Finding financing to start and expand a company is an age-old problem, and most entrepreneurs find it to be one of the greatest struggles they face.
While the process can be time consuming, frustrating, and intimidating; however, if you are informed and well prepared, your chances of securing the needed capital are greatly increased.
In putting together a loan package, ask yourself the following basic questions. The answers to them and the information provided to back them up are essential to the lending decision and its speed.
1. What is the specific purpose of the loan?
Your lender or investor will review your financial requirements among three types of capital acquisition:
Used to meet fluctuating needs that will be repaid during the company’s next full operating cycle, generally one year. Short term business loans are sometimes called hard money business loans. They are used to aid businesses with cash-flow problems.
Used to meet needs that will be repaid with profits over a several-year period (usually not more than seven years). If seeking growth capital, you will be expected to show how the money will be used to increase profits sufficiently to repay the loan in the agreed-upon time frame.
Used to meet permanent needs. Equity capital must be raised from investors who will take a risk in return for some combination of dividend returns, capital gains, or a specific share of the business.
2. What amount of financing will support my needs?
Do not ask, how much can I borrow? Have enough existing capital so that, augmented by the loan, the business can operate on a sound financial basis. For new businesses, this includes sufficient resources to withstand startup expenses and the initial operating phase, during which losses are likely to occur. Be able to inject between one-third and one-half of the total capital required. If you plan to borrow equity from friends or relatives, determine what the repayment terms will be.
3. When and for how long will I need these funds?
Most of today’s lenders are providing growth capital in the form of asset-based loans, i.e., loans for acquiring land, buildings, or equipment which can be used as security. While the majority of these loans carry terms of three to seven years, some may extend over longer periods. For financial planning purposes, the entrepreneur should keep in mind that longer loan periods incur larger overall interest costs.
4. How will I generate sufficient cash flow to repay the loan?
Consider the situation from the lender’s point of view: if you were asked to lend someone money, you’d want assurance of being paid back in full, and in a timely manner.
5. What collateral can be utilized (if applicable)?
Estimate its value, and be ready to provide supporting appraisals.
6. Will the owners provide personal guarantees?
Having a comprehensive and well thought-out business plan is essential in obtaining financing. In fact, without one, even stepping into the bank is pointless. To lenders or potential investors, a plan not only provides information and reveals your evaluation of your venture’s feasibility, but also reflects your management abilities. An analytical, objective business plan convinces lenders you are cautious, conservative, and capable. One that is poorly researched, makes unsupported assumptions, or draws unfounded conclusions shows you are inexperienced and – in their eyes – reckless. Lenders receive so many proposals that they cannot afford to spend much time evaluating each business plan. That means your plan has only a few minutes to make a good impression, and must therefore speak for itself as a sales tool. One key is to make sure your business plan is as thorough and accurate as possible and that you can back up all your claims with facts.
As a sole proprietor or principal of a corporation, you may be asked to back up your business loan with personal assets (your house, stocks, or bonds). If you’re in a partnership, a personal guarantee must be signed by all principals for repayment of the loan.
It is important to emphasize that businesses with several years of successful operation will find it far easier to obtain financing than startups, as lenders will be much more receptive and confident in your ability to repay a loan at that point. In fact, without a strong business plan with realistic expectations and forecasts, managerial experience, and collateral, it may be impossible for a new business to get a loan at all. Lenders are always leery of extending financing to new ventures or unproven management teams, as they represent a high risk of default.
This doesn’t mean you can’t get a loan as a startup, but rather that you will have to compensate for the lack of a track record by being strong and well-prepared in other areas. Demonstrate by your enthusiasm and the thoroughness of your business plan that you are committed to the venture and that it will succeed. After all, when applying for a loan, you’re selling both yourself and your business.
Small business owners should develop and nurture the relationship with the bank once credit is granted. Stay in touch with the lender, keeping them updated on the company’s progress. Learn what other products and services the lender might offer that may apply to your business. As your business grows, you may need to restructure or use credit for other developmens. It makes sense to turn to someone already familiar with you and your business.
Be sure to stay close to your banker; be open and honest about major changes and significant events, whether good or bad.. As your lending officer has to tell your story to other people in the organization (including his superiors), nothing can jinx the relationship faster than a lack of candor. Feeding bankers regular information is, of course, time-consuming when you have a company to run. However, it’s all part of building credibility and trust, and will enable you to use your banker’s knowledge to help ensure the continued success of your business.
Information courtesy of the Small Business Administration.