Every business at some point will require outside financing. This generally means obtaining some form of bank loan. For many, this turns out to be an aggravating process. You may be financing a new business or simply in need of seasonal financing, but proper planning will substantially enhance your chances of obtaining a loan. An additional benefit may be that you will learn more about your business.
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Every business at some point will require outside financing. This generally means obtaining some form of bank loan. For many, this turns out to be an aggravating process. You may be financing a new business or simply in need of seasonal financing, but proper planning will substantially enhance your chances of obtaining a loan. An additional benefit may be that you will learn more about your business.
Various methods of outside financing include venture capital, additional investors and bank financing, the latter being the most common method. Many banks offer both conventional and SBA loans, and I advise talking with your banker to see which type of loan makes more sense for your particular situation. Let's now look at the various aspects of applying for a loan and how they may affect you.
The Loan Process
You should first have an understanding of what your banker is interested in and anticipate questions that might arise during the loan process. Most business owners think that having substantial capital is the only criteria that interests banks; however, banks are in the banking business and have no interest in running your business should you default on the loan. All this means is that banks are more interested in how you will repay the loan in addition to the capital you may have.
Although it may seem obvious to you why the loan is needed, the first step is to determine why you need the loan. Basically, there are four common reasons for requiring a loan: for working capital, seasonal peaks, equipment purchasing, and acquiring or starting a business. Even though the basics for needing the loan are the same, your loan package should be customized to reflect the reasons for obtaining financing.
Cut Expenses, Reduce Debt
Next, work to get your business in the best possible financial order. Pay close attention to expenditures. Try to reduce expenditures as much as possible, which will increase your cash and profits; accounts receivable is another area that may require some work to shore up your finances (see "Cash Building" from February/March 2010). Never forget to look at salaries—even your own—for a possible reduction.
Also, in today's business climate, banks will require a personal guarantee for the loan. For this reason, your personal financial condition will be critical in securing financing.
Preparing the Loan Package
The next step is actually preparing the loan package.
Financial Data: Usually two to three years of financial statements will be required, as well as three years of projections on the balance sheet, income statement and cash flow statement. Other financial data may include prior years' tax returns, financial ratios, information of historic growth rates, etc. Include any other information that will convince the banker of the fiscal soundness of your business. If your financial performance has been poor, emphasize the positive aspects of the business such as improved gross margins, increases in cash flow or key financial ratios.
Of course, startup businesses will not have prior financial data. In these cases, projections and budgets are critical. These budgets and projections should be supported by factual information so your goals look credible and are not viewed as just "pie in the sky" wishes.
Industry Data: Including knowledge of pertinent financial ratios and industry statistics will further convince your banker of your credibility. Be sure to point out areas where you exceed the industry standard in a particular area. Sources for this type of information include trade associations and Internet resources like First Research.
Ownership Information & Résumés: This information is important no matter whether you're starting a new business or trying to obtain funding for an existing business. Information on you and other principal stakeholders regarding background, education, experience and capabilities is vital.
Financing Plan: In a narrative format, you should explain the reasons for the financing request, the amount you need and repayment terms you're requesting. Also, make clear the use of the loan proceeds. All of your loan package, including this section, should tie together into a concise financing plan.
Other information may be needed to substantiate your loan request. When requesting financing for a new business, always include information on marketing, management plans, industry background and predictions, and pro forma financial information.
If a working capital loan or line of credit is requested, you should provide information on how much funding will be needed during slow periods and how it will be repaid during peak periods.
One important rule to remember is not to hide unfavorable information. A particular area where this comes into play is the strengths and weaknesses of the company. Such information should be fully disclosed, as well as how you plan to overcome the problem. Full disclosure will add to your professionalism, while the failure to disclose will undermine your credibility.
Secure a Second Opinion: Last, but certainly not least, is to have someone look over your loan package, such as a financial advisor or CPA. This person can offer an objective analysis of your efforts, point out shortcomings and make suggestions for improvements.
In summary, do your homework before applying for a loan. Know your business, know your industry and know the answers to questions before they are asked. Having this information will greatly enhance your probability of obtaining your loan.
