by Courtney Lloyd
Your business is growing. More projects are coming in, you need to hire more employees, or you would like to purchase a bigger location. Whatever the scenario, you have decided that you need some financial help. Before you approach a bank for a loan, here are six tips to help understand how lenders evaluate your application and what you can expect.
#1 – You are one of the most important factors in the decision-making process.
This includes your personal credit history and credit score. You are your business, and you are the one paying the company’s debt, so this is a vital indicator in a loan decision. In most cases, you will be asked to personally guarantee the loan. Pull your personal credit report from annualcreditreport.com–review it to make sure there aren’t any errors and that it is up to date. It can take three to four weeks for mistakes to be corrected, so starting early is helpful as you want to be sure that the lender is pulling the accurate report the first time. Also, your managerial expertise and experience are relevant as poor management has been most frequently cited as the reason businesses fail. Highlighting your education and history in the field is beneficial.
#2 – Repaying the Debt.
Lenders will determine if the business can generate enough cash and manage those funds to continue making existing loan payments, along with the new loan payment. Cash is king, and if your company is not generating enough it is unlikely that the company can afford to add more debt. A bank does not want to put you in a worse condition and, in a sense, set you up to fail. Understand your financial statements and make sure your company has a strong cash flow. Money in the checking account does not always necessarily support this.
#3 – The Case for Collateral
What assets can you pledge as a source of repayment? Rarely are banks originating unsecured loans, so a lender wants to know what the secondary source of repayment will be. This can be accounts receivable, inventory, equipment, real estate, etc. Many companies need capital to purchase supplies when new projects are coming in. In this case, the accounts receivable would be collateral in case of default. Banks normally will only use a percentage of the value as collateral.
#4 – The Equity Equation
Your down payment, or the equity you have in the business, is also significant. As mentioned, it is unlikely that a bank will finance 100% of the collateral, so it is expected that you will put some of your own funds into the deal. This shows your commitment to the loan. An owner’s equity versus the debt is strong leverage needed to sustain a business, especially in a tough economy. External factors, including the state of the economy, potential new bank regulations or possible changes in your life, are also considered.
#5 – Documentation!
Be prepared. Normally two or three years of personal and business tax returns are required, along with your interim business financials. Most banks will also like to see a personal financial statement, which can be supplied by your banker. If this is a new business, an extensive business plan is also imperative, as it incorporates all the facets of starting a company. The net worth and cash flow are key indicators of the strength of your business. Other factors reviewed are sales and profitability trends. These financials will help a banker determine a business’s credit-worthiness.
#6 – Know Your Banker
The economic landscape and new financial regulations have changed underwriting dramatically. Loans that once were getting approved easily are now not. Enhancements such as using the Small Business Administration (SBA) can help improve your case. Find out if your lender is an SBA Preferred Lender, as this can speed up the turnaround time and potentially strengthen the deal. You need your banker to know your business now more than ever and, in turn, you need to have a strong relationship with your banker. This, along with being prepared and understanding what a bank is seeking, will give your business an advantage in the loan decision process.
Courtney Lloyd is a Relationship Manager at STAR Bank. Contact her at Courtney.Lloyd@starfinancial.com