Borrowing Money for Small Businesses

Borrowing Money

by Chris Margetis

Borrowing money is one of the most common sources of funding for a small business, but obtaining a loan isn't always easy. 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. This discussion outlines some of the key factors a bank uses to analyze a potential borrower. Also included is a self- assessment checklist at the end of this section for you to complete.

KEY POINTS TO CONSIDER

Let's begin by exploring some of the key points your banker will review:

1. Ability to Repay/Capacity

The ability to repay must be justified in your loan package. Banks want to see two sources of repayment -- cashflow from the business, plus a secondary source such as collateral. In order to analyze the cash flow of the business, the lender will review the business's past financial statements. Generally, banks feel most comfortable dealing with a business that has been in existence for a number of years because they have a financial track record. If the business has consistently made a profit and that profit can cover the payment of additional debt, then it is likely that the loan will be approved.

2. Credit History

One of the first things a bank will determine when a person/business requests a loan is whether their personal and business credit is good. Therefore before you go to the bank, or even start the process of preparing a loan request, you want to make sure your credit is good.

First get your personal credit report. You can obtain a report by calling TransUnion, Equifax, TRW or another credit bureau. It is important that you initiate this step well in advance of seeking a loan. Personal credit reports may contain errors or be out of date. In many cases, people find that they paid off a bill but that it has not been recorded on their credit report. It can take 3 to 4 weeks for this error to be corrected -- and it is up to you to see that this happens. You want to make sure that when the bank pulls your credit report that all the errors have been corrected and your history is up to date.

Once you obtain your credit report, how do you know what it says? Many people receive their credit reports yet have no idea what the strange numbers signify. The following should help in interpreting and checking your personal credit report.

3. Equity

Example: A new business needs a $100,000 to start. The business owner must put $20,000 of her own money into the new business as equity. Her loan will be $80,000. The debt to equity ratio is 4:1. Note also that this is only one of many factors used to evaluate the business -- just having the right debt/equity ratio does not guarantee you'll get the loan.

The balance sheet indicates the amount of equity or net worth of a business. The net worth of the business is often a combination of retained earnings and owner's equity. In many cases, owner's equity will be shown as a loan from shareholders and therefore a liability. If a business owner wishes to obtain a loan, she will be obligated to pay the bank back first and not herself. Consequently, it may be necessary to restructure the liability so that it becomes owner's equity or subordinate the loan. If the current debt to net worth is 4 or over it is unlikely that the business will be able to obtain additional debt/loan.

QUESTIONS YOUR BANKER WILL ASK

The key questions the banker will be seeking to answer are as follows:

1. Can the business repay the loan? (is cash flow greater than debt service?) 2. Can you repay the loan if the business fails? (is collateral sufficient to repay the loan?) 3. Does the business collect its bills? 4. Does the business control its inventory? 5. Does the business pay its bills? 6. Are the officers committed to the business? 7. Does the business have a profitable operating history? 8. Does the business match its sources and uses of funds? 9. Are sales growing? 10. Does the business control expenses? 11. Are profits increasing as a percentage of sales? 12. Is there any discretionary cash flow? 13. What is the future of the industry? 14. Who is your competition and what are their strengths and weaknesses?.

4. Collateral

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, even many microloan programs, requires at least some collateral to secure a loan. If a potential borrower has no collateral to secure a loan, she/he will need a co-signer that has collateral to pledge. Otherwise it may be difficult to obtain a loan.

The value of collateral is not based on the market value. It is discounted to take into account the value that would be lost if the assets had to be liquidated.

5. Experience

A client that wants to open a business and has no experience in that business should not seek financing let alone start the business unless they intend to hire people who know the business or take on a partner that has the appropriate experience. Regardless, the client should be advised to take some time to work in the business first and take some entrepreneurial training classes.

SELF-ASSESSMENT CHECKLIST

Whether you are applying for a microloan, SBA loan or a traditional bank loan, there are certain factors that improve your ability to obtain financing.

To receive a simple checklist to do before you begin to seek capital, and a F*ree 5 Day course in Small Business Administration via email, send me an email at mailto:loans_advice@aweber.com.

------------------------------------------------------------ Christos Margetis is a Business Analyst & the president of ClickGoFind.com & owner of various other Financial sites. The tips in this article were extracted from Chris's Financial Blog at http://www.clickgofind.com:8080/blogs More information on Business Loan Resources you can always find on his site at http://www.clickgofind.com/?page=SearchResults&keyphrase=business+loans ------------------------------------------------------------

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