Filling out the paperwork to apply for a business loan is easy.
But getting approved by a lender is much harder.
Loans typically get rejected because of poor cash flow, insufficient collateral and too much existing company debt. A business must be prepared before they apply—it helps to increase their chances of success and to avoid wasting valuable time in the process.
Here are a few things to know before you apply for a business loan:
1. Identify the purpose of the loan.
Funding sources want to know what the loan is going to be used for and how that money will generate additional profit for the company.
A loan should be used to fund a short-term cash need, like buying a piece of production equipment or launching a new product or service.
Business loans shouldn't be used to fund continuing company losses—that is, losses where you don't expect a significant change in the level of revenue after the cash infusion.
If your company is not going to make a profit from loan, it probably isn't a good time to apply for a business loan.
Because you may have difficulty paying it back after a period of time.
2. Know your numbers.
Like so many business owners, I was traditionally bad at reviewing my financial statements and key metrics monthly. Before you apply for a business loan, ensure you understand the past three years of your profit and loss statements, balance sheets and cash-flow statements.
Always ask what exactly your company needs to improve in order to qualify for a loan in the future.
Most funding sources are data-driven—numbers can help make them feel more comfortable with the risk of loaning you money.
Many lenders also depend on your past results to predict the future. Your financial statements should have enough detail to show an analysis of how the cost of goods, gross margin and net profit have changed over time, and what those changes mean for the company moving forward. It helps to understand what's behind each individual number and any changes to it.
3. Make a confident forecast.
When you apply for a business loan, present a believable prediction of where the company will be over the next three years. Emphasis on believable: If no company has ever achieved these type of results, it's unlikely that funding sources will be convinced that your business will be the first one.
You can build this forecast from the bottom up—not the top down—through simple multiplication. For example, know the time and cost of driving each customer purchase and the gross profit on each sale. Here are a few more tips to help you build a confident forecast:
● Understand the lifetime value (LTV) of a customer.
● Show where the leverage is for increasing profit and how the company will make money as the business grows.
● Make sure that the forecasts are conservative by increasing expected expenses by 20 percent and reducing forecasted revenue growth by 35 percent. Under this scenario, can the company still make a profit and repay the bank within terms?
4. Know how you will pay back the loan within the agreed-upon terms.
This is a key question any funding source will try to determine when you apply for a business loan.
Some banks charge single-digit interest rates, and are not able to take significant risks. They will check the cash flow from your profit and loss statement, the current ratio on your balance sheet and your cash-flow statement to see if the company can cover the additional expense of the loan.
Lenders often will require companies to demonstrate that the cash flow the business will generate under multiple forecasted sales is enough to keep the loan payback secure. Since all banks want to manage downside risk, they will pay particular attention to the worst-case scenario.
5. Show your collateral.
When a company applies for a business loan, funding sources want to minimize risk. Some will insist on a personal guarantee from the owner and anyone who has more than a 20 percent share of the company. (That's because they want to make sure that you will stand behind company's loan.)
It is also important to show any funding source a track record of previous personal and company loan repayments. Any past record of repayment can help make the bank's decision easier.
And when it comes to getting low-interest rates, personal credit scores need to be above 650 to qualify for a business loan in many cases .
6. Leverage your relationship with the bank.
Financials are important, but funding decision makers still invest in people they know, like and trust.
Try to talk with the staff at a few funding sources before applying for a business loan. Update them on what's going on in your company at least twice a year. Establishing a trusting relationship can help make the financial documents and projections you'll eventually present to them more believable.
In addition, be sure to ask about what funding options they have available. If the bank is aware of your company needs they'll be able to provide lending options that are right for you.
7. Practice the loan presentation.
Get confident before you apply for a business loan—practice the presentation several times in front of your company's accountant. Have them ask tough questions about the data. Repeatedly say in the presentation that you believe “this loan is a very low-risk."
Talk to several funding sources that can lend money at a variety of rates and terms. They all have different sets of guidelines for their targeted loan portfolio.
Remember that a “no" doesn't mean that's the answer forever—it may just be a “no" for now. Always ask what exactly you company needs to improve in order to qualify for a loan in the future.
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