So you have your next great growth idea in hand. The catch is you need cash to implement it. Before dusting off your suit and marching off to the bank, consider these five critical elements to get a business loan that best meets your specific needs.
Too many business owners fall prey to the common misconception that a senior loan is a one-size-fits-all financing solution. Following suit may land you in front of a banker unprepared and likely to be rejected -- or worse. Selecting a capital source that is poorly aligned with your circumstances has the potential to destroy value (meaning the wealth you have tied up in the business) or even deal a fatal blow to your firm.
Worry not. A little forethought goes a long way toward matching your financing needs with specifically suited sources of cash, saving you precious time and maximizing your plan’s profit potential.
Follow these steps to get a business loan:
1. Choose whether to Beg, Borrow or Steal
Ok, we’re not proposing a life of crime. What we are suggesting, however, is you consider the advantages/disadvantages of all potential capital sources before defaulting (no pun intended) to a senior loan.
First, confirm that a loan is the appropriate source of capital. Perhaps you should seek an equity investment (beg). Or maybe a little creativity will allow you to temporarily reallocate some of your firm’s cash flow to fund your plan (steal).
The topic of financing options will serve as good fodder for a future blog article, but here are a few options to get your creative juices flowing:
- License non-core intellectual property
- Sale leaseback on your building (if you own it)
- Stage your growth (spread need for cash in smaller increments over time)
- Approach a friend (former colleague or boss who trusts you) for a loan or investment
For your shortlist of prospective sources, compare:
- Cost (whether that’s interest rate or a percentage of your business)
- Repayment rate and schedule, overhead (reporting requirements, covenant adherence, etc.)
- Timeline to receiving funds
- Probability of securing funds along needed timeline and
- Ramifications if your growth takes longer or costs more money to achieve than expected (eg: increased costs, options for next round of funding, ceding control of your business)
Weighing these factors should lead you to the best capital source.
2. Look in the Mirror
Having ruled out other sources of capital, you can now confidently begin the preparation to get a business loan. Start by putting yourself in the bankers’ shoes. What does the loan officer see when they sit across the table from you? Would “you” lend to you? From a personal standpoint, they’ll assess the following:
- Appearance. Are you professional and credible?
- Your character, trustworthiness, integrity, diligence and resolve.
- Your personal and corporate credit history.
- Your experience. Can you articulate a compelling case for the plan and can you point to past success that instills confidence in your plan?
From a corporate perspective, they’ll assess your venture’s risk profile:
- Does you firm have at least three years of positive cash flow at margins that compare to or exceed industry norms?
- Do you and your firm have collateral that a bank would deem a credible source of repayment if you were unable to service the loan (and are you willing to give the bank a lien on those assets)?
- How does the proposed loan amount compare to your annual cash flow?
- What’s the nature of your need: seasonal, one-off, ongoing? Real estate or operations?
- Does your prospective lender know your industry well?
Your answers to these questions will influence your loan eligibility and where you seek your cash infusion.
3. Select Loan Type
Now that you’ve characterized your personal and professional appeal, you’ll want to familiarize yourself with the various types of loans. Loans come in all shapes and sizes, from a revolver to a term loan to venture loans to accounts receivable factoring.
Traditional senior loans are among the most affordable options, but a senior lender can’t stomach much risk. However, your willingness to provide collateral and whether you’re seeking a line of credit, term loan or equipment financing all play into their appetite. Subordinated or mezzanine lenders are happy to step in where senior lenders become squeamish, but higher risk comes at a higher price.
Different loan types will appeal to different situations. A short-term need could be filled by factoring your accounts receivable. An SBA (US Small Business Administration) loan can offer low competitive pricing and can be a compelling option for real estate or business loans, but you’ll need to provide a personal guarantee and the SBA is not typically the fastest to secure. Even peer-to-peer lending, where you borrow from an individual rather than an institution, has become a legitimate option to consider.
With the range of options, you’re likely to find a business loan that suits your specific needs.
4. Craft the Story
With your target audience in mind, you can now pull together your pitch. Lenders have different loan application requirements so don’t go too far down this path before seeking some guidance from prospective lenders, but keep in mind there is a direct correlation between the quality of your proposal and both the likelihood of and timeline to approval.
Your story should contain certain components:
- A thoughtful, researched plan should discuss your growth idea along with its implementation plan and schedule. It should showcase your team and identify both your competition and your advantages over them. It must also demonstrate intimate industry knowledge.
- List the anticipated hurdles and how you intend to clear them. Prepare a “Plan B”… and ideally “Plan C” in case things don’t evolve as planned, any seasoned lender will ask.
- Have you profitably executed a plan like this before? Great, talk about it here.
- NOTE: While some of this information can be verbally communicated, the written word helps a lender circulate your case internally and reinforce your contact’s story as he or she advocates on your behalf.
- Provide current financials and for the prior three years. Historical financials need not be laden in detail; high level internal financials are sufficient to get the conversation started. Include income statements and balance sheet for each period. Be sure to detail your collateral.
- Read one of our balance sheet blog articles for a refresher on what a lender looks for in a balance sheet
- Work with your bookkeeper or controller to generate projected income statements, balance sheets and cash flow statements. Project beyond the period of repayment. The real key here is cash flow projections; many banks will want monthly figures.
- Be optimistic, but realistic. Hockey stick projections are common in venture capital pitches, but signal to a lender that you should be raising equity, not senior debt.
- Show how you intend to deploy the money you borrow and explain what will drive that schedule.
- Itemize how you propose to repay the loan and along what timeline. What do you see is the objective probability of meeting that proposed payback schedule?
Skin in the game
- Most lenders will want to see some shared risk. Confidence in your plan may erode if they see you hesitate to put your money where your mouth is.
- Shared risk can come in multiple forms, but often means a request to sign a personal guaranty.
Lenders are busy just like you so include a 1-2 page executive summary so they can quickly assess the fit and come back to you with a preliminary response.
5. Go Shopping
With your pitch at the ready, you are now prepared to explore the fit with lenders and take the final step to securing your loan. Seek referrals from your CPA, attorney or other trusted advisor who knows you, your business and the current lending landscape.
Not sure who to call, feel free to contact us if you’d like a lender suggestion (email@example.com, 888-631-1124).
Once you have a shortlist, spend a little time researching each prospective lender before lobbing in your first call. Check the loan or investment criteria on prospective lenders’ websites to whittle down your list of prospective loan sources.
Then start picking up the phone. Lenders field these types of exploratory calls every day and a 5-10 minute call can give you a quick sense for whether it make sense to invest more time exploring the fit. If it’s not a fit, ask for a lender who might have an interest. Lenders are great about making qualified introductions to peers looking for a different loan profile. Learn from the “no’s”. Ask for feedback and refine your pitch.
Find at least 2-3 lenders who are excited about the loan and request term sheets (proposals). Having multiple banks in the hunt for your business will allow you to see how each performs under pressure.
Once you have a handful of term sheets, have your bookkeeper or controller test upside and downside scenarios against the bank’s proposed covenants (a covenant is financial metric or ratio that a bank watches to warn them if loan repayment may be at risk). If you might need extra breathing room, ask for it… although it may not feel like it right now, that may be far more valuable than negotiating hard on price (interest rates and fees).
Take a step back and ask which lender you like and trust the most. Who would you feel most comfortable calling with bad news if you hit a snag? Find out what happens in a downside scenario. Will a bank work with you as you work through an unforeseen challenge or will they simply hand you over to their workout group? Every situation is different, but many seasoned borrowers value relationships and broad covenants and strong long term relationships over interest rates and other pricing.
Now it’s time to negotiate and select your partner.
You Have a Loan. Now What?
Once you get a business loan, your work has really only just begun. Your lender is your partner and treating them as one will ensure they remain by your side. Ensure your bookkeeper and/or controller keeps you in the loop of all matters relative to your plan. Similarly, keep your lender informed of good news and bad. They expect obstacles will present themselves, but will want to learn how you respond as challenges surface. Your lender needs to answer to his or her credit committee whose job it is to ensure repayment. Your job is to arm your lender with all he or she needs to support your story.
Remember, sound financial systems and reporting are the foundation of a healthy banking relationship. Be certain your bookkeeper and/or financial controller is up for the challenge. With those resources in place, you can squarely focus on turning your plan into the profitable growth you had envisioned.
THE DRIVEN INSIGHTS ADVANTAGE
Driven Insights is experienced in leading service businesses on the journey to leveraging financial and operating metrics to accelerate growth. Our bookkeepers and controllers are charged with much more than simply “doing the books” – they ensure each client understands and uses the insights we share.
Interested in learning more? See for yourself how Driven Insights can provide the insight and control you need to achieve your most critical goals by contacting us at firstname.lastname@example.org or 888-631-1124.