Five Things To Know When You Are Seeking Debt Financing
Guest Author – Maia Hardy, Loan Officer, Community LendingWorks
Capitalization can be one of the most challenging aspects of starting or expanding your small business. Borrowing money is a common source of funding but it is not always easy. Before you approach a lender, you will need to understand the factors they will use to evaluate your application and how you can position yourself to be “loan ready”.
Here are five things to know before going to a lender.
You need a business plan
Every lender is going to require some form of a business plan. It does not need to be exhaustive but it should address the following:
- Who are you and what is your business?
- What makes your business unique & how will you reach your client/customer base?
- How much capital do you need?
- How will it be used (create a project breakdown)
- How do you plan to pay back the loan? (cash flow projections)
Understand your financial position before you talk to a lender
If you are already in business, lenders are going to ask for historical financials (usually 2-3 years). Be prepared and come to your lender with ACCURATE financial statements. Expect lenders to ask for the following:
- Profit & Loss
- Balance Sheet
- Cashflow/Sales Projections (2 years)
- Tax Returns (Personal & Business- 3 years)
If you are a startup, lenders rely heavily on your cash flow projections to evaluate your ability to repay debt. Have realistic projections and be prepared to back up your numbers and calculations.
Know your collateral position
Business Loan Underwriters are looking for ways to mitigate risk when they are evaluating your loan request. One way they do that is by securing your loan with collateral. Collateral is a term that is used to describe personal or business assets that you either own or plan to purchase with loan funds. Common forms of collateral are:
- Furniture, Fixture & Equipment (FF&E)
- Personal Assets (Auto’s, RV’s, Boats, other equipment)
- Real Estate
Lenders are aiming for a 1/1 ratio. This means that for every dollar that you borrow, plan on a lender asking for equal value in collateral (Keep in mind: this is depreciated value). If you are under the 1/1 ratio, the gap may be bridged by bringing on a co-signer, or the lender may ask you to contribute more as owners’ equity. In addition, some lenders may allow friends and family to pledge collateral for you.
Have skin in the game!
Lenders want to see that as a business owner, you have assumed or plan to assume some of the risk. Typically, lenders will ask for 5-10% owners’ equity invested in the project. Equity is key, as it addresses a few key elements:
- Lenders want to see you are invested into the project and that you believe enough in your business that you have invested your own capital.
- Equity won’t guarantee loan approval, but by having sufficient capital into a project, you significantly increase the odds for a successful loan request.
You need to understand your credit situation
Your credit score shows your ability to repay the loan and your past financial performance. Your lender will obtain your personal credit report as a part of the application process. It is critical that you explain any credit challenges up front to lending staff. You should obtain a credit report from all three major credit bureaus before you submit your loan application to a lender. Inaccuracies and blemishes on your credit report can hurt your chances of getting a loan approved. Ask your loan officer how they evaluate credit; some lenders do not use your score as a determining factor in whether or not your loan application is approved.
www.annualcreditreport.com is a website backed by the consumer financial protection bureau that allows you to pull your credit report free once a year.
Lenders will want you to stand behind the loan by personally guaranteeing repayment. Make sure you understand your financial position and know that if the business is unable to repay the loan commitment, you as the business owner will be personally responsible. Additionally, if you are a shared owner with at least 20% ownership, a lender may require you personally guarantee the loan as well.
Looking for ways to build your credit? Check out Community LendingWorks Credit Builder Loan Program!
Are you in need of money to start or expand your small business?
Community LendingWorks is a non-profit lender that provides debt financing up to $75,000 to help businesses start or expand. CLW pairs their loan products with technical assistance and business development services to ensure their borrowers are successful. Community LendingWorks is based in Lane County but can lend to businesses statewide. For more information visit: www.communitylendingworks.org.