Whether it’s for startup costs or capital expansion, eventually most businesses need to borrow money. Being prepared and understanding the requirements can increase your chances of getting a loan and making the process easier.
Reasons for borrowing
When applying for a business loan, be sure to start with a clear plan for how you’ll use the money. Lenders prefer to offer funding that will be used to enhance the value of the business rather than to cover operating expenses because of a decrease in revenue. Here are some reasons that businesses borrow money:
- Capital for startup expenses or expansions
- Opportunities that could likely enhance the value of a business, such as advertising or buying inventory in bulk
- Credit records to help a business qualify for larger loans in the future
- Equipment financing
Borrowing from the right source
If you’ve decided to borrow, it’s important to choose the best lending source for your specific situation. To determine that source, make a realistic assessment of how much you need and can afford to repay, as well as the terms that suit you best. Here are some recommendations to consider when choosing a lender:
- Consider your alternatives – Before applying for a loan with a financial institution, carefully consider all alternative sources of capital. Investors, friends or relatives—or even the seller if you’re purchasing a business—can possibly provide a portion of your borrowing needs that may not qualify for a bank loan. Discuss these options with your financial advisor or your banker.
- Choose the right lender – If you decide you need a loan, approach lenders who make loans to businesses of your size, in your industry or in your geographical area. If the institution already knows you, your business, your industry and potentially your customers, they may already have a great deal of the information they need to make an informed lending decision.
- Explore leasing versus purchasing – If you expect to use the funds to purchase a piece of equipment, you may want to discuss leasing options with the equipment vendor instead. Many manufacturers offer leasing agreements with lenders who may be familiar with your type of business.
Type of loan sought
When you’re looking for funding for your business, you don’t need to choose a specific type of loan before you approach a lender; they’ll help you decide what financing is best for your needs. Here are some ideas to keep in mind when choosing a loan:
- Loan terms – Be sure that the terms of a loan will align with your expected cash flow, allowing you to meet the payment terms, on schedule and in full.
- Collateral – Try to avoid pledging a lot of collateral for relatively small loans. Instead, offer collateral that is tied to the purpose of the loan. For example, if the loan is for purchasing a new machine, offer a security lien on the machine as collateral.
- SBA loans – Depending on the size of your business, you may want to consider a Small Business Administration (SBA) loan. The SBA encourages lending to small businesses by guaranteeing parts of loans made to businesses of certain sizes where the proceeds are being used for certain purposes. You can talk to an institution offering SBA loans to learn more.
Be prepared to discuss the financial status of your business and provide supporting documentation, including, but not limited to, these documents:
- Accounts payable policy
- Bank statements
- Business license
- Business plan
- Credit policy
- Current profit and loss (P&L) statement
- Insurance policy
- Lease and/or loan agreements
- Ownerships and affiliations with other businesses
- Personal financial information
- Tax returns and CPA-prepared financial statements
- Organizational documents, including Articles of Incorporation, LLC or Partnership Agreements, Operating Agreements, By Laws, etc.
Your business plan should play a major role in your decision to borrow and may play a major role in a lender’s evaluation of your loan request.
Be sure that your business plan is current and includes everything the lender needs to understand your business and make a fully informed decision. The main components of the plan should include at least the following items:
- Business description
- Competitive analysis
- Development plans
- Financial information
- Key personnel
- Management plan
- Marketing strategies
Be prepared to discuss how you currently (or plan to) operate and maintain a profitable business. Evidence of your successful business practices can include, but is not limited to, these resources:
- Solid business plan
- Track record of profitability
- Strong credit record
- Documented history of success in other business ventures, even if you weren’t the owner
- Network of reliable and successful mentors who can advise you in your business practices
Taxes and other financial information
Your tax return is the primary document that lenders use to determine your creditworthiness as a business owner. To help you gather tax information to present to potential lenders, here are some questions to consider:
- What has your annual revenue been during the past 2 to 3 years?
- Are your payroll, property and income tax filings up to date?
- Do you work with a qualified tax professional to help you maximize your tax benefits?
- Do you have records that verify the stability of your client or revenue base?
- Is your cash flow greater than your monthly loan payment would be?
The bottom line
Now that you have an idea of what lenders look for, you can use the process of preparing to borrow as a tool to evaluate your business and plan for its success. The proper preparations can strengthen your business as well as your case for borrowing.