Let’s face it, landing a business loan for a small company isn’t easy.
To many of us, it seems like banks are slow to grant a loan when we need it most, but are very willing to lend us money when we don’t need it quite so badly.
We've got to remember that banks are in the business of earning interest from loans, and the definition of success for lenders takes into account the inevitable minority of loans that don’t get repaid. In these cases, the bank not only loses out on the interest but often loses the principal as well. In order for banks to stay in business, they need to closely manage their percentage of unsuccessful loans. For that reason, it’s understandable why banks are so methodical when it comes to lending money!
So the lending process is tough, that's a given, but it's also a system that has been the catalyst for many small businesses. In fact, some entrepreneurs would say that their relationship with their banker has been the pivotal ingredient to growth.
To determine whether a bank loan is the right source of funding for you, first recognize that banks generally like to do business with companies that have a track record, rather than pure startups. At a minimum, banks generally like to see two years of existence and the corresponding tax returns. Further, banks expect your credit for the business to reflect a pattern of timely payments, and that you have good personal credit. This means that your personal life could ultimately impact the health of your company. If you don’t have these attributes, consider seeking funds elsewhere. Try other options like credit cards or friends and family funding for your small business.
If you do meet the fundamentals any bank looks for in considering a business loan for small companies, we’ve included a few tips to put you in the best position.
- Rely on relationships: For a business loan, it’s important to leverage any existing relationship and track record you might have with a bank or banking officer. This includes your personal banking activity as well. Your odds of success are much higher if you have this kind of positive history with the bank. Additionally, you may be able to get advantageous pricing on your loan if they see you as a “valued customer” whose business they want to retain or expand.
- Build on success: If you’re seeking a loan for a business that’s in a sector in which you have a track record of success, make sure you highlight that in your pitch to the loan officer. This builds confidence that you are experienced and equipped to operate effectively in this field of business.
- Paint the picture: For the financials, banks like to see an income statement, balance sheet and profit and loss statement on an accrual rather than a cash basis. Also, make sure your business plan and your financial records are clear, accurate and available at the time you make your loan request. Remember, this is no time to cover things up – the very beginning of the process is the time to paint the complete picture for the loan officer. It will save you time and embarrassment later on.
- Show you know: Be ready to demonstrate to the bank that you can pay the interest and principal of the loan within the allotted term. Have a strong handle on the financial statements, and be ready to make a strong case of how the existing cash flow of the company, and/or the projected future cash flow, will be more than sufficient to cover the payments. The bank will want to assess the projected debt-to-income and debt-to-net worth ratios. For example, a strong candidate company will have no more than a 3-to-1 leverage ratio of debt to tangible net worth. Further, you should be ready to discuss the sensitivity of the ability to repay the loan, where the risks are and what your fallback plan is in the event that things don’t go according to plan.
- Put skin in the game: The closer your business is to a true “startup,” the more likely it is that the bank will ask for a personal guaranty on the loan. Certainly you, as head honcho, should have the most confidence of all that the business will work. Be prepared to step up so the bank believes that you will not have a problem providing the guaranty.
Remember, banks want to make good business loans to good companies. That’s their mission. While it’s true that many loans are denied because an applicant company is not a worthy risk, too many times business loans are denied simply because of poor preparation, lack of displayed commitment, ineffective business communication, or a combination of these blunders. But if you follow the tips above, you will find yourself in the best light possible, and you will be judged on the true merits of your business as you try to land the loan!