Borrowing money is one of the most common sources of funding for a small business, but obtaining a loan isn't always easy. To successfully obtain a loan, you must be prepared and organized. You must know exactly how much money you need, why you need it and how you will pay it back. Most importantly, you must be able to convince your lender that you are a good credit risk.
The most common sources of funding are banks and credit unions. Generally, you will be able to get a loan if you can show that your business proposal is sound. Before you approach your banker for a loan, it is a good idea to understand as much as you can about the factors the bank will evaluate when they consider making you a loan.
Types of Business Loans
Terms of loans vary from lender to lender, but there are two basic types: short-term and long-term. Generally, a short-term loan has a maturity of up to one year. These include working capital loans, accounts receivable loans and lines of credit.
Long-term loans have maturities greater than one year but usually less than seven years. Real estate and equipment loans may have maturities of up to 25 years. Long-term loans are used for major business expenses such as purchasing real estate and facilities, construction, durable equipment, furniture, fixtures, vehicles and so forth.
Approval of your loan request depends on how well you present yourself, your business and your financial needs. Lenders want to make loans they know will be repaid. The best way to improve your chances of obtaining a loan is to prepare a written proposal.
A well-written loan proposal contains:
- General information about your business, the purpose of the loan and the amount required
- History and nature of your business, including details of what kind of business it is, its age, number of employees and current business assets
- Details of your company's ownership structure
- Management profile, including background, education experience, skills and accomplishments
- Market information, including a clear definition of your company's products as well as your markets, identify your competition and explain how your business competes in the marketplace, profile your customers and explain how your business can satisfy their needs
- Financial information, including balance sheets and income statements for the past three years, a projected balance sheet and income statement if you are a new business, personal financial statements on yourself and other principal owners of the business and any collateral you are willing to pledge as security for the loan
Loan Request Review
When reviewing a loan request, the lender is primarily concerned about repayment. To help determine its likelihood, many loan officers will order a copy of your business credit report from a credit reporting agency. It is very important that you have a sound record of credit-worthiness as indicated by your credit report, work history and letters of recommendation.
The lender will also consider whether you have sufficient experience and training to operate a successful business, and whether your loan proposal demonstrates your understanding of and commitment to the success of the business. Also, the lender will consider whether the business has sufficient cash flow to make the monthly loan payments.
Some of the key factors a bank uses to analyze a potential borrower are:
- Ability to repay
- Credit history
Ability to Repay
Banks want to know that you will be able to repay your loan. They like to see cash flow from the business plus a secondary source such as collateral, which is an asset pledged for the repayment of the loan. In order to analyze the cash flow of the business, the lender will review the business's past financial statements.
One of the first things a bank will determine when you request a loan for your business is whether your personal and business credit is good. Therefore, before you go to the bank, review the condition of your credit.
A start-up businesses generally cannot obtain 100% financing through conventional or special loan programs. A business owner usually must put some of his or her own money into the business because financial institutions want to see a certain amount of equity or ownership interest in a business. Equity can be built up in a business through retained earnings or the injection of cash from either the owner or investors. Most banks want to see that the total liabilities or debt of a business is not more than four times the amount of equity. Therefore if you want a loan you must ensure that there is enough equity in the company to leverage that loan.
Financial institutions are looking for a second source of repayment, which often is collateral. Collateral are those personal and business assets that can be sold to pay back the loan. Every loan program requires at least some collateral to secure a loan. If you do not have collateral to secure a loan, you will need a co-signer that has collateral to pledge. Otherwise it may be difficult to obtain a loan.