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SMALL BUSINESS SOLUTIONS

(January /February 2008)

By Anne Richter

Introduction

Despite the trend toward consolidation in the business world, it’s a good time to be an entrepreneur. There are more tools and resources available to the small business owner than ever before, and small business has rapidly become the focus of big business as companies scramble to build and market solutions tailored to the needs of this rapidly expanding market.

In the next several issues, we will be covering a range of topics pertaining to small business – and whether you are already a small business owner or just considering your options, you may be surprised at how much the landscape has changed in recent years.

PART I: SMALL BUSINESS LENDING

Working with the Bank – What to Expect

The first part of this series deals with small business lending – what should you consider when seeking financing for start-up costs or expansion of an established business? Most people associate banks with commercial loans, and for good reason: banks have typically been the major source of commercial business funding.

Although banks have a reputation for conservatism in lending practices and standards, small business owners should not be deterred. It has become easier for small businesses to work with banks, in large part due to the expansion of loan programs designed to assist small business owners – like those offered through the Small Business Administration (SBA).

When working with a bank to obtain a loan, one thing is certain – preparation and organization are key. Before you initiate the process, it’s helpful to understand what factors banks consider when evaluating loan requests. Weighing your business against these factors can give you a good idea of what to expect as a prospective borrower.

• Ability to Repay – It comes as no surprise that the primary factor banks consider is the likelihood of getting their money back. Established businesses with a good track record and strong cash flow are the best candidates for loans. Start-up businesses and established businesses operating marginally will be subject to a more thorough loan review, and will also need to show good collateral as a backup source of repayment. If you cannot provide the necessary collateral yourself, you will most likely need a co-signer on the loan.
• Credit History – If it’s been a while since you checked your credit score, now may be a good time. Banks will always run a credit check with any loan request, and it’s important to know in advance what they’ll see on your report. Many people have errors on their credit report that they don’t know about – and since it can take a long time to get any errors corrected, so be sure to initiate this process well in advance of a loan review. From the bank’s perspective, red flags on a credit report include anything from declaration of bankruptcy to frequent late payments. If there are extenuating circumstances that had a negative impact on your credit history (e.g. debt due to a major medical event), it does not hurt to submit a letter of explanation with your loan request.
• Equity – To obtain a loan, you must be able to show some amount of equity in your business. Established businesses are typically required to have a liability-to-equity ratio of 4:1 – that is, the business’ liabilities should not be more than four times its equity. Start-up businesses will be expected to front the equity – the exact amount will vary depending on the bank, but can range anywhere from 20-40% of your total request.
• Experience – It may seem obvious, but be sure that you can demonstrate to a lender that you have the experience necessary to be successful in your business venture. The best way to showcase your expertise is with a well-written business plan, which should accompany your loan proposal. 

Selecting Your Lender

Relationship banking may sound a tad antiquated, but in the lending industry, it can still make a difference. For those contemplating their own business, it is worthwhile to start building good commercial banking relationships. When selecting a lender, consider the type of client it caters to – will a smaller bank be able to meet your needs? Is a large bank attentive enough to its small business clients? Large or small, make sure the bank understands your business – referrals from small business clients in your industry are a good place to start.

Once you’ve selected a bank, ensure your good standing as a commercial client and loan prospect. Manage your account effectively and avoid bounced checks, low balances, and overdraws. Borrow a small, short-term loan and repay quickly to establish your business credit. Most important, keep an open line of communication with your banker and help them better understand your business.

Loan Proposals 101

The loan proposal is your opportunity to highlight the most promising aspects of your business to an often risk-averse lender. It should demonstrate, at every point, why you are a good candidate for a loan. It should be thorough (especially for a start-up business), but be sure to stick to the essentials – you don’t want to overwhelm your lender with too much information. In general, a good loan proposal contains the following elements:

• Cover Letter/Executive Summary – A brief overview of your business, the exact amount of the loan you’re requesting (never ask a bank for “whatever they can give you”), and the purpose of the loan.
• General Information – Basic information about your company (name of business, address, names of principals); the amount of the loan you’re requesting, and a detailed description of how the loan will be used.
• Detailed Business Description – Details about your business; including products/services provided, ownership, and legal structure. Provide profiles/biographies for key leaders/employees.
• Market Analysis – Description of your market, major competitors, your competitive advantage within the marketplace, description of your customer base, and how your products/services meet the needs of your customers.
• Financials – For established businesses, provide complete financial statements from the past three years. For new businesses, provide projected balance sheets/income statements. Include personal financial statements for principal(s), and details about collateral pledged (if applicable).

Be sure to verify the accuracy of all information provided (especially any financial statements), proofread the final document, and make copies for yourself before submitting the proposal to the lender.

When the Bank Says “Yes”

Congratulations! The hardest part is over. Carefully review all loan documents, and consult an attorney or accountant if you have any questions. Keep your banker apprised of your progress as you assemble the necessary paperwork – and be sure to communicate any concerns you may have along the way.

When the Bank Says “No”

First, realize that you have a right to know why your loan request was declined. The information can only help you the next time around. For smaller loans, many banks now use automated credit scoring programs, which can reduce subjectivity in the loan approval process. But when it comes to understanding why you didn’t get a loan, make sure an actual person can explain the reasoning. You may have issues on your credit report that need further clarification, or you may simply need to provide additional information in your loan proposal. Either way, do not be shy about asking your lender for feedback and advice.

Next, don’t give up – obtaining a loan, especially if you’re just starting your small business, takes persistence and perseverance. You can also rest assured that as the small business sector grows; so too does competition within the small business lending market – meaning more options and greater opportunity are undoubtedly on the horizon for millions of aspiring entrepreneurs.

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