Loans are a time-tested way of raising capital for your business. We would love to tell you that it is as easy as going to the bank and asking for money, but as you probably know by now it is quite the opposite. We wrote the following steps to help you raise the right amount of capital to get your business going.
Step 1: Decide how much money you need.
This is an obvious but often overlooked. Entrepreneurs, particularly start-ups, when budgeting for their business often focus on what they will need to get their business going, or to finance a particular project without accounting for working capital or cash for contingencies. This is dangerous because lack of working capital can mean the death knell for the business.
On the other hand, some entrepreneurs, again start-ups, drastically overestimate their costs. This will make lenders not only question the entrepreneurs’ assumptions, but also question whether they know what they are doing.
Now that we decided on an amount, lets focus on the lender.
a) If you are a start-up:
Loan amounts below $25,000 are considered smaller, micro-loans. Not all banks will be interested in doing a SBA guaranteed loan for small amounts (more below). Micro-lenders and Alternative-lenders are better equipped to handle this type of loans. These lenders usually make smaller loans and have a community focus. Look to credit unions, local development corporations and other non-profit lenders.
Small Business Administration (SBA) guaranteed loan is a guarantee to the lender. If the borrower defaults, the lender is guaranteed repayment of a portion of the loan by the SBA. You are still liable for the loan, so your obligation does not go away. From our experience, an amount of $50,000 and above is the usual range for SBA loans. The higher the amount requested the more the lender would look for collateral to secure the loans. Start-ups and existing businesses can apply for SBA guaranteed loans.
b) If you are an existing business:
If you own a company that has documented sales (you will need to show previous years’ tax statements) then you can apply for conventional bank loans. These loans are usually easier to apply, and may have lower interest rates. Normally for a conventional bank loan, you will need to be in operations for at least 2 years.
c) Set your expectations:
The bank does not want to own your business. It is highly unlikely that you will get a loan for a 100% percent of the project cost. You will need to put down a co-payment. Although the minimum co-payment varies by industry and lender, expect to put down at least 20%-30% or more of the cost of the project.
Step 2: Find out your credit score.
You should check your credit score and look over your credit report to make sure there are no problems. A credit score of above 650-680 is considered “Good”, but it does not mean you will get a loan. A credit score in the 700-800’s is very good and increases your chance of getting approved.
You can request your credit report from one of the reporting agencies, or use one of the many online services available to check your score.
Step 3: Start researching your options.
Start weighing all your options. Think of ways to strengthen your loan application. Can you find a co-signer? Bring in a partner with good credit or experience? Invest more cash into the business? If you think that you are not a strong candidate for a business loan, you can present the lender with options to increase your chances.
Step 4: Start writing the business plan and create the financial projections.
The business plan is more than a plan—it is a tool that helps you evaluate your business concept, your product or service, and discusses how to implement your ideas. A business plan is also a tool to obtain investors, lenders, and strategic partners. You can find many resources and opinions on the Internet as well as your local bookstore on how to build an effective business plan. A lender will usually require a comprehensive business plan as well as a projected 1-year cash flow projection (month-by-month), 3 years income statements, a balance sheet, a statement of sources and uses of funds, and a loan amortization schedule. One mistake that we usually see is that the figures on the Business Plan do not match the figures on the financial projection. Double-check your work before sending it to the bank.
Step 5: Find a lender
Finding the right lender is not easy; each lender has its own criteria for lending. However you can use the list below to get an idea of what type of institution is a better fit for your loan needs.
a) Commercial Banks
Banks are one of the largest small business lenders but their approach to lending varies. Commercial Banks decisions are based on your strength as a borrower (a good credit score, personal financial statements, experience and collateral) the banks goals for the period and their lending philosophy. Banks may be looking to expand their small business loan consumer base; others may focus on larger loans or a specific industry.
You will need a high credit score if you are applying for a bank loan (with or without the SBA guarantee). Although, this is not an absolute rule for all banks, we found that a credit score over 700 is a better predictor on the success of a loan application. The bank may look for collateral (home equity, saving, etc) if you are applying for amounts over $50,000.
The borrower’s personal financial situation is key for the application. The bank’s underwriter will analyze the person’s net worth; as well as look at her previous earnings, length of credit history, among other factors.
For lower amounts the bank may not require a business plan. However, if there is a particular weakness in the loan application, the loan officer may ask the borrower to submit a business plan and financial projections.
b) Non-Bank lenders
These institutions do not conduct consumer banking but offer business services and business loans. Lenders’ requirements vary depending on the institution, and some prefer lending to specific industries. The Non-bank lender may take longer to process your loan application than a regular bank, but they can approve loans that banks find too risky.
Non-Bank lenders usually require a business plan and ample documentation with the loan application. Compared to banks these lenders have more flexibility working with lower credit scores as long as the borrower has the necessary experience and collateral.
c) Region specific Lenders
There are neighborhood specific for-profit/non-profit lenders that have more flexible lending terms. For example: Credit Unions and Community Development Organizations may lend to specific neighborhoods. The nature of your business and the reason why you are requesting the loan should fit with the organizations’ goals.
d) Micro and Alternative lenders
Micro and Alternative Lenders lend to riskier borrowers. These borrowers usually have low credit scores or they are just building credit, also they don’t have a strong financial history and have little or no collateral. These institutions lend lower amounts and charge higher interest rates.
Step 6: Prepare the loan application package
A “Loan Package” is the paperwork you submit to the bank in order to apply for a loan. The Loan Package includes the following:
• Business Plan
• Business Financial Projections
• Personal Financial Information
• Personal Tax Statements
• Information about business, location, sales contracts, etc.
• Business Owners’ Resumes
Step 7: Waiting
Loan applications are approved or declined much quicker than people think. A lender can approve an SBA express loan within 36 hours. Regular commercial loans have similar processing times. You should expect to get an answer within 2 weeks, and hopefully close the loan (get access to the money) within another 2 weeks. However, if the institution needs more documentation, or if the loan is for a larger amount, then it might take longer to process the loan, especially SBA loans.
