Most small businesses will eventually require some form of debt financing to continue to fund their growth or maintain their operations. When this need arises, it’s important for small business owners to understand all of the options at their disposal.
Unlike consumer finance, small business finance allows many different options for business owners to secure the capital that they need for their enterprises to flourish. While traditional bank financing can still provide one of the most solid options for the funding of small business, there are a host of other means of financing smaller companies that don’t come with many of the stringent criteria and challenging hoops that traditional lenders often impose.
Still, for those who qualify, traditional bank financing, including secured loans and small business lines of credit, are usually the best options. That is why understanding how to best ensure that a business will be approved for a loan is one of the most important tasks that any small business owner can undertake. Laying the groundwork for strong creditworthiness today can make the difference when a cash crunch occurs tomorrow.
Traditional lenders look for sure things
At their core, traditional bank loans and small business lines of credit are a cut above most other financing options for one simple reason: Banks and other traditional lenders rarely ever take an equity stake in the business and, generally speaking, are not interested in foreclosure as a means of profiting. This means that going with a bank loan or line of credit can offer small businesses large amounts of capital without taking on a partner who will participate in the upside. While this may not seem like an especially big deal at first glance, the laws of compounding ensure that being able to retain all of the profits and ownership in a growing enterprise is one of the most certain ways to become fantastically wealthy.
But the fact that bank lenders don’t participate in the upside also means that they are particularly risk averse. Although they don’t advertise it, most bank lenders are looking for the closest thing they can find to a sure thing. Unlike some other forms of financiers, bankers are not speculators or gamblers. And this means that, in practice, bank lending practices when it comes to small business loans are extremely stringent.
Maximizing one’s chances of getting a bank loan
For businesses that need hundreds of thousands or millions of dollars in credit, there simply is no better alternative than getting a low-interest-rate bank loan or business line of credit. But there are three things that a business must adhere to in order to maximize its chances of securing bank financing.
The first is that the owner and the business itself must have impeccable credit ratings. One of the best ways to ensure that one’s business will have a good business credit rating is to make sure that the owner’s finances are never comingled with the business’ finances from the beginning. The business should, of course, also use a variety of different forms of credit and always make timely payments, in full, by the deadline.
At the same time, business owners should shoot for the highest possible personal credit rating that they can attain. This is helped by maintaining a number of different types of credit. It is also aided by only using around a quarter to a third of the credit available to that individual. This means that someone who could qualify for a $50,000 auto loan might want to pay for $35,000 of it in cash instead. It also means that someone who has credit cards with $10,000 limits should probably only charge up to $3,000 or so at any given time. And they should always make sure to pay off those credit cards on time.
Coming in prepared
Solid credit ratings are only a third of the battle when it comes to securing business loans. Another important factor is having one’s financial statements and detailed business plan in order. As a general rule, banks look for lending opportunities where there is clear value creation taking place. This means that banks want to see exactly how the capital that they are lending to the enterprise will be used to achieve higher profits, not just higher revenues.
Coming into the loan meeting with an income statement, the company’s balance sheet and a cash flow statement are important first steps. These documents should be as detailed as possible. It is also a good idea to have a detailed budget, accounting for every dollar of the loaned money and how it will be spent. The more professional these materials are, the higher the chances that a business will be extended a loan, particularly if there is a convincing case that the loaned money will directly lead to increases in the company’s profits. Banks know that profitable companies are far likelier to repay loans in full than companies that get into trouble. Show them that your company will put the money to good and profitable use.
Be an established business in an established industry
The final pointer about how to maximize the chances that your business will be extended a bank loan or line of credit may be a bit more difficult to readily influence. The fact of the matter is that not all companies fit the mold that bankers are looking for. Participating in an unproven industry or being a new startup with a revolutionary idea or new technology are virtual guaranteed deal killers when it comes to securing bank financing.
For this reason, companies that do not meet all of the tough standards that banks look for may wish to consider alternate forms of financing. All of these alternative sources of funds come with notable downsides when compared with traditional small business financing. However, for the right companies, they can be a good fit.
Just a few examples of alternative lending and financing includes such things as mezzanine financing, factoring, asset-based finance, online lenders and angel investors. While these may not be the owner’s first choice in getting a loan, they should always be kept on the table.