Many banks in Maine, and other states, remain hesitant about loaning money to start-ups and small business owners, even nearly a decade after the financial crisis of 2008. Stricter lending policies often make applying for financing a nerve-wracking and time-consuming process. If you need a loan to start or expand your business, here are some ways to give your loan application a leg up on other applicants.
Understanding Business Credit Scores
Business credit scores come from various reporting agencies, such as Experian, Equifax and Dun & Bradstreet. Each agency has its own algorithm for calculating credit scores. Like personal credit scores, higher business credit scores equate with lower risk (and vice versa).
Credit agencies use employer identification number (EIN) to track your business. Data is compiled from your EIN registration, including the company’s address, phone number, owners’ names and industry classification code. The agency may also search the Internet and public records for bankruptcies, judgments and tax liens. Payment experiences may also be reported to the credit agency by landlords, suppliers, leasing companies and other creditors.
In addition to timely bill payment, business credit scores factor in:
Industry. Participation in high-risk industries tends to lower a business credit score. Some agencies keep track of the percentage of companies under the company’s industry classification code that have filed for bankruptcy.
Size. Higher annual revenues or net worth generally increase your credit score.
Structure. Corporations and limited liability companies tend to receive higher scores than sole proprietorships and partnerships.
Track record. Credit agencies also look at the length and frequency of your company’s credit history. Once you establish credit, your business should periodically borrow additional money and then repay it on time to avoid the risk of being downgraded.
Credit scores are important for businesses. They help lenders decide whether to approve your loan request, as well as the loan’s interest rate, duration and other terms. Unfortunately, some small businesses and start-ups have no credit history. Try not to let this happen to you by building your company’s credit history by applying for a company credit card and paying the balance off each month. Utilities and leases should be put in your company’s name, so the business is on the radar of the credit reporting agencies.
Do you disagree with your business credit score? Sometimes, credit agencies base their ratings on incomplete, false or outdated information. Monitor your credit score regularly and note any downgrades. In some cases, the agency may be willing to change your score if you contact them and successfully prove that a rating is inaccurate.
Think like a Lender
A lender has these questions in mind at the most basic level:
- How much money do you want?
- How do you plan to use the loan proceeds?
- When do you need the funds?
- How soon can you repay the loan?
First, basic background information is needed. You’ll need to explain your business and how it’s been financed to date. This includes your personal cash infusions, forgone salaries and sweat equity, as well as any equity contributions from friends, family members and outside investors.
Two types of financing are typically offered by banks: lines of credit and asset-based loans. A line of credit is primarily used to meet working capital fluctuations. It’s generally considered short-term, and banks may expect repayment within the next year. However, in practice, most businesses keep their revolving credit lines open for many years, occasionally drawing and repaying funds based on operating cash flow.
Asset-based loans are typically used for specific items, such as equipment purchases or plant expansions. With asset-based loans, the length of the loan is usually tied to the life of the asset that’s financed — and that asset is usually pledged as collateral for the loan. Business owners aren’t typically allowed by the bank to finance 100% of an asset purchase. Instead, a reasonable down payment contribution is expected.
Remember the Three C’s
The focus of your loan application should be, “This is how you’ll get your money back,” because banks want to lower their risk. Before approving a loan request or deciding on the loan terms, your lender will assess the three C’s:
Character. How strong is the management team? Skills, reputation, training and experience are key indicators of whether a business loan will be repaid. Banks also look at the company’s track record with creditors. This includes trade references from key suppliers and business credit reports. Trade references tend to be submitted by businesses without established credit histories and those who deal with smaller suppliers that don’t report to credit agencies.
Capacity. To determine your ability to repay the loan, lenders will evaluate past and projected financial statements, as well as your business plan. Underwriters want to know how you’ll use the loan proceeds to increase cash flow enough to make loan payments by the maturity date.
Collateral. In the event that you don’t generate enough incremental cash flow to repay the loan, these are the assets pledged. It’s a lender’s back-up plan in case your financial projections fall short. Examples of collateral include savings, stock, real estate, inventory and equipment.
In addition, the owner’s personal credit will be factored into the lending decision for the business, and the bank will likely require a personal guarantee from the owners. So, even if your business is incorporated, expect to share personal financial details and put your personal assets on the line to secure the debt.
Lenders have no interest in you “winging it” when it comes to applying for a loan. They want serious borrowers who are invested in their businesses and aware of their financial condition and performance. Here are five tips for putting your best foot forward:
- Take time writing narratives and projecting future growth.
- Be realistic about your strengths and market opportunities.
- Be honest about your weaknesses and potential threats to your growth.
- Always double check your math when calculating ratios and building financial projections.
- Ask someone else to proofread your writing to ensure that it’s clear, concise, objective and accurate.
Lenders have seen all kinds of business plans and financial projections, and they know how to critically evaluate the underlying assumptions. Where possible, support your assumptions with research and market data.
Compile a Formal Package
Put together a comprehensive loan package before meeting with your lender. It should include:
- A narrative “statement of purpose,”
- Your business plan
- Three years of business financial statements (including balance sheets, income statements and statements of cash flow), if available,
- Three years of business tax returns, if available,
- Personal financial statements and tax returns for all owners,
- Appraisals for assets pledged as collateral, and
- Prospective financial statements.
If your lender thinks you’ll make a viable borrower, they will give your application to the bank’s underwriting committee. Underwriters will have greater confidence in your historic and prospective financial statements if they’re prepared by a CPA and conform to U.S. Generally Accepted Accounting Principles.
However, remember that this list is just a starting point, and lenders may ask for additional information, such as interim financial statements, lease agreements and marketing brochures.
Afraid of Rejection?
Not every loan application is approved by lenders. So, don’t give up if one bank turns you down. Ask why the application was denied and fix the problem when making future loan requests.
Consult with Filler & Associates or your professional financial advisors to increase your chances of getting approved. They’re familiar with the loan application process and can help you compile a comprehensive loan package, as well as preparing realistic business plans and prospective financial statements.