Getting A Loan For A Business

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1 ers Getting A Loan For A Business Brief #05.03 Latest Revision: 06/2013 South ern Ohio Chapt There are several potential sources of funds for start-up businesses. Among these sources are the owner s own savings, a second mortgage loan, charging against credit cards, loans from friends or relatives, investments of business partners, bank business loans, credit unions, federal/state/local government loan programs, and, for non-profit businesses, grants. To reduce the need for start-up capital, some businesses arrange deferred payment terms with their suppliers. Historically, however, the seed money for most businesses has come from the owner s personal savings; less than 10% comes from banks. Businesses that have existed for a period of time and have a good track record are more likely to be approved for a bank loan. Likewise, businesses that show the potential for significant growth and a high rate of return and need a substantial influx of capital may be good candidates for a venture capital investment. This Brief focuses on what the start-up entrepreneur should know about obtaining loans from banks and other conventional lending institutions: the terminology; what the lender is looking for; repayment plans; and loan guarantees. Some of these items also apply to in-business borrowers. Note that lending institutions have their own lists of requirements, which may not fit the generalities in this brief. Terminology Equity is the amount of money that you put into the business on your own, i.e., money that you don t have to borrow or pay back. The effort that has been put into the business in order to get underway is often called sweat equity, such as the development of software. Other types of equity can include intellectual property, such as patents or inventions. Collateral is that property pledged to the lender for that lender to sell to pay off the balance of your loan in the event that you default or you re unable to make regular payments against it. Types of collateral (and the typical loan value to the lender as a percentage of face value) include: Inventory raw material: 50% of its cost Equipment: 50% of its appraised worth Real estate: 75% of your equity Marketable securities: 75% of their current value Accounts receivable: 90% of total invoices due Cash savings accounts, C.D.s: 100% Client Sales Order: 90%, using a check with the bank as co-payee. 2013SCORE Ohio, Brief Number 05.03, Revised 03/ of 7

2 In general, and dependent upon a number of factors including the type of business and the quality of your presentation, lenders would like your equity to represent 20 to 50 percent of the funding required to sustain the business. Until a business is well established, a lender will require a personal guarantee by the owner(s) that pledges personal assets against the loan. This reinforces the commitment of the borrower to insure the success of the business. Remember that should you default on a personally-guaranteed loan that your personal holdings are at risk. Considerations of the Lender Small business loan criteria vary considerably from one lender to another, with many factors receiving different emphasis when a loan is considered. For example, some stress hard asset collateral, while others stress profitability or continuity of the business. However, lenders (banks in particular) generally hold the following points to be important: Ability of the business to generate a cash flow sufficient to pay off the loan is vital. Appearance: personal traits; people skills; and body language; your promptness in showing up for your appointment; the manner, clarity and enthusiasm with which ideas are presented; and preparedness in anticipating and answering the banker s questions. All of these have an effect on the banker s impression of you. Consequently, a positive first impression is a must for you. A negative one may kill your chances of being considered. Knowledge of the business and the market in which it operates. This information is best contained in a business plan. In the process of developing a plan for your business it is necessary to work through all the considerations to be looked at in order to get the business up and going. Reasonable financial projections of sales, costs and income based upon a thoughtful analysis of the market and the potential for the penetration and growth of the product or service you intend to offer. The dominant factor a lender looks for is your ability to repay the loan with profit and cash flows generated from operations. The adequacy and quality of the equity and collateral you have to offer. Personal balance sheet As a borrower with a new business it is normal for the borrower to personally sign for the loan which means pledging personal assets against the loan. A personal balance sheet will reveal assets and liabilities that the lender needs to know about. Credit rating and financial history - A credit rating is based on the amount of debt outstanding and the amount of regular payments related to income. If the borrower does not have a history of good credit the lender will properly determine that the borrower is not a good manager of his finances and, therefore, not a good prospect for the loan. Experienced and competent management and supporting functions (attorney, accountant, business consultants) Honesty: If there is something in your personal or credit background that is questionable, disclose 2013 SCORE Ohio, Brief Number 05.03, Revised 03/ of 7

3 it up-front to the lender because he or she will out about it eventually anyway. A written business plan that describes the business, the nature of the market and potential for growth in it, the organization and its people, the process, projected profit and loss statements, balance sheets and cash flows, how much financial help is required and how much you and others can contribute. SCORE has a number of Briefs that can help in the preparation of your business plan. Don t let anyone prepare your business plan for you. The fact that you wrote the plan will become readily apparent to the potential lender during your loan application meetings and the lender might well question your dedication and competence. Presentations and business plans should avoid non-essential fluff. This includes newspaper and magazine articles relating success stories in California or New York, franchise propaganda, proforma income statements without accompanying balance sheets, pretty binders, and endless technical discussions of the product or service. Existing businesses need to present essentially the same information to a lender as startups, except that they have the advantage of having historical financial data to support their future projections. Considerations of the Borrower Suggested steps to get the right bank so that you don't waste your time and the bank s time and end up with a rejection: Evaluate a bank by finding out what it has to offer that will fit your needs and your capability for assuming the debt. Your current bank should be your first consideration because you are established there, so, if it meets your criteria, stay put. It is alright to talk with more than one lender, however, word gets around if a borrower is shopping for a loan and some informed banks may not take a serious look at the proposal. If your bank is seeking an SBA guarantee of your loan, be aware that the SBA will not consider applications from multiple banks simultaneously. Many entrepreneurs use smaller financial institutions which don't provide the type of loans or products a business needs for growth; therefore, you may be better off starting with a financial institution which can service all of your present and future needs. Some Credit Unions also make business loans. Your evaluation process should seek answers from the lender to such questions as: Do you have any small business loan officers with whom I may speak? Note: You may find that a bank branch manager may not have the experience or the lending authority to handle your small business loan request. It may be better at the outset to ask a branch manager who the small business loan officer is for his bank, then approach that officer. What small business loans do you handle? Do you handle SBA guaranteed loans? Do you have any connections with federal/state/local loan programs for which I may be eligible? 2013 SCORE Ohio, Brief Number 05.03, Revised 03/ of 7

4 Are you presently lending on my type of business? Note: Some banks do not lend on certain types of projects. Examples: fishing boats, farms, oil/gas-related ventures, cafeterias, speculative activities. Once you have contacted the proper person at the institution whom you've identified as being the proper one for you, you should be prepared to offer a business plan and other supporting data early on. Steps Involved in Obtaining a Loan Before applying for a loan for a new business venture, visit the lending institution to find out what the loan officer will expect from you, such as what forms you must use. The visit may save you from wasting time and may be the start of a solid commercial relationship. Make an appointment with the lender to make a presentation on your business and its needs. After you have prepared your business plan, including the details of how much you wish to borrow, for what purpose and how it will be repaid, send at least two copies of it to the lender in advance of the date of your scheduled presentation. If you have a place of business, give the lender a tour. The workplace should be clean, neat and organized with an atmosphere of activity. Make your presentation, mindful of the considerations outlined in the preceding section on what lenders are looking for. If a bank appears reluctant to lend you money, ask if you can be considered for an SBA loan guarantee. The bank may be willing to check with the SBA to see if they re willing to share the risk. Be prepared to answer questions on the spot. If the business plan you ve presented is the result of thoughtful and thorough work on your part, you should have no problem responding. This or subsequent meetings with your lender may cover succession plans, long-range personal and company goals and timetables and organizational goals. It will be helpful to have a succession plan in writing. It also can help to get a key person life insurance policy on yourself in a minimum amount equal to the value of the requested loan. Loan Repayment Plans Your proposal and repayment plan should be formulated in light of the bank s requirements. First, if the loaned funds are to be used to purchase a specific asset, the asset must last at least as long as the loan period. Second, the assets should generate the repayment funds by increasing sales, cutting costs or increasing productivity. Third, your cash flow projections should show your company s capacity to meet interest as an expense and to repay principal from net profits. Finally, you should provide two ways out, or two different sources of repayment. The lender wants assurance that if the first way - the assets and the company - is blocked, there s a second, ordinarily comprising your own, and perhaps others guarantees, validated by an accountant. Preparing a repayment schedule is a complex task, but you won t be required to do it all yourself. Lending officers anticipate calls for advice on this and other elements of your loan proposal. They look to you to be the expert only on your business but you will be expected to provide all the requisite financial data SCORE Ohio, Brief Number 05.03, Revised 03/ of 7

5 Is there any other action you can take to swing the odds in your favor? Most bankers admit there is: Don t confine your patronage to the loan department. Buy additional services and refer other depositors. A bank, even a big money-center bank, is a business like any other and will go to some lengths to satisfy customers - especially now, as competition for the small business market heats up. If Your Loan Request is Rejected If the lenders ultimate decision is negative, don t hesitate to ask why. You ll enhance your chances of making the next attempt successful. You might also ask the rejecting loan officer for recommendations on how to improve your presentation (including your business plan) and suggestions on lending institutions who might be receptive to your needs. Grants/Non-Profits Grants awarded by foundations and government entities are generally limited to not-for-profit, tax-exempt organizations operated for educational, literary, religious, charitable and scientific purposes (most fall under IRS 501-C-3 regulations). There are some grants available under mandated federal statutes to individuals for such purposes as scholarships, student loans, research and development, and general welfare projects. A person starting or operating a for-profit business is not eligible for a grant. Suggested sources for further information on establishing a non-profit organization and/or identifying providers for grants: Grant Revenue Center, Main Public Library 8 th & Vine Streets Cincinnati, Ohio The SBA: Executive Service Corps of Cincinnati (513) (A counseling group specializing in guidance on non-profit matters) Reed Hartman Highway Blue Ash, Ohio Dayton Metro Library (937) 463-BOOK (2665) 215 E. Third St. Dayton, Ohio For-profit business are rarely eligible for grants SCORE Ohio, Brief Number 05.03, Revised 03/ of 7

6 Sample Installment Note Installment Note $, 20 FOR VALUE RECEIVED, the undersigned promise(s) to pay to the principal sum of DOLLARS ($ ) and interest from on the balance of principal remaining from time to time unpaid at the rate of per cent per annum, such principal sum and interest to be payable in installments as follows: DOLLARS ($ ) on the day of, 20, and DOLLARS ($ ) on the day of each and every month thereafter until this Note is fully paid, except that the final payment of principal and interest, if not sooner paid, shall be due on the day of, 20. All such payments on account of the indebtedness evidenced by this Note shall be applied first to accrued and unpaid interest on the unpaid principal balance and the remainder to principal. Payments are to be made at, or at such other place as the legal holder of this Note may from time to time in writing appoint. And to secure the payment of said amount, the undersigned hereby authorizes, irrevocably, any attorney of any Court of Record to appear for the undersigned in such Court, in term time or vacation, at any time after maturity, and confess a judgment, without process, in favor of the holder of this Note, for such amount as may appear to be unpaid thereon, together with reasonable costs of collection, including reasonable attorney s fees and to waive and release all errors which may intervene in any such proceedings, and consent to immediate execution upon such judgment, hereby ratifying and confirming all that said attorney may do by virtue hereof. At the option of the legal holder hereof and without notice, the principal sum remaining unpaid hereon, together with accrued interest thereon, shall become at once due and payable at the place of payment aforesaid in case default shall occur in the payment, when due, of any installment of principal or interest in accordance with the terms hereof. All parties hereto severally waive presentment for payment, notice of dishonor, protest and notice of protest. (signed) 2013 SCORE Ohio, Brief Number 05.03, Revised 03/ of 7

7 Disclaimer The information contained in these briefs is for general information only. While we endeavor to keep the information up to date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the information, products, services, or related graphics contained in the briefs Through these briefs you may be able to link to other websites which are not under the control of SCORE therefore the inclusion of any links does not necessarily imply a recommendation or endorse the views expressed within them. Any reference from SCORE to a specific commercial product, process or service does not constitute or imply an endorsement by SCORE or SBA or SCORE Chapter 34 or 2013 SCORE Ohio, Brief Number 05.03, Revised 03/ of 7

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