinancing, acquisitions, or expansion. They generally carry a monthly repayment plan with the term determined by the expected lifespan of the assets for which the funds are to be used, along with other factors.
SBA loans can be a terrific option for funding your small business. These loans are administered by the U.S. Small Business Administration, a federal agency charged with assisting small businesses in a number of ways. SBA loan programs set guidelines for independent institutions to provide funding for small businesses, backing the loans to eliminate a portion of the risk to the lender. SBA also offers a number of educational and support programs to aid the success of small business ventures.
Short term loans are available for smaller amounts, most often less than $100,000. The terms of these business loans usually extend one year at most, and repayment is generally done in a lump sum at the end of the term. These loans can be a good solution for the business that needs to build up an initial stock of inventory, or for other investments with returns that will be realized quickly.
For the business that is subject to seasonal changes in cash flow, a line of credit may be the best option. These business loans allow you to borrow in small increments when cash flow is slow. There is an annual borrowing limit placed on these accounts, and repayment must be done fairly quickly to avoid additional expenses.
If capital is needed to purchase business equipment, often the best way to meet the need is with equipment financing. The approval process for these business loans are often less stringent than a more general loan, as the equipment purchased provides the collateral against the balance owed. This method of funding carries less risk than using your business or personal assets as collateral, often making it a good alternative for startups.
Whichever funding method you choose, be sure to research the terms and obligations thoroughly to be sure your needs will be met and the costs are manageable. Comparison shopping can be the key to selecting the best rates and terms for your business loan. With a good business plan and the right resources to get the ball rolling, you can build your business into a solid and profitable venture.
Get Off to a Good Start or Don't Start at All
The number one reason small businesses fail is they do not properly capitalize their start-up. If a business does not have enough resources to sustain operations until they turn a profit they will likely be forced to close their doors early. In fact, the Small Business Administration cites this as the cause for nearly one third of all small business failures.
It may be wise to delay opening until such time as you can accumulate the required funds to sustain your business from revenue alone. A good rule of thumb is to estimate how many months you'll need to be open until you can turn a profit, and then double that number. Whatever your costs are for that period of time is the amount of money you should generate before actually starting your business. Doing this will give you more time to generate a loyal customer base and help to increase sales to the point where both personal funds and outside investment are no longer required.
The Business Plan
While a business plan is not required by all banks it is always a good idea to complete one before you make a loan application. A business plan will help you visualize income goals, business expenses, possible customers, competitor strengths and weaknesses, and help you identify possible exit strategies for any potential loans you may require.
Business plans do not have to be long, drawn-out documents. They can be as simple as one page, as long as it covers the following items:
- What product/service do you offer
- Who are your customers and how do you plan to reach them
- What are your start-up costs, your expected revenue, and expected expenses
- How do you plan to meet expenses until such time as the business becomes self-sustaining
Why Your Exit Strategy is Important
Knowing how you will exit, or payoff, the business loan before you apply will actually help bankers to approve you. The more precise you can be here, the better. If your only plan to payoff a business loan is from proceeds you win by hitting the lottery you'll likely have a hard time with conventional banks. However, if you can show the lender you have put some serious thought and consideration into how you will repay them, you will have a much better chance of loan approval.
For example, if you do business with the government and have just signed a contract that will guarantee $100,000 of income in six moths time you will find the banks much more willing to lend you $100,000 for up to six months. Also, two offers are always better than one. If you have multiple loan offers from different banks competition may help you improve terms with each individual lender. It also lets each lender know there is another lender out there which could be a possible exit for its own loan. Remember; with business loans it pays to know your exit even before you enter.