Preparing Your Business to Borrow
All businesses reach a critical juncture when they need additional capital to get to the next level. In this environment, when a business is poised to take on more customers or larger orders, it can’t afford to let the competition step in just because it’s unprepared to access the capital it needs. Yet studies show that nearly 80% of businesses are turned down by banks for financing. One of the top reasons banks give for denying a loan to businesses is that they weren’t prepared—they were missing some of the pieces of the puzzle.
As a result, many businesses either do without the capital they need or turn to higher-cost financing options through alternative lenders, neither of which is a good option for a business on the verge of breaking out. Long-range planning for growth needs to include a strategy for accessing capital when the business is ready for it. That includes knowing what all the pieces of the puzzle are and how they fit together for the best chance of obtaining the amount of capital needed at the right cost.
Strong Cash Flow
Banks want to know that your business has enough money to make the loan payments and cover all other expenses. They look at your cash flow history, as well as projections, to gauge how strong and secure it is. If your business is operating on very tight margins, look for ways to cut expenses or increase revenues before applying for a loan.
Cash flow pays the bills, but profits are what keep you in business. Banks want to see that your business model works and is capable of making money over the long term. Businesses that can show sustained profit growth are better positioned to repay their loans over time.
A Sturdy Balance Sheet
The ability of a business to increase its net worth year over year is an indication of good management. At the very least, your balance sheet should show that your business has enough assets to pay off short- and long-term obligations.
A Sound Business Plan
A sound business plan articulates your vision, objectives and the specific strategies for achieving them. However, in the end, your plan will only stand out if it can clearly answer the following key questions:
- Can it be profitable enough, fast enough, to make timely loan payments?
- Will it be viable in the long term to be able to repay the loan fully?
- Is there sufficient demand for its product or service in its target market?
- Is there an effective strategy for manufacturing, marketing and delivering the product to its market?
- Does the management team have the chops to make it happen?
When you’re ready to access capital, this information should find its way into the loan proposal to present to the lender.
When seeking financing, a business’s primary objective is to present the best possible case for loan approval. A well-conceived loan proposal strongly indicates to lenders that your business is a sound risk. The critical elements of your loan proposal should include:
- Executive Summary. Think of the executive summary as your “elevator pitch” that briefly describes the business, the market and the loan amount, and how the capital is to be used to help the company grow.
- Business Summary. This should be a fact-based summary describing the business’s history, growth, current activity and business results.
- Loan Amount. Describe specifically the methods used to determine the amount of capital the business needs to borrow.
- Loan Purpose. Describe how the capital will be used, including cost estimates for equipment, expansion proposals and any support documentation.
- Management Profile. You need to establish the credibility and competence of the management team with a management profile that describes its experience, qualifications, skills and credentials.
- Financial Statements. This includes at least three years of profit and loss statements, balance sheets and other financial documentation. They will also want to see financial projections for earnings and cash flow for the next two to three years. Some lenders also require copies of the owners’ personal tax returns.
- Loan Repayment Plan. Describe the terms you’re seeking (interest rate, loan term) and how you expect to repay the loan based on sales and cash flow projections.
- Statement of Collateral. Your Plan B for repaying the loan is the equipment or facilities you are purchasing or any assets the company or owners can offer as collateral. Having suitable collateral reduces lender risk and increases your chances for loan approval.
Generally, lenders want to understand your business so they can lend with confidence. Even if your business has no immediate need for capital, it would be important to start putting the pieces in place and managing them as if you did. That way, when you’re ready to take your business to the next level, you can be confident in your ability to get the capital you need.