Important Lessons Learnt While Getting Finances for Small Businesses
Lending is always a delicate and somewhat complicated process because substantial amounts of money are inevitably involved. A majority of small and medium businesses don’t easily get bank financing because of their basic lack of knowledge in navigating the whole process. However, persistence and going about it the right way will always yield the right and desired results. The following four notable lessons can be learnt while making an effort to get bank financing.
Financing May Not Be Required At All
Strange as it may sound initially at least, the first lesson many people learn when they attempt to get their maiden business loan is that they may not require financing at all, at least at that point of time. That’s why you need to carefully figure out first if at all financing is required in the first place. Moreover, you have to ensure that debt financing is the right option for you.
If immediate cash-flow that supports your interest payments is lacking and yet you anticipate higher growth in future, equity financing may be a more viable option. So first think whether at all you need the money at all or not. Are you buying new equipment, commercial real estate, or planning to expand?
Certainly taking a loan to cover up for accumulated losses, building leased offices, or buying assets that are unnecessary for your business does not make sense. Rather, you will have to strongly convince your lender what you are going to do with his money and that his funds would be used wisely to generate revenues and profits in future. Once you are able to do that, then only will you get to see the funds rolling in.
The industry to which you belong and risks involved
It is also for you to gauge first how risky the industry to which you belong is. If you function in a high risk industry, you have to have a definite plan to tackle and overcome any obstacles which your competitors can’t.
The lender will first see that and it’s only when you show him something worthwhile to that effect that he will consider shelling out the funds. Otherwise, not. In terms of risk analysis, you have to also check if your financials are sound, the number of years that you have been in the business and if any outstanding debts and/or liabilities exist.
Know your lending bank
Your chances of landing adequate bank financing increase when you think like your lending bank. Since a majority of banks have a similar revenue model with somewhat similar interest rates, the onus is on you to prove beforehand that you shall not default on payments later. This implies that you will have to analyze certain risk factors that the lender will consider first.
These include: the business plan and model, which is all about your ability to overcome economic changes and whether your model will be able to sustain growth in future; and your personal equity which requires looking into whether you are risking your own funds as business capital and should the business fail, would you still be able to repay your debt.
Your pitch determines success or failure
When you approach the lender, particularly for the first time, make sure that you have a coherent and convincing appeal for him to at least consider the merit of your application. Most first time applicants get their appeals rejected because of a faulty appeal that fails to convince prospective lenders.
Even the SBA or Small Business Administration, the US federal agency underwriting many such loans insists that the application should be absolutely free of any shortcomings and must include a complete and proper business plan, all relevant financial information and the last three years’ personal and business tax returns.
This suggests that going over your business plan carefully before submitting it is mandatory and that your analysis and future strategies makes sense. Look for any shortcomings and address them promptly and properly to deliver a faultless and convincing business plan.
It never pays to approach only one lender with the hop of landing an external financing deal. Apply to other banks as well so that your chances of negotiating more easier and favorable terms with other lenders increase. This could cut your loan costs substantially and improve your bottom line in the long run. Should your application be rejected by a bank, don’t lose heart.
You can always approach private investors and online lenders. Even though their interest rates may be higher due to increased risk, you can always go for them provided your cash flows support repayments later.
External financing may not be worth its value and your time
It is often seen that only a tiny fraction of new businesses get funds from a lender who’s not the business’s founder. Therefore, unless the business comes equipped with adequate hard assets usable as collateral for debt financing, going fund hunting is most likely to be unfruitful.
It would be applicable to a few startups with a very high future growth potential and exit plans that attract accredited venture capitalists and angel investors. It is therefore, better that you develop a lesser capital-intensive model and finance your startup privately rather than go external fund hunting.
Importance of personal collateral and credit
These matter a lot when a startup approaches a lender for funding. The US Federal Reserve’s Survey of Small Business Finances reveals that 25 percent of companies that are below five years of age and about 50 percent of sole proprietorships of a similar age, guarantee their business debts personally.
Since a fraction of smaller businesses borrow externally, this implies that a bulk of the capital borrowed by entrepreneurs is borrowed personally and/or guaranteed personally. With the involvement of personal debt, the lender’s risk is less on the business’s potential than on the business owner’s collateral and credit. Without a commendable personal credit and adequate assets which cane be pledged against a loan, borrowing for your new business can be major hassle no matter how great the business idea is.
In short, it’s only a business that has a high-growth potential business with appropriate exit plans that will get precedence when it comes to external debt financing. The above mentioned points may be kept in mind before you flip the switch for a loan.
Anne is a Senior Author for SBL. She began her career as an independent consultant for local businesses after graduating with a BA in Management. Since that time, she’s expanded to writing as well as consulting to spread helpful knowledge to small business owners across the country.