Loans are big business for small business owners. Even applying for a simple credit facility can mean risking a lot. But a well-prepared borrower can negotiate from a position of strength, saving thousands of dollars.
Before going out with your hat in your hand, remember these six keys to borrowing success:
Make it personal
Long before you need a loan, you need a personal relationship with the lender. Loans are about trust, and trust starts with familiarity. Invite a banker to your place of business; impress them with product samples, maybe even take them out to lunch. A good relationship with a banker (or two) can benefit your business in other ways. Take advantage of their experience and contacts by asking for their help on nonbanking issues. Ask a banker to join a formal board of business advisors and you may learn more about your own business as well as theirs.
Know the numbers
Every business loan has terms and covenants that may require you to meet or maintain certain operating parameters. Those restrictions could mandate certain profits, cash flows, or balance sheet ratios. Be prepared by reading up on these crucial business metrics in a book such as Annual Statement Studies, published by the Risk Management Association, or R.M.A. for short.
The R.M.A. guide includes common financial ratios and composite financial statements culled from more than 360 industries. You can get a glimpse into the mind of a banker by picking up a copy at your local bookstore, library or bank. Alternatively, download just the pages you need for your industry at rmahq.org. Benchmark ratios from the R.M.A. statements are likely to become your targets to qualify for, or to maintain, commercial credit.
Sweeten the deal
What banks want even more than profitable loans are customers who use savings and checking accounts and fee-generating services. If a loan request is your first and only contact with a bank, be prepared for a polite refusal. Instead, offer your bank a reward for structuring an attractive loan — shift your business checking accounts, payroll accounts and wire transfers to the lender. If your business accounts are slim, consider moving your personal mortgage or retirement savings. The more benefit for the bank you can offer, the more the bank will reward you with favorable rates and terms.
Plan not to fail
If you want to win a banker’s trust, show that you know all the ways your business could potentially fail. Write down 10 challenges your business faces — and the ways in which you would overcome those challenges. A list of potential pitfalls will show that you are prepared for success, and will also pre-empt many questions from the loan review committee that could slow approval.
Don’t ignore the biggest risk to your business: key-person risk. If you or your business partners are incapacitated (or die) tomorrow, could you repay the loan? Key-person risk is present in every business and can best be addressed by investing in a substantial life insurance policy. It’s not unusual for banks to require insurance valued at twice the loan balance. It’s morbid, and may be expensive, but it shows that you are helping the bank reduce its exposure to risk.
A thorough business plan with clear projections is vital to getting a loan approved. But projections that are too optimistic will get you into trouble. Remember that nothing ever goes as planned, so a pessimistic budget is the best kind. You will sleep better at night knowing that you have a little padding built into your numbers, and the bank will be impressed when you come in under budget.
When you’ve finally closed a loan and think you can relax, think again. Loan covenants may change every month or quarter, and the bank may review your credit-worthiness periodically, too. Keep a clear eye on the terms and your ability to stay within the defined parameters. Equally important, keep building your relationship with the banker — no bank is immune from shifts in policy or priority, so be sure that your relationship is one that they value.
If you can put all the pieces together — a solid relationship, a convincing business plan, risk management, and lots of upside for the bank — you’ll be ready to negotiate a generous loan package. Remember: For a well-prepared borrower, everything is negotiable.