10 questions to ask before applying for a bank loan
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Most small business owners need a bank loan at one point or another, and applying for one involves a lot more than filling out paperwork and saying a prayer. Among other things, you need to consider the state of your personal and business finances, how you will repay the loan, and how much money you actually need.
Here are some of the key questions you should ask yourself before starting an application:
Am I likely to qualify for the loan?
You’re only going to hurt your credit if you ask for a loan that you won’t get. “Just like if you’re turned down for a personal credit card, it’s harder to borrow in the future,” says David Gass, business consultant and coach in Meridian, Idaho. “If you are refused, the next bank considers you a bad risk.” He suggests asking lending institutions about their specific requirements before applying. Many will let you know the minimum credit score they require, the cash flow you need to show, and other qualifying factors.
How much do I really need?
Before approaching the bank, make sure you have a good idea of how much money you really need. The best way to determine this is to create a monthly cash flow projection. Does your client pay you in 60 days, but you have to pay your suppliers in 15 days? If so, you might need some extra money to help out. “It will look bad on you if you come to the bank asking for $50,000, then they ask you to create a cash flow projection and you find out you actually need $100,000,” says Adam Hoeksema, co -founder of Muncie, Ind.-based ProjectionHub, a web-based application to help entrepreneurs make financial projections. “You need to know how much you need and how you will use the funds before you approach the bank.”
How much can I borrow based on the asset I’m using as collateral?
Business owners often think that if they buy equipment for $100,000, they should be able to borrow $100,000 by pledging the equipment as collateral. But banks generally disagree, Hoeksema says. “Banks will value your asset below what you think the value should be and then they will only lend up to a certain percentage of the asset’s value.” For example, banks can lend up to 70% of the value of new equipment, and perhaps only 60% for used equipment.
Do I have enough cash to repay the loan?
Your banker will likely ask you to provide financial projections for the business. Be sure to include your debt repayment plan in these projections. Bankers will look for companies that have some leeway, and you may need to show free cash flow three times your debt payment needs, Hoeksema says. “They don’t want to see if you lose a client, you won’t be able to repay your loan this month. If your projections show you have very little room for error, you might scare them off.”
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Will the money help my business grow?
If you borrow $10,000 for payroll or other day-to-day operating expenses, you’re not generating more income from the loan, and you could be in the same place in three to six months. Instead, you should invest the borrowed dollars in the parts of the business that will generate more revenue over time and help reduce future borrowing needs, Gass says. “If I take that dollar and mine it, put it into sales and marketing and generate more revenue – $1 generates $5 – then it’s worth it. It’s about developing the ‘business.”
What is my company’s credit rating?
Most people know their personal credit score, but very few know their business score, says Rohit Arora, CEO and co-founder of Biz2credit, a New York-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 the score is not as high as you think it should be, it may be because there are pending liens against your business. Also, make sure your suppliers report your payments. You can try to increase your score by reducing your business credit card balances or by requesting a line of credit increase to reduce the percentage of your available credit in use. “The lender will verify your business, and your score is the final arbiter of whether or not you get the loan,” says Arora. “Even if you have outstanding personal credit and good assets, if many business contacts say you pay them late, that will scare off lenders.”
Are my personal finances in order?
Bankers may want to see your “overall financial statement,” including personal information such as outstanding student loans, personal credit card debt, and mortgage payments. Until your business reaches a substantial size ($5-10 million in annual revenue or more), the bank will 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 consider you a good candidate for a loan,” Hoeksema says. . “If you have a lot of personal debt and very little collateral you can provide to the bank, you may need to find a strong co-signer.”
Do I have all the documents I need to apply for the loan?
Arora says some studies have shown that up to four out of five loans are never closed — “not because the business didn’t qualify, but because of the paper chase.” When applying for a business loan, you will need a lot of documentation. For example, if you are seeking a loan from the Small Business Administration, Arora recommends providing business and personal income tax returns for the past three years, personal financial statements, and financial projections for the next 12-24 months. “If you go to [lender] and aren’t fully prepared, not only does that make you look unprofessional, but by the time you get the documentation in place, it could be outdated,” he says.
Does the loan have a prepayment penalty?
When you take out a loan, find out if you are free to repay it early without any penalty. Some states allow lenders to charge prepayment penalties, in which case you should try to negotiate a compromise. For example, you might accept a penalty only if you repay the loan within a relatively short period of time, say, within six months of the loan date. “Prepayment is especially helpful if you think your business will soon expand and you may need a larger line of credit,” says Jeanne Brutman, a New York-based financial planner for small business owners. . “By having a good cash surplus and a refund or [paid-down] line of credit, it shows the lender that you are responsible for the debt and can handle an increase in your total credit. »
If I die, how will the loan be repaid?
It’s something most people don’t like to think about, but in the event of death, an unpaid business loan can affect your family. “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 example, the bank may come after that. Learn about a lender’s policy in the event of death to best determine how to protect your family. “Most business owners understand that if they insure their home and the business goes bankrupt, they could lose their home,” Brutman said. “But they may not understand that if they die it doesn’t cancel their debts.” It may be preferable to place your assets in the name of your spouse, if he or she does not own a stake in the business. Brutman also recommends P&C insurance which, in the event of death, takes professional debts into account.