About Borrowing Money for Your Small Business

About Borrowing Money for Your Small Business
  • Opening Intro -

    There may come a point in your small business ownership where you will want to borrow money.

    That money may come in handy to help you purchase equipment, expand your location or even to help you meet payroll.

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Obtaining a business loan isn’t as easy as getting a personal loan. You need to know what your banker requires when qualifying your business for a loan.

1. Your financing options.

There are two types of business financing options you will consider: equity financing and debt financing. Equity financing represents funds raised that give borrowers a stake in your business. For instance, you might issue stock shares that give shareholders ownership. The advantage here is that you assume no debt, but the disadvantage is that you relinquish a measure of control over your business.

For the smallest of businesses, equity financing may be achieved by having friends and family members provide funding. Venture capitalists may also provide support, risk takers who may know your industry. Technology companies and health service companies are of prime interest to a venture capitalist.

Debt financing is the typical approach business owners take when seeking money. Here, you may approach your bank, a credit union or other financial company to obtain a loan. The lender does not take a stake in your business as the loan is offset by your assets.

With both financing options, your debt-to-equity ratio is of prime importance. You stand a better chance of receiving financing if the amount you owe others (debt) is significantly below the stake (equity) you have in the business.

2. Business and personal credit.

How good is your credit? You need to have a good credit rating to qualify for a business loan.

Bankers will look at both your personal and business credit when considering your application. You should examine your personal credit reports, what you can obtain through AnnualCreditReport.com at no charge to you. Review your reports to ensure that the information about you is correct. Obtain your personal credit score too.

Your business credit history reports may be listed with Dun & Bradstreet, Equifax and Experian. The latter two, along with TransUnion, provide your personal credit reports too. Like your personal credit reports, your business credit reports should accurately convey your business status to include: your business name, federal tax identification number, your current debt as well as your credit lines.

3. Your ability to repay your debt.

Your debt-to-equity ratio may be favorable and your cash flow consistent. Even so, lenders will scrutinize your financial statements to verify that your cash flow is sufficient to pay back what you owe.

You may have a few things working for you too. The longer you are in business, the more comfortable bankers are with working with you. Demonstrating consistent profit can also help your cause. If your profit margin is thin you may still qualify for a loan if the amount borrowed won’t cause your business to operate in the red.

4. Equity and Collateral

There are two areas where lenders will scrutinize when considering your application: equity and collateral. Equity represents your personal stake in the business, including the funds you contributed to launch your enterprise as well as the its debt-to-equity ratio. The lower your debt level to your equity, the better your ratio.

Collateral represents what you own and are willing to put up to secure the loan. Without collateral you will need a co-signer to vouch for the loan. This individual will be putting their personal reputation on the line and will be tapped to repay the loan if you default. Collateral can come from your personal home, a car, equipment, a retirement account, jewelry or anything else of value that the bank accepts.

5. Management Competence

Another factor your lender will look at is management competency. If you demonstrate control of your business, you have a better chance of being approved for a loan.

Besides your ability to repay the loan, your banker will examine if you pay your bills on time, control your expenses, manage your inventory, have a profitable operating history and are experiencing sales growth. Other factors include your accounts receivable, the future of your industry and your competition.

Loan Considerations

There are other matters important for receiving a loan. Your banker will review your business plan, she may ask for references and may request your personal income tax returns and examine your financial statements. Certain legal documents, such as, your articles of incorporation, franchise agreements, commercial leases and business licenses may also be required.

Lastly, expect your banker to ask you why you are applying for a loan and how those funds will be used. If you are purchasing assets, the names of your suppliers may be required.

See AlsoEssentials of a Business Action Plan

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