Applying for a bank loan involves much more than completing paperwork and saying a prayer. Among other things, you need to think about the condition of your personal and business finances, how you’re planning to repay the loan and exactly how much money you actually need. Here are some of the key things to ask prior to starting an application.
Things to ask Before you apply to get a Loan from the bank
1. Is it likely I’ll qualify for the loan?
You’re only going to hurt your credit in the event you apply for a loan you won’t get. “Just like if you get declined for a personal credit card, it makes it more difficult to borrow in the future,” says David Gass, a business consultant and CEO of Anderson Business Advisors. “If you get turned down, it looks to the next bank like you’re a bad risk.” He suggests asking lending institutions about their specific requirements before you apply. Most will inform you about the minimum credit score they require, the cash flow you need to show along with other qualifying factors.
2. Just how much do I really need?
Before you approach the bank, ensure that you have a good handle about how much cash you actually need. The easiest way to determine this would be to develop a monthly cash-flow projection. For example, when your customer pays you in 60 days however you have to pay your vendors in 15 days, you might need some extra money to tide you over.
“It will reflect poorly on you if you come into the bank asking for $50,000, then they ask you to create a cash-flow projection and you find out that you actually need $100,000,” says Adam Hoeksema, co-founder of Muncie, Ind.-based ProjectionHub, a web app that can help entrepreneurs make financial projections. “You should know how much you need and how you will use the funds before approaching the bank.”
3. How much can I borrow depending on the asset I’m using for collateral?
Business owners often think if they buy a piece of equipment for $100,000, they should be in a position to borrow $100,000 by pledging the equipment as collateral. But banks usually don’t agree, Hoeksema says. “Banks will value your asset below what you think the value should be, and then they’ll only lend up to a certain percentage of the value of the asset.” For example, banks might lend up to 70 % of the valuation of a brand new piece of equipment, and possibly only 60 percent for used equipment.
4. Do I have adequate cash flow to repay the loan?
Your banker will most likely ask you to provide financial projections for the business. Make sure to include your debt repayment plan in those projections. Bankers are going to be looking for companies that have some wiggle room, and you may need to show available cash flow that’s three times more than your debt payment requirements, Hoeksema says. “They don’t want to see if you lose one customer, you won’t be able to make your loan payment this month,” he says. “If your projections show that you have very little room for error, you’re likely to scare them away.”
5. Will the money help my company grow?
If you’re borrowing $10,000 for payroll or other routine operating expenses, you’re not generating more revenue from the loan and may find yourself in the same spot three to six months from now. Instead, you’ll want to put borrowed dollars into the areas of the business that will generate more revenue over time and help reduce future borrowing needs, Gass says. “If I take that dollar and leverage it, put it into sales and marketing and drive more revenues — $1 driving $5 — then it’s worth it. It’s all about growing the business.”
6. How good is my business credit rating?
Most people might know their personal credit rating, but hardly any know their business score, says Rohit Arora, CEO and cofounder of Biz2Credit, a New York City-based company that arranges loans for small businesses. As with personal credit, you can find your business credit score through Experian, TransUnion or Equifax. If your score isn’t as high as you think it should be, it could be because there are outstanding liens against your business. Also check to make sure your vendors are reporting your payments.
You can try to improve your score by reducing the balance on your business credit cards or requesting a credit-line increase to lower the percentage of your available credit being used. “The lender is likely to check your business, and your score is the final arbiter of whether you get the loan or not,” Arora says. “Even if you have stellar personal credit and good assets, if a lot of business contacts are saying you’re paying them late, that’s going to scare off lenders.”
7. Are my personal finances in order?
Bankers may want to look at your “global financial statement,” including personal information like outstanding student loans, personal credit card debt and mortgage payments. Until your company reaches a substantial size ($5 million to $10 million in annual revenue or higher), the bank will almost certainly rely heavily on your personal financial statement and personal credit score to determine the creditworthiness of your business. “If you have a $200,000 mortgage on a house worth $250,000, and you have $200,000 in student loans, the bank may not see you as a good candidate for a loan,” Hoeksema says. “If you have a lot of personal debt and very little collateral that you can provide to the bank, you may need to find a strong co-signer.”
8. Do I have all of the documentation I need to apply for the loan?
Arora says some research indicates that around four in five loans never close not because business didn’t qualify, but because of the paper chase. When applying for a business loan, you’ll need a lot of documentation. For example, if you’re seeking an SBA loan, Arora recommends you provide the last three years of business and personal tax returns, personal financial statements and financial projections for the next 12 to 24 months. “If you go to the [lender] and aren’t fully prepared, not only does it make you look unprofessional,” he says, “but by the time you get the documentation in place, it might be outdated.”
9. Does the loan possess a prepayment penalty?
When obtaining a loan, find out if you’re free to pay it off early without having a penalty. Some states allow lenders to charge prepayment penalties, then you definitely need to try to negotiate a compromise. For instance, you may agree to a penalty only when you pay off the loan in a relatively short time period, say, within 6 months from the time of the loan. “Prepayment is especially valuable if you believe your business may grow soon, and you may need a larger line of credit,” says Jeanne Brutman, a New York City-based financial planner for small-business owners. “By having good excess cash and a paid-off or [paid-down] line of credit, it shows the lender you’re responsible with debt and can handle an increase in your total credit.”
10. If I die, how will the loan be repaid?
It’s something the majority of people don’t want to take into consideration, but in the event of your death, an unpaid business loan can impact your loved ones. “Most people think, if I die, the bank is out of luck, but that’s not true,” Brutman says. If you leave a large life insurance policy, for instance, the bank may come after that. Find out what a lender’s policy is in the event of your death to best determine how to protect your family. “Most business owners understand that if they’re collateralizing their house and the business fails, they could lose their house,” Brutman says. “But they may not understand that if they die, it doesn’t cancel out their debts.” It may be best to put your assets in your spouse’s name, if the spouse doesn’t have an ownership stake in the business. Brutman also recommends personal property and casualty insurance coverage, which, in the event of your death, takes business debt into account.
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