Starting a small business is daunting in itself. Building an idea from the ground up; assuming the risks involved in a project that may or may not work; it requires a spirit unique to entrepreneurs--one of optimism, perseverance, and an ability to ignore the naysayers while still being realistic and objective.
The same qualities that make you uniquely suited to owning a small business are also necessary to the process of applying for a small business loan. You have to persevere through challenges and paperwork. You must refuse to shy away when the odds feel stacked against you. And while staying objective about your qualifications for a loan, you'll need to overcome your fears of being turned down while following the process step by step.
Don't let the fear of being turned down hold you back from applying for a small business loan. Instead, follow these steps to make your business loan application the best it can be.
Prepare Your Business Plan
Before extending a loan to your business, your lender needs to understand exactly what your business does, and how your business will generate enough revenue to repay your loan. While a strong business plan alone won't guarantee your eligibility for a business loan, you won't make it far into the lending process without one.
Your business plan should include a mission statement, overview of your business model, market research including target market planning, a revenue forecast and break-even analysis, and other relevant accounting documents that exemplify your business's potential.
Make your plan detailed and organized, but also take the time to share the heart behind your business. Loan officers are people, too, so don't underestimate the power of a good story in qualifying your business for a loan.
Determine Your Loan Amount
Figuring out exactly how much capital you'll need to make your business a success can be challenging. You want enough to cover your expenses and put your business in its best possible place to succeed, but you don't want to put your business at risk with a loan you can't afford.
If you followed the steps to complete a thorough business plan, you've likely estimated your expenses and know what it will take to make the next phase of your business happen.
You've determined how the funds will be used, you've estimated costs for each legitimate expense, and you're confident that you're using your loan for a good reason that will offer a positive return on the investment.
In terms of your ability to pay back the loan, lenders often use a debt service ratio to calculate the loan size your business can afford to take on. Using your cash flow statement, determine the amount of cash your business typically has on hand at the end of the month, after all expenses like payroll, rent on retail space, inventory costs, and other debt payments have been taken out. Divide that number by 1.5 to determine the monthly payment amount your business can likely afford to take on.
Most lenders consider a debt service ratio of 1.5 to be a fairly accurate estimate. However, you could use a greater number to be very conservative, or a bit less if you're willing to take a risk. Just make sure your debt service ratio never falls less than 1.0, as that's an indication that you're likely to default on your loan.
Clean Up Your Credit History
While lenders look at a large number of factors to determine your eligibility for a business loan, the first and most significant is typically your credit history. This includes your business credit history as reported by Dun & Bradstreet, the business credit reporting agency of record, as well as your personal credit history as the business owner if you're applying to fund a relatively new business.
Ideally, lenders are looking for a credit score above 700 to qualify you as an excellent candidate for credit. Borrowers with scores in the 620-650 range or above will still have options available, albeit usually at a higher interest rate. If your credit score is under 600, it can be very difficult, although not impossible, to qualify for a small business loan. If you do qualify, except the rates to be very high.
Of course, the best way to maintain a strong credit report and score is to pay your bills on time, every time--both personally and for your business. Additionally, check your personal credit reports for accuracy every six months or so through the three major personal credit reporting agencies--Experian, Equifax, and TransUnion. If you find erroneous information, contact the agency in writing to correct the error.
Control Your Cash
A potential lender wants to know definitively that you can afford to pay back your business loan. To determine this, your lender will investigate your company's cash flow and cash on hand--typically using the debt service ratio mentioned above.
If your company frequently faces cash flow struggles due to late payments from customers, consider incentivizing on-time or early payments. Offer online payment options to simplify the process, and create a standardized procedure for reminding your customers of their outstanding invoices.
In addition to your receivables, maintain a strong bank balance as a buffer against short term cash flow concerns. Businesses with seasonal sales patterns must be particularly wary of having too little cash in the bank, as lenders could determine that you wouldn't be able to make loan payments during slow sales periods. Ideally, aim to maintain a bank balance sufficient to pay three months of expenses, including the debt payment for which you're applying.
Research Your Options and Apply
These days, your options for taking out a small business loan extend far beyond your local brick and mortar bank. Consider your specific funding needs and research whether you're interested in a traditional Term Loan or SBA loan, an equipment loan, a short-term loan or microloan, or any of the various other options available.
There's a business loan out there to fit virtually every need you may have, so make sure you know your options before you make your choice.
Once you've done your research and made your choice, you are ready to submit a loan application! Having followed the steps above will make the application itself much more straightforward to complete. Just make sure you are detailed and honest in your application, and be patient for the results.
Finally, remember that even if your first loan application is turned down, all hope is not lost. Go back to the drawing board, see what you missed, and keep trying until you succeed. Good luck!