Applying for a business loan from a bank is a daunting process. There is no shortage of offers from banks to lend your company money, however, many hopeful entrepreneurs soon learn how difficult it is to borrow from a commercial bank.
Below are some things you can do before you start looking for a loan that will increase your company’s chances of closing a deal.
Borrow Money Before You Need It
The best thing you can do is borrow money before you need it. I’ve seen too many companies start to look for financing when they are about to run out of cash. This is too late and scares away lenders who feel the owner should have had a better handle on his or her company’s finances.
A revolving line of credit is a great way to start. It is a credit facility that enables you to draw down funds when cash is needed, then it pay back when the business generates extra cash. You only pay interest on the borrowed amount. They are relatively easy to set up for creditworthy customers. It establishes a track record a bank can rely upon if you need to borrow more money.
Clean Up the Balance Sheet
The first thing the bank will look at is your balance sheet. They immediately want to know how much debt your company has and how much collateral is available to back up a loan. The amount of cash on hand and equity also matter. For example, SBA loan criteria is a debt/equity ratio of 4:1 – $50,000 of equity can get you up to a $200,000 loan.
Some things to do to clean up your balance sheet:
- Contact customers to accelerate collections. This has the added benefit of making your accounts receivable more attractive as collateral since banks exclude invoices over 90 days old
- Put more cash into the business (increase equity)
- If you have inventory, convert all work-in-process to finished goods. Banks accept only saleable, non-obsolete finished goods as collateral
Have Plenty of Good Collateral
Make sure you have more collateral than the amount you want to borrow. You can do this by listing available collateral in the business – and your personal life – then putting a dollar value next to each line.
Run accounts receivable aging reports and collect any unpaid balances over 60 days old. If you have inventory, run an inventory by SKU report that provides unit counts and values. Prepare a total value by SKU and verify it with supplier receipts. Expect to pledge personal collateral, such as equity in your home or securities you own. Banks have to manage their risk. They do so by requiring good collateral they can easily monetize should a loan go into default. They will also ask for a personal guarantee in addition to the collateral.
Improve Your Personal Credit Score
Banks will run a credit check on the owner of the business. An owner’s poor credit rating is a big red flag for lenders – they will assume poor personal credit management will result in the same behavior for the business.
Get a free credit report from each of the three larger credit agencies. Correct any erroneous information. Many of them offer separate services to help consumers clean up their credit reports. This can take up to 60 days, so give yourself plenty of time to clean up your report before applying for a loan.
Find the Right Lender
Keep in mind that banks are regulated entities. They have many rules they must follow in order to be licensed to operate. Most commercial banks cannot lend to companies with operating losses – they question whether the company has the cash flow to service the debt.
If your company has operating losses, then specialty financing is a better option. These are non-bank lenders that make loans to small and mid-sized businesses that otherwise could not obtain financing. Kabbage, OnDeck and American Express are some well-known examples. They are more costly options. They may also require repayment in the form of a daily cash withdrawal from your checking account (OnDeck) or by skimming a portion of cash proceeds remitted to you on a daily basis (American Express).