08/ 28/ 2006
by Marcia Passos Duffy
Banks and financial institutions are often not eager to part with money when it comes to small businesses. The reason is that small businesses have a notoriously high failure rate. While you may think that your business doesn't fall into the "failure" category, you do need to prove your credit worthiness to a bank if you want to not only get a business loan but one with favorable terms.
To do this, you need to look at the loan process in an objective way from the bankers' point of view.
The key questions on the mind of any lender are the following:
- Why do you need the money?
- How much do you need?
- How do you plan to repay it?
Why do you need a loan?
The old adage is true: You can always get a loan if you don't need it. But most small businesses seeking loans obviously need it. But the question banks want to know is why do you need the money? And it better be a good reason.
If the business is sinking, and you need money to bail the business out of trouble, no bank will loan you a cent. Good reasons for asking for a loan include opening up a new office or manufacturing facility, expanding product lines, opening new sales territories or buying equipment that will help increase profits. The key is that the reason ought to be an investment that will increase profits. For obvious reasons, lenders won't fund a company that is spiraling downward, so you must convince the lender that your already-profitable business will become even more profitable with this investment that will be funded by the loan.
How much money do you need?
Loans are not blank checks, so you need to determine exactly how much you need for your business venture. More often than not, business owners will ask for too little rather than too much because they underestimate a business expense. For example, if you need a loan to launch a new product line, the money should cover not only the raw materials of the new product line, but should also include marketing expense associated with launching the products, a new warehouse to store the product and/or the purchase of new factory equipment to make the product. A lender is most likely well versed in the hidden costs of launching a new product line, so you need to as well, or you will loose credibility as well as your chances of getting a loan.
Another reason business owners tend to ask for less money than what they need for the entire project is that they are either afraid of asking for too much and getting turned down, or they are shaky about their ability to pay back a higher amount. In either case, the lender will know that the numbers don't add up and your chances of getting the loan go down.
How will you repay the loan?
Lenders prefer that a business has cash flow--or cash reserves--that are sufficient to make the monthly loan payments. To prove this, you will need to provide two to three years of financial history, plus three to five years of projected earnings. These projections should show the earnings you expect from the investment you plan to make with the loan money, plus how those profits will help repay the borrowed cash.
In short, to increase your chances that the lender will say "yes" to your request to borrow money, make sure you know why you need the money, exactly how much you need, and how you plan to repay the loan. It is also helpful to make sure your credit rating is clean and provide a solid business plan to the lender.
