Thursday, August 14, 2014

Three pointers before you apply for a bank loan

Small business owners may be considering a bank loan to start a new business or expand an existing company.  You may have heard of the 5 C's of credit:  Credit, Collateral, Capacity, Character and Conditions - believe it or not, these are still what banks consider when evaluating a loan application.  While you should consider all five elements, there are three that are critical to consider before you meet with your banker.

Here are three things you will need to know before you make an appointment with your lender.

  1. Know your numbers

Know exactly how much you need and what it will be used for. It is not advisable to start the conversation with, "How much can I get?"  This indicates to the banker that you are not fully prepared and have not done a business plan or your homework.

How much do you have to put down?  Banks want to see anywhere from 15 to 50%, depending on if you are applying for a government guaranteed loan, the industry and your experience.  Typically a borrower needs more than collateral, meaning cash.

New businesses and start-ups should be prepared to have closer to 30-40% cash to put down, especially if the owners do not have industry experience or collateral.
  • Plan to put some 'skin in the game' with cash and/or collateral.
  • Start-ups and first time business owners are seen as risky from the bank's perspective.  
Part of preparing a business plan is developing some financial benchmarks or being able to provide past financial history.  You should have a complete grasp of your financials and key financial statements including sales and cash flow projections, Income Statement (also called profit & loss) and a Balance sheet.

You also need to prove that your personal finances are in order and that you have enough savings to invest in the business, live on and make the loan payments.

2.  Check your credit

WRONG!  Bad Credit is
a BIG Problem!
Personal credit scores can make a big difference in applying for a business loan. You can get a free credit score online - be sure to visit a credible free source, and you are eligible for one free credit check a year.

If you are purchasing an existing business, the bank will likely review the business credit score as well.

"Not only do business owners need to ensure that the people they're borrowing from are reputable and honest, they also need to make sure their own personal credentials are in order before approaching potential lenders." BusinessNewsDaily.com 

3.  Recognize Your Capacity

One thing that is becoming more important in evaluating loan proposals is the business owner's capacity, or ability to run the business.  Lenders are looking for at least two years' experience in the industry and ideally, business ownership.  Your business plan will help show prepared you are and if you are capable of starting the business.

Business experience can make a difference in loan requirements; for example, a client was informed that he would need to provide at least 40% cash contribution to buy an established business since he did not have a history of business ownership.  If you looking to buy or start a business in an industry that you have never worked, I recommend volunteering or working for a while to gain industry knowledge.

Summary

There are numerous other factors business owners should consider before applying for a loan.  Here are a few:
  • Find out what your loan options are or what type of loan you will be seeking.  There are different loan programs that might apply depending on what you will be using the money for.  If you are purchasing land or equipment, the SBA 504 program might be a good fit.
  • Find out about the loan requirements and process.  Follow the instructions - incomplete loan applications can be dismissed for being incomplete.
  • Before you apply, you should interview the banker.  Some banks will not lend to certain types of businesses or industry.  For example, certain institutions will not lend to any new business or start-up. Loan applications can be time consuming so it will save time in the long run to find out if a bank will even loan for the use you are seeking.
  • If you are new to the industry, gain experience by volunteering, finding a mentor, working in the business.  Banks typically want to see at least two years' field and management experience.
Your business advisor can assist in preparing to apply for a loan.  Keep in mind that when you first meet with a banker, it is a mutual interview.  You want a banker that is going to be on your side and part of your team, and they want a borrower that is going to repay the loan and contribute to a successful portfolio.  With online accessibility, many banks have its loan application checklist and additional requirements and forms to sign online.