Experienced executives and experts share their advice and fixes for your challenges in business.
Most businesses require outside capital. The question is, what is the best kind to seek? Should it be a loan, small business grant, venture capital, crowdfunding, or an investment from friends and family? Depending on the type of business and the market, you’ll need to tailor your funding search and your approach so that you make the best choice for your particular company. And what should be done before deciding to seek financing? Having a convincing business plan in hand is important. You can improve your chances of securing funding if you know how much money you need, how it is going to be spent, and how long it will take for for you to repay the loan or give a return on investment. Approaching a lender is not unlike preparing for a job interview. You’ll need to anticipate questions, consider all the variables, and know your competitive edge. Three business professionals give some insight into the process of obtaining funding and what you should know beforehand.
Assistant professor of management,
E. J. Ourso College of Business, LSU
From a strategic perspective, you’ll want to consider how a loan fits within your broader objectives. Unlike a line of credit—the better option for managing cash flow in a business—a business loan is usually taken with a specific purpose in mind, such as to initiate a business or to purchase equipment.
The first consideration is where to get the loan. In today’s business environment, there are many sources from which you can borrow. Consider friends, family, or crowdfunding sites, in addition to the more traditional banks, credit unions or small business associations. Terms, conditions and amounts can vary across these sources, so make sure you compare them to get the best options for your business.
The second, and more important, consideration is when to get the loan. It may seem counterintuitive, but loans are easier to obtain when you least need them. For this reason, you’ll want to have a clear road map that allows you to secure the loan in advance of when the cash is needed. This planning affords you more time for finding the best source, and it demonstrates to potential lenders that you are in control of your finances rather than desperate for financing. The riskier you appear, the higher the interest rate you will have to pay to fund the loan.
The third consideration is why a loan is needed. Business loans require repayment, which is an added obligation that can weigh down future business cash flow requirements. You might want to weigh the costs and benefits of a loan against equity financing as a method to fund your business. A loan is an instrument to finance your business but is not the only instrument. Good planning takes into consideration the trade-offs associated with the myriad financing options available in today’s business world.
Senior vice president, Corporate Lending, BancorpSouth
Obtaining financing can be a critical component for companies—and unsettling for many business owners.
Knowing and sharing specifically what you are going to do with loan proceeds is a good start and adds to the comfort level of any lender. Regardless of the size or type of financial institution, your business banker will also want to know a lot about you personally: who you are, how long you’ve been in business, your history of meeting financial obligations and more. How a business owner has handled things in the past is generally an indication of how things will be handled as he or she forges ahead. If it’s a new business venture, be ready to provide operating expense/revenue projections for a year, since you’ll need time to increase sales during your ramp-up period. Another thing to consider is the length of the loan. Should it be five, 10, 15 years … or somewhere in between? Monthly debt payments are critical and can make the difference in the company’s success. Your lender may be able to structure the loan in a way that helps sustain cash flow and leads to profitability for the business.
Lenders will look mostly at your company’s ability to repay through cash flow, but be prepared to offer assurances and/or additional collateral to recoup potential losses on a loan if the enterprise underperforms. Real estate, inventory, equipment, receivables and other business assets are typical collateral requirements that help minimize risk for the lender and affect the loan decision.
Have a plan. Be prepared to place approximately 10% to 30% capital into the transaction on average and to personally guarantee the debt. Additionally, it’s a good idea to provide the lender with the credentials of decision makers in your company to demonstrate your experience and expertise. Choose the financial institution wisely, and get to know the person with whom you may be dealing. Speak with a loan officer to determine what financial documentation he or she requires based on your business or business idea. Loan requests can be denied or face greater scrutiny because of incomplete applications, so be thorough. If you have a startup business, ask your lender about SBA loan guarantees that can help mitigate risk in the structuring of a loan. Don’t hesitate to set up a meeting with a lender to discuss your needs. You may find that a banker is much more willing to discuss—and possibly approve—your request than you think!
WILL CAMPBELL JR.
Director, Louisiana Small Business Development Center, Southern University
When you apply for a business loan, lenders assess your credit risk based on a number of factors, including your credit/payment history, revenue, and overall financial situation. These factors are called the 5 C’s of credit: credit history, capacity, collateral, capital and conditions.
Your credit report gives a detailed list of your credit history—past and present. It demonstrates how you pay your bills on a monthly basis, which is an indication of how you may be counted on to handle obligations in the future. The lender takes in consideration both your personal and business credit in making its decision.
Lenders determine whether you can comfortably make your payment. Capacity to pay is determined by calculating a business owner’s debt service ratio. The debt service ratio is calculated by dividing total revenue by expenses. This number should not exceed the bank’s debt service ratio standard. This standard may vary based on the lender’s policies.
When considering a loan application, the bank will evaluate how the loan will be secured. Most business loans are secured by real estate, equipment, contracts or invoices. What collateral a bank may use varies based on each business owner’s situation. Also, some loans are unsecured loans, such as lines of credit and signature loans.
Capital represents the other assets you have, such as savings, investments and other income, which can help repay the loan.
The lenders would like to know what the purpose of the loan is, how you are going to use the money, and when you will pay the money back. Other factors that are considered in this process are the environment and economic conditions.
The more thorough you can be in providing assurance in these five areas, the more likely your lender will be to seriously consider your loan application.