We spend a lot of time talking to owners who have questions about the next steps they need to take for their business. We’re sharing the most common questions we are asked.
Is it important to find a bank near my home or business?
Not as much as it is to finding the right bank for your small business. Choosing the right bank for your business involves more than opening a new account at your personal bank or picking the branch office nearest you. You need to understand what services your business requires. Does Bank A provide them? If so, how much?The best way to determine whether or not to consider a particular bank is to find out the answers to the following questions:
- Is the bank healthy? Does it have strong financials?
- Does the bank have a business division focused on lending to small- and medium-sized companies?
- Does the bank work with the U. S. Small Business Administration on lending to small businesses?
- Does the bank offer small business retail and cash management services? For example, small business checking and savings accounts, money market accounts, credit cards, and online and mobile banking services, just to name a few.
View your banking arrangements as a long-term relationship. Consider not just what you need immediately, but services you may require in 18 to 24 months.
What documents should I have ready?
Before you start applying for loans, you should get some basic documentation together. The following are typical items that will be required for any small business loan application:
- Personal background: Either as part of the loan application or as a separate document, you may be asked to provide some personal background information, including previous addresses, names used, criminal record, educational background, etc.
- Resumes: Some lenders require evidence of management or business experience, particularly for loans that are intended to be used to start a new company.
- Business plan: All loan programs require a sound business plan to be submitted with the application. The business plan should contain a complete set of projected financial statements, including profit and loss, cash flow and balance sheet.
- Personal credit report: Your lender will obtain your personal credit report as part of the application process. However, you should obtain a credit report from all three major consumer credit rating agencies before submitting a loan application to the lender. Inaccuracies and blemishes on your credit report can hurt your chances of getting a loan approved. It’s critical you try to clear these up before beginning the application process.
- Business credit report: If you are already in business, you should be prepared to submit a credit report for your operations. As with the personal credit report, it is important to review your business’s credit report before beginning the application process.
- Income tax returns: Most loan programs require applicants to submit personal and business income tax returns for the previous three years.
- Financial statements: Many loan programs require owners with more than a 20 percent stake in your business to submit signed personal financial statements. You may also be required to provide projected financial statements either as part of, or separate from, your business plan. It is a good idea to have these prepared and ready in case a program for which you are applying requires these documents to be submitted individually.
- Bank Statements: Many programs require one year of personal and business bank statements to be submitted as part of your loan package.
- Collateral: Collateral requirements vary greatly. Some loan programs do not require collateral. Loans involving higher risk factors for default require substantial collateral. Strong business plans and financial statements can help you avoid putting up collateral. In any case, it is a good idea to prepare a collateral document that describes cost/value of personal or business property that will be used to secure a loan.
- Legal documents: Depending on a loan’s specific requirements, your lender may require you to submit one or more legal documents. Make sure you have the following items in order, if applicable:
- Licenses and registrations required for you to conduct business
- Articles of Incorporation
- Copies of contracts you have with any third parties
- Franchise agreements
- Commercial leases
What type of questions should I ask my banker?
Sometimes, you don’t know what you don’t know. Here are some questions you should ask when meeting with your potential banker.
- What type of financing is available for my business?
- Do you provide financing for businesses in my industry/sector? What has your experience been with businesses similar to mine?
- What is your loan approval process? On average, how long does it take?
- Can I fix the interest rate?
- Do you ask for an owner’s guarantee?
- Do you work with the Small Business Administration as a resource for lending to small businesses?
Should I consider an online lender?
If you’re a small business owner seeking a business loan, yes, you should consider an online lender. While these creditors currently account for a tiny fraction of all small business finance, they are currently the most rapidly growing source of small business debt. In fact, the Federal Reserve Bank of New York has found that nearly 20 percent of small businesses seeking to borrow money have applied to online lenders. While loans from online lenders are often more expensive than other forms of small company credit – interest rates are similar to those of credit card loans – small business owners should consider online lenders as a source of financing for several reasons:
- Many online lenders offer products that match the financial needs of small business owners better than many products offered by banks, (e.g., small balance loans).
- Online lenders offer quick and simple loan applications.
- You may be more likely to obtain a loan from an online lender than from a bank. Online lenders sometimes find borrowers rejected by banks to be creditworthy because they evaluate small businesses differently.
How does my personal credit affect my ability to get a business loan?
In today’s economy, many people have experienced their personal credit scores decrease due to a myriad reasons: unpaid loans, bankruptcy or just simply misinformation reported to the credit reporting agencies. As an entrepreneur, your personal credit can and often will affect your ability to obtain a business loan or other types of financing. Many lenders review their applicants’ credit scores as part of their decision on whether or not to approve the loan. To the majority of lenders, your credit score reflects how well you handle money. A low credit score may indicate that you don’t handle your finances well, and therefore, won’t be able to handle your business finances well either.
What does it really mean when a bank wants to involve the SBA?
Securing small business financing can be challenging. Whether you are just starting out or looking to grow, banks can be rigorous in their lending review practices. For example, businesses with few assets to their name may find it hard to secure a traditional loan. Other business owners may not be able to provide the reassurance that lenders seek to alleviate their concerns that your business may fail and the loan won’t get repaid. If your lender decides that you aren’t the right candidate for a traditional business loan, they may consider an SBA loan program. The SBA doesn’t lend businesses money. Instead, their programs transfer the risk away from banks and encourage them to make loans to small businesses by guaranteeing a large part of the loan.
How much can I afford?
Figuring out how much you can afford to borrow for your business is a crucial step in the loan process and one you should definitely take before approaching potential lenders. Banks and other lenders use several tools to determine if a business entity is a good candidate for a loan, one of which is a debt service coverage ratio (DSCR).The DSCR is your net operating income divided by your total annual debt service. The first half of that equation – your monthly net operating income – takes into account things like your revenue/sales, the cost of goods sold, your payroll, rent, utilities, and other miscellaneous expenses. Simply put, it’s what you make, minus what you spend. The second half is based on how often you make debt payments, and what the amounts of those payments are. The DSCR is most commonly expressed as a multiple, and that multiple indicates how much cash you have left over after expenses to make your debt payments. Here are a few examples:
- Once you’ve figured out what your finances are, you find out that you have a DSCR of 1.5x (expressed as a multiple). This figure means that you can pay back your annual debt payments in full, and the half over again if you’d like. That’s a pretty good coverage ratio!
- Alternatively, if after you’ve figured out your finances, you find out that you have a DSCR of 1x. This means that you have just enough to make your debt payments. Typically this isn’t a high enough ratio for most lenders. Most banks and lenders generally look for DSCRs of 1.25x or greater. Demanding a higher DSCR is good to the borrower and the lender because it inherently provides a cushion for the “what ifs”.
- On the other hand, a DSCR below 1x means that you do not have the ability to repay your loans. It’ll be hard to secure a loan with this ratio.
Once you understand your DSCR, you’ll be able to then answer the question, “how much money can my business afford to borrow?”
Should I consider equity funding rather than debt funding?
Deciding between equity financing and taking out a loan for your business is a challenge for all small business owners when they need capital to start or expand a business. Should you look for an investor? Or should you go to a bank?Having an investor write you a check may seem like the perfect answer if you want to start a business, or expand an existing one. Mainly because it’s money without the stress of repayment of interest and other costs associated with a loan. But these monies often come with conditions: You may have to relinquish some control of the business operations, share the profits, or even give up an ownership share. The business relationship with a bank is very different from an investor’s equity injection. Probably the most important difference is that you do not need to give up part of your company. The bank or lending institution has no say in the way you run your company and does not have any ownership in your business.
Most small business owners opt for a blend of both equity and debt financing to meet their needs for starting or expanding a business. These two forms of financing complement each other well; the key is finding the right ratio.
Our small business loan experts are ready and willing to discuss your specific questions in more detail. Contact us today to explore the next steps for your business.