101 Things you need to know before you apply for a loan
If you are among the 40% of baby boomers AARP says plan to work until they die, and if you plan to start or buy a business instead of working for someone else, your venture will likely involve some sort of financing.
Unless you plan to fund this enterprise solely with savings—not recommended unless you are fabulously wealthy—you’ll need a business loan. As any lender can tell you, the better prepared you are before making your request for business credit, the greater the likelihood of getting approved.
Part of this preparation is understanding what bankers will need to approve you. Banks make a major portion of their profits from loans. They’re not in the business of saying no; they just say it when your application doesn’t meet lending requirements, which are much stricter now than before the financial crisis. But be aware that start-ups are almost always considered risky bets, and many lenders are reluctant to finance them. Also know that many larger banks won’t even consider small loans, which are less profitable than larger loans but require the same amount of time to analyze and administer.
Don’t let these discourage you. Get organized. How small is small? According to the Small Business Administration (SBA), the median small business loan from a financial institution is roughly $135,000, with highest around $250,000. SBA loans, which are not underwritten by the US Government but by SBA partners (lenders, community development organizations and microlending institutions), range from $5,000 (a microloan) to $5 million, with the average around $371,000.
Do Your Homework about SBA LOANS So what exactly are lenders looking for? Basically, they’re searching for clues that your business will be able to repay the loan, plus interest, with metronomic regularity. Most financial institutions will expect the loan to be fully secured, either with business assets or personal collateral. Having some skin in the game, meaning you have your own equity invested in the business, strongly works in your favor.
Lenders also will be looking at opportunities to profit from your success, so as your business grows, so will your business relationship. The buzzword in banking circles these days is cross-selling, so your business loan provider may also seek to be the issuer of your business’s credit cards and holder of your treasury accounts. Lenders will also be looking at you—your personal finance record, your credit score, your assets, your work experience, and your character. If you’re starting a business for the first time, having partners with the experience and track record that you lack may also be a requirement.
The Questions You Need to Answer Once you’re ready to make your request, ask the financial institution for the documentation it requires. Then, be prepared to answer the questions, in depth, on the right side of the chart. Once you’re ready to make your request, ask the financial institution for the documentation it requires. Then, be prepared to answer the questions, in depth, for each of the categories listed below.
Purpose: What will the funds be used for? (Note that banks won’t lend for speculating, passive investments, pyramid sales or gambling.)
Amount: How much money do you want to borrow? Why that particular amount? Term and
Repayment Plan: For how long will you need the money and what is your specific plan for repayment?
Collateral: What assets, business or personal, do you intend to use as collateral? What is their market value? What portion of their value can you use as collateral?
Asset and Liability Statement: Your current, complete business asset and liability financial statements (your balance sheet).
Current Income and Financial Performance Statement: Your current, complete business statement of income and expenses (your profit and loss statement, or P&L).
Business Plan Details: Your written plan for your business including goals and action steps, timetable, resource allocation, funding required, and related financial data. You may be asked for cash flow projections for at least a year.
Historic Financial Performance Information: Past business financial performance information under your ownership or under the previous owner’s ownership.
Other Information As Required: Information about you (your C.V., your loan Guarantor—someone who will pledge his/her assets and financials to guarantee repayment of the loan should you default. Guarantors can be a legitimate tipping point factor in getting a “yes” to the credit request.
If You’re Turned Down What do you do if you get a no? Don’t give up. Pursue the reasons for the rejection. Was it a procedural thing—a missing piece of information on the application—or something else? Then ask what would it take to get a yes.
You can then either alter your request accordingly and resubmit it, or take it elsewhere. If you keep hitting a brick wall, consider alternative sources of funding. Many entrepreneurs seek out financing from family and friends. Some use their available credit from credit cards or home equity lines of credit to finance their businesses.
If your “no” comes from a commercial bank, consider community banks and credit unions, many of which specialize in small business loans. You may also want to look into alternative sources of business credit, like Kabbage.com, which offers cash “advances” of between $500 and $50,000 to businesses that already have a performance record, such as online sales. If you do decide to go online to fund your business, be sure you understand all of the terms and conditions of the financing, as they can differ from conventional small business loans.
Once you have decided to apply for a loan guaranteed by the SBA, you will need to collect the appropriate documents for your application. The SBA does not provide direct loans. The process starts with your local lender, working within SBA guidelines.
Determining Your Financing Needs
Before you seek financial assistance, you should thoroughly assess your current financial situation. Ask yourself the following questions to determine your business’ financing needs:
What is the nature of your need?
Do you need money to start or expand your business or as a cushion against risk?
How urgent is your need?
Whenever possible, it’s better to anticipate your needs rather than looking for money under pressure. It is harder to gain approval for a loan when your company is already in trouble, so plan ahead and secure financing well in advance of a crisis.
How great are your risks?
All businesses carry risk, and the degree of risk will affect both the cost of your loan and available financing alternatives.
In what state of development is your business?
Needs are generally more critical during transitional stages – start-up and expansion being two of the most urgent and costly.
For what purposes will the capital be used?
The lender will need to know your specific intentions for the money, to assure themselves that your business will thrive and that repayment is assured.
What is the state of your industry?
Whether your industry is depressed, stable, or quickly-growing will have a distinct effect on your search for funding sources. Businesses that prosper in tough economic times will generally receive better funding terms.
Is your business seasonal or cyclical?
Seasonal needs for funding are generally short term, and consist of smaller loans with a quicker maturation. Loans advanced for cyclical industries, such as construction, are designed to support a business through depressed periods – these industries are sometimes known as ‘feast and famine’ businesses as the cash flow is often erratic and unpredictable.
How strong is your management team?
Effective management is an important element of business. Your lender will be looking for a strong managerial presence.
How does your need for financing mesh with your business plan?
If you don’t yet have a business plan, make it a priority to write one. All lenders will want to see a solid, well thought out business plan for the start-up and growth of your businesses.
Use the checklist below to ensure you have everything the lender will ask for to complete your application. Once your loan package is complete, your lender will submit it to the SBA.
- SBA Loan Application – To begin the process, you will need to complete an SBA loan application form. Access the most current form here: Borrower Information Form – SBA Form 1919
- Personal Background and Financial Statement – To assess your eligibility, the SBA also requires you complete the following forms:
- Business Financial Statements – To support your application and demonstrate your ability to repay the loan, prepare and include the following financial statements:
- Profit and Loss (P&L) Statement – This must be current within 90 days of your application. Also include supplementary schedules from the last three fiscal years.
- Projected Financial Statements – Include a detailed, one-year projection of income and finances and attach a written explanation as to how you expect to achieve this projection.
- Ownership and Affiliations – Include a list of names and addresses of any subsidiaries and affiliates, including concerns in which you hold a controlling interest and other concerns that may be affiliated by stock ownership, franchise, proposed merger or otherwise with you.
- Business Certificate/License – Your original business license or certificate of doing business. If your business is a corporation, stamp your corporate seal on the SBA loan application form.
- Loan Application History – Include records of any loans you may have applied for in the past.
- Income Tax Returns – Include signed personal and business federal income tax returns of your business’ principals for previous three years.
- Résumés – Include personal résumés for each principal.
- Business Overview and History – Provide a brief history of the business and its challenges. Include an explanation of why the SBA loan is needed and how it will help the business.
- Business Lease – Include a copy of your business lease, or note from your landlord, giving terms of proposed lease.
- If You are Purchasing an Existing Business – The following information is needed for purchasing an existing business:
- Current balance sheet and P&L statement of business to be purchased
- Previous two years federal income tax returns of the business
- Proposed Bill of Sale including Terms of Sale
- Asking price with schedule of inventory, machinery and equipment, furniture and fixtures
Business Loan Application Checklist
SBA is not the only source for small-business loans. State and local economic-development agencies – and numerous nonprofit organizations – provide low-interest loans to small business owners who may not qualify for traditional commercial loans.
When it comes to applying for these loans, the good news is that most of these other lenders require the same kinds of information. Of course, each loan program has specific forms you need to fill out. But for the most part, you’ll need to submit the same types of documentation. So it’s a good idea to gather what you’ll need before you even start the application process.
Here are the typical items required for any small business loan application:
Loan Application Form
Forms vary by program and lending institution, but they all ask for the same information. You should be prepared to answer the following questions. It’s a good idea to have this information prepared before you fill out the application:
- Why are you applying for this loan?
- How will the loan proceeds be used?
- What assets need to be purchased, and who are your suppliers?
- What other business debt do you have, and who are your creditors?
- Who are the members of your management team?
- Personal Background
Either as part of the loan application or as a separate document, you will likely need to provide some personal background information, including previous addresses, names used, criminal record, educational background, etc.
Some lenders require evidence of management or business experience, particularly for loans that can be used to start a new business.
All loan programs require a sound business plan to be submitted with the loan application. The business plan should include a complete set of projected financial statements, including profit and loss, cash flow and balance sheet.
Here are some resources for preparing your business plan:
- Essential Elements of Writing a Good Business Plan
- Templates for Writing a Business Plan
- Personal Credit Report
Your lender will obtain your personal credit report as part of the application process. However, you should obtain a credit report from all three major consumer credit rating agencies before submitting a loan application to the lender. Inaccuracies and blemishes on your credit report can hurt your chances of getting a loan approved. It’s critical you try to clear these up before beginning the application process.
Business Credit Report
If you are already in business, you should be prepared to submit a credit report for your business. As with the personal credit report, it is important to review your business’ credit report before beginning the application process.
Income Tax Returns
Most loan programs require applicants to submit personal and business income tax returns for the previous three years.
Many loan programs require owners with more than a 20 percent stake in your business to submit signed personal financial statements.
You may also be required to provide projected financial statements either as part of, or separate from your business plan. It is a good idea to have these prepared and ready in case a program for which you are applying requires these documents to be submitted individuall.
The following forms may be used to prepare your projected financial statements:
- Balance Sheet
- Income Statement
- Cash Flow
- Bank Statements
Many loan programs require one year of personal and business bank statements to be submitted as part of a loan package.
Accounts Receivable and Accounts Payable
Most loan programs require details of a business’s most current financial position. Before you begin the loan application process, make sure you have accounts receivable and accounts payable.
Collateral requirements vary greatly. Some loan programs do not require collateral. Loans involving higher risk factors for default require substantial collateral. Strong business plans and financial statements can help you avoid putting up collateral. In any case, it is a good idea to prepare a collateral document that describes cost/value of personal or business property that will be used to secure a loan.
Depending on a loan’s specific requirements, your lender may require you to submit one or more legal documents. Make sure you have the following items in order, if applicable:
- Business licenses and registrations required for you to conduct business
- Articles of Incorporation
- Copies of contracts you have with any third parties
- Franchise agreements
- Commercial leases
- Organizing your documents
Keeping good records is essential for running a successful business, but even more critical when applying for a loan. Make sure required documents are orderly and accurate. All information you provide will be verified by your lender and the organization guaranteeing the loan. False or misleading information will result in your loan being denied. Finally, make sure you keep personal copies of all loan packages.
What Is Collateral?
Collateral is an additional form of security which can be used to assure a lender that you have a second source of loan repayment. Assets such as equipment, buildings, accounts receivable, and (in some cases) inventory are considered possible sources of repayment if they can be sold by the bank for cash. Collateral can consist of assets that are usable in the business as well as personal assets that remain outside the business. This collateral table [link to collateral table in Understanding the Basics/Collateral) shows how different forms of collateral are valued by a typical lender and SBA.
You can assume that all assets financed with borrowed funds will be used as collateral for the loan. Depending on how much equity was contributed by you toward the acquisition of these assets, the lender may require other business assets as collateral.
Certified appraisals are required for loans greater than $250,000 secured by commercial real estate. The SBA may require professional appraisals of both business and personal assets, plus any necessary survey and/or feasibility study. When real estate is being used as collateral, banks and other regulated lenders are required by law to obtain third-party valuation on transactions of $50,000 or more.
Your Home or Personal Assets May Be Considered as Collateral
Owner-occupied residences generally become collateral when:
- The lender requires the residence as collateral
- The equity in the residence is substantial and other credit factors / sources of collateral are weak
- Such collateral is necessary to assure that the principal(s) remain committed to the success of the venture for which the loan is being made
- You operate the business out of the residence or other buildings located on the same parcel of land
To the extent that worthwhile assets are available, adequate collateral is required as security on all SBA loans. However, the SBA will generally not decline a loan when inadequacy of collateral is the only unfavorable factor.
For all SBA loans, personal guaranties are required from every owner of 20 percent or more of the business, as well as from other individuals who hold key management positions. Whether a guaranty will be secured by personal assets or not is based on the value of the assets already pledged and the value of the assets personally owned compared to the amount borrowed.
What Are Earnings Requirements?
Financial obligations are paid with cash, not ‘on paper’ profits. When cash outflow exceeds cash inflow for an extended period of time, a business cannot continue to operate. This means that cash management within your business is extremely important. In order to adequately support your company’s operation, cash must be at the right place, at the right time and in the right amount.
Making Timely Debt Payments
A company must be able to meet all its debt payments (not just its loan payments) as they come due. All SBA loans require that the borrower be able to reasonably demonstrate their ability to repay the intended obligation from their business operation. The lender will consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan before making funds available. Payment history on existing credit relationships (personal and commercial) is considered an indicator of future payment performance, so endeavor to pay all of your bills and other debts on time to show the lender that you are dependable. Lenders will also want to know about any contingent sources of repayment (ways you can pay your debt if your business fails).
Preparing a Cash Flow Projection Report
Applicants are generally required to provide a report detailing when their income will become cash and when their expenses must be paid. This report is usually in the form of a cash flow projection, broken down on a monthly basis and covering the first annual period after the loan is received. A critical factor in loan approval is making sure the lender understands how these revenues will be generated. This is especially true when the projections are for a new business or an expanding business with anticipated revenues and expenses exceeding past performance by a significant amount (20 percent or greater).
If you can show your lender a clear business plan that provides for all debt payments concerning the business to be paid on time, your application has a better chance of being approved. If you have savings or assets set back to cover the possibility of future income from the business falling short of your projections, this will also help your case.
Working capital is defined as the difference between current assets and current liabilities. Current assets are the most liquid of your assets, meaning they are cash or can be quickly converted to cash. Current liabilities are any obligations due within one year. Working capital measures what is leftover once you subtract your current liabilities from your current assets, and can be a positive or negative amount. The working capital is available to pay your company’s current debts, and represents the cushion or margin of protection you can give your short-term creditors.
Positive Working capital is essential for your company to meet its continuous operational needs. The availability of working capital influences your company’s ability to meet its trade and short-term debt obligations, as well as to remain financially viable. If your current assets do not exceed your current liabilities, you run the risk of being unable to pay short term creditors in a timely fashion.
Businesses that are seasonal or cyclical often require more working capital to stay afloat during the off season. Although your company may make more than enough to pay all its obligations yearly, you must ensure you have enough working capital at any one time to meet your short term obligations. For example, a company may do significantly more business over the holidays, resulting in large payoffs at the end of the year. However, the company must have enough working capital to buy inventory and cover payroll during the off season as well, when revenues are lower.