Tag: business loans

Factors for Obtaining a Business Loan

We are going to discuss the factors that are involved when a bank is making decision as to whether or not to provide a loan to a entrepreneur or small business owner. Foremost, they’re going to look at the individual entrepreneurs credit score. While it may seem as clear-cut as simply just looking at the credit score and going from there – a number of financial institutions will take a complete look for issuing a approval or denial letter. For instance, many individuals that are engaged in the continuing buying and selling of real estate will often have very high debt to income ratio was given that they have a number of loans secured by a number of different properties. As such, this can have a slightly negative effect on a independent real estate entrepreneurs credit score and thus might bring their score down to a point where they would otherwise not be accepted for a loan. Again, this is not provide the whole picture of an individual’s finances given that the realist the entrepreneur may have very appropriately leverage these properties and is within completely normal range for this type of business activity. As such, many banks will look – again – at a total financial picture of the individual borrower before making a decision. In certain cases, other factors such as a previous bankruptcy may impact the individual’s ability to obtain a conventional business loan or a business loan that is backed by the small business administration. Generally, any individual prior three years is not eligible for however, there are a number of specialty lenders out there that are willing to take the risk on a higher lower quality borrower if they have substantial assets or collateral to back the financial instrument.

The second factor that the financial institution is going to look at is the collateral that is used in conjunction with the business loan. Banks and lenders are not really in the business of taking a risk or generating a profit from capital appreciation or profit. Banks are in the business of lending money for a specific interest rate with the intent to receive these payments on a monthly basis without fail. As such, the financial institution is going to want to see that nearly 100% of the money that their lending is going to be used for the acquisition of tangible assets for banks to provide extensive working capital loans to individual small businesses. However, there are exceptions to this rule especially among professionals such as doctors, lawyers, dentists, certified public accountants, and other individuals uphold a professional license that generate revenues from their professional services. In these instances, a financial institution may be willing to accept a much lower collateral amount given that the individual is going to be able to generate substantial revenues by providing their services to the general public. Again, working capital loans are primarily geared towards high-margin businesses and individuals uphold professional licenses. Prior to submitting an application to a bank for a loan, a full list of the assets are going to repurchase with the loan proceeds should be provided so that the bank understands exactly what their funds are being used for. In some cases, a financial institution may actually purchase the assets directly themselves and then provide the items to the individual entrepreneur so that the appropriate titling and collateral can be held directly by the bank. This is primarily reserved for companies that are engaged in the large-scale acquisition of equipment and specialized assets.

The other factor that is going to come into play as it relates to receiving a business loan is the character of the borrower. Usually, a criminal background check is done against every borrower that is seeking a business loan. As such, previous criminal history maybe impede an individual’s ability to receive a small business administer. If it walks per Newark and they should speak with an attorney as well as an accountant to ensure that they are able to properly qualify for a business loan given any past issues with the law.

Finally but certainly not least – the financial institution is going to want to see your very well-developed business plan. As we have discussed throughout this website, the business plan should have a three-year to five-year overview that will allow the bank to make a decision as to whether or not to provide the borrowed funds. As always, this business plan should have a profit and loss statement, cash analysis, balance sheet, and other financial metrics that a lending institution is going to want to see to render a lending decision planning materials that you have developed in order to make sure that they fall in line with industry standards and that they are appropriate for the amount of money that you are seeking. The certified public accountant will also assist you with putting together a personal financial statement that a bank is almost always going to want to say as a relates to your current assets and current outstanding liabilities. Your personal financial statement is going to need to list everything you own such as a home, car, retirement accounts, and other assets that are considered to have tangible value. All of your debts are also going to be showcased within this financial statement including credit cards, existing business loans, mortgages, and any other type of liability that you are able to get the funding you are seeking.

In closing, if it seems that there is a lot of documentation that is needed in order to get a business loan then you are not wrong. All banks and lenders are going to want to see that their investment is secured by a substantial amount of collateral and that the individual entrepreneur is qualified to operate the business on a day-to-day basis. As such, it is imperative that an individual entrepreneur is extremely prepared as it relates to making sure that everything is organized, neat, and can be easily followed by a loan officer or a lending committee. Throughout this website, were going to continue to discuss some of the issues that are involved with obtaining business financing through financial institutions such as banks, credit unions, and independent lenders.

Credit Scores and Business Plans

The things that is often brought up to us is whether or not a discussion regarding individual’s credit score should be put within the business plan. Usually, when we develop a business plan on a customized basis for a client we do not include information regarding the individuals personal credit. This is primarily due to the fact that the individual bank or financial institution is going to pull all three major credit reports when they are examining the loan application. However, especially for service-based businesses there may be times when it is appropriate to discuss the underlying credit of the individual borrower directly within the business plan. This is especially true if the individual is applying for a small business administration loan given that the credit score is going to be a very important factor when making a lending determination. As a whole, most banks consider three primary factors when developing and reviewing a loan application. First, they thoroughly review the business plan to ensure that the business is going to be able to remain economically viable in most economic climates. This includes an overview of the anticipated revenues, expenses, and pretax profits. It is important within the business plan to show that the business can satisfy the debt obligation by more than 20% per month within the first years of operation. Most banks and lenders focus substantially on the ability of the individual entrepreneur to make timely monthly principal and interest payments regardless of how the business is doing.

Second, the loan officers or lending committee will look very thoroughly at the individual bar themselves in regards to their experience, educational background, and their ability to effectively operate the business on a day-to-day basis. Most people that seek small business administration loans or conventional business loans are new entrepreneurs. The small business administration programs were developed specifically so that newer and younger entrepreneurs could have access to affordable credit. This is going to be one of the key factors moving forward as it relates to the federal government support of these programs. One of the nice things about getting a small business administration loan is that the terms are flexible especially for an entrepreneur that does not have a substantial amount of experience operating businesses on a day-to-day basis. Most importantly, a full resume and biography should be included within the business plan so that the bank has an understanding of the individual’s ability to effectively bring a new enterprise to profitability with a positive cash flow within the first 24 months of operation. If this is specific for a professional practice, such as a dental practice, then a substantial amount of information regarding the practitioners history and their ability to render services to the public should be included as well.

Third, there is going to be an examination of the collateral that is going to be used for the loan. Most banks and lenders strive to have his much collateral as possible so that in the event of a default they are able to recoup their investment. Common types of collateral include real estate, furniture, fixtures, related equipment, retirement accounts, checking accounts, 401(k) accounts, and any other asset that has a salable value. For SBA loans, most banks want to see that at least 80% of the loan is collateralized. This is why a 20% capital injection is typically needed by the borrower in order to ensure that the bank is comfortable providing this investment to the entrepreneur. Of course, one of the other frequent questions we get is whether or not the individual entrepreneur is going to need to provide a personal guarantee for the loan. The short answer is yes. Almost all banks and lenders require that the individual entrepreneur personally undersize the loan in conjunction with their company. After the credit crisis of 2008 and spanning through a recession for three years – most banks have implemented much more stringent lending protocols so that in the event of a default the bank is able to recoup a significant portion of the loan. This is one of the things that an entrepreneur should discuss with their certified public accountant given that when a small business administration loan is undertaken – a substantial amount of the individuals personal assets can be put at risk. As such, it is up to the entrepreneur to make an appropriate determination as to what they consider to be a can reasonable risk for their personal assets. Many people have a significant amount of concern specific for their primary residence. This of course could mean that a house could be lost in the event that a business fails. As such, it is important that the entrepreneur determine whether or not they consider this to be acceptable risk.

In closing, lending is a very complicated process especially for small businesses given the high-risk nature of these operations. The small business administration seeks to alleviate some of the risks associated with banks providing small business loans by issuing guarantees. However, it is still very much incumbent upon the entrepreneur to have an airtight business plan that will ensure that even if revenue targets are not met the business is able to satisfy the underlying debt obligation. This is going to be something that we continue to discuss on this website also focusing on how to properly develop a business plan that is specific for a SBA lending bank.

Business Plan for a Bank

Writing a business plan specific for a bank loan is a pretty straightforward process. This is due to the fact that the primary concern of the bank is that your business is going to be able to make the monthly principal and interest payments on any debt instrument that you obtain. Usually, a significant portion of the business plan specific for a lending institution is focused significantly on the tangible assets that we purchased with the capital required. Although service-based businesses typically do not need very many tangible assets, a banking institution and its respective loan officers are going to want to see that they have a significant amount of collateral backing the debt obligation.

In many cases, the bank will also require a personal guarantee from the borrower. This puts homes, retirement accounts, bank accounts, vehicles, and other assets that are owned by the individual as part of the overall collateral that is used for the business loan. As such, a significant amount of attention should be paid as to whether or not the entrepreneur wants to undertake such a substantial financial obligation given that all of their personal assets are generally put at risk as well.

The key to showcasing a business plan to a lending institution is also the focus on the fact that the business is economically viable. Most importantly, the business plan needs to very clearly show that the business is able to produce a highly predictable revenue so that monthly payments can be made without question. In some cases, especially for businesses a take a little bit of time to ramp up, a financial institution may allow for interest-only payments or reduced payments during the first six months of the life of the loan. However, this is something that is usually subject to negotiation as banks want to see that they are going to receiving their interest payments quickly once the loan funds are disbursed.

On a side note, it should be mentioned that many banks and financial institutions will directly disburse the funds to companies that are selling the business its tangible assets. Usually, for any purchase that is over $10,000 – the bank is going to want to make this payment on their own given that they want to make sure that the funds are actually going to where they have been allocate,  and they want the proper documentation for the underlying asset. There are exceptions to this rule, but vendors should be sourced prior to applying for a loan so that the bank can very quickly make a disbursement to vendors if they decide to make a disbursement directly to the asset selling company. In many cases, this works similar to a real estate transaction would occur with the bank itself disburses funds to the property seller.

One of the other things at the bank is going to want to see as well as a substantial amount of market and industry research as relates to the business. This includes having an economic overview in regards to how the economy is doing, the interest rate environment, and other important factors that are occurring as relates to the economy as a whole. Industry research should include information regarding how the industry is growing, the growth rate, aggregate revenues, aggregate payrolls, and any potential regulatory trends that may impact the way that the industry does business. This is especially true in areas where there is a significant amount of regulation guiding the way that these businesses conduct business on a day-to-day basis. One of the nice things about the Internet these days is that industry resource can be sourced very quickly from a number of different reputable sources. Our website uses a number of publicly available information sources when sourcing its industry research. Typically, the section of the business plan can range about two pages should provide clear overview of anything major regarding the specific industry in which the company will operate. The section of the business plan also outlines the demographics of the customers at the business will have all concurrently showcasing major competitors of the business will face once it begins revenue-generating operations.

The bank is also going to want to see a significant marketing plan so that they can understand exactly how the business is going to reach customers at the very onset of operations. In this section, many entrepreneurs will also put in information regarding how they will promote the business prior to revenue generation. This is important so that a major grand opening can occur and that revenues can be produced very quickly. This is especially important for retail businesses as they need to have revenues commence immediately so that he can pay for all the underlying operating costs in addition to any debt obligation.

As it relates to the financial projections, a business plan specific for a lending institution should always include a three year to five year profit and loss statement, cash analysis, balance sheet, breakeven analysis, and business ratios page. Special attention should be paid to the common size income statement and the profit and loss statement so that these figures are developed in line with industry standard figures. Almost all financial institutions will verify the financial model provided by comparing it to similar companies within the industry.

Of course, any businesses every business is different and certain things need to be adjusted in order to reflect this fact. If an individual entrepreneur is having a significant amount of trouble developing the financial model than they can work directly with the business plan writing firm or a certified public accountant that can assist them in developing this financial model. One of the things that many entrepreneurs make a mistake about is not having a complete understanding of how a profit and loss statement, cash analysis, and balance sheet operates. There are a number of great resources on the Internet and through this website that can help an entrepreneur understand exactly how these three financial statements work together. One of the things that an entrepreneur can often miss if they don’t understand the statements is how their liabilities can change depending on how sales occur. A certified public accountant can be an invaluable source of information not only is it relates to tax matters but also general accounting matters as well.

One of the things that should also be included within the business plan that is going to be presented to a bank is any critical risks and problems of the business may face as it progresses through its operations. As we discussed before, it is unpleasant have to think about all the negative scenarios that can occur to a business – however, it is important to the bank understand that the entrepreneur knows that not everything will always go as planned and at specific matters will occur and the business we need to deal with them appropriately. In fact, most business plans that go to the bank have a requirement they have a critical risks and problems page.

Finally, most business plans also include a SWOT analysis. This analysis focuses on the strengths, weaknesses, opportunities, and threats. A bank is going to want to see a detailed description of each of these four matters for any specific business. Usually this is done in bullet point format, but can also be written in paragraph format.

Asset Based Lending

Asset-based lending has become very popular over the past 10 years given that it is a low-risk form of investment for many financial institutions. There are a number of different businesses that are very heavily asset focused including real estate businesses, retail companies, automotive businesses, and other enterprises that are actively engaged with the buying and selling of actual tangible goods or property. Most lenders are very receptive to providing capital for these types of businesses given that they are able to almost fully collateralize their loan with the assets that are being purchased. As such, many businesses that are in the startup phase of their operation are able to receive a significant amount of capital support from a bank, credit union, or similar financial institution given that this is considered a low-risk form of lending for these companies. Of course, a business plan is going to still be required given that these companies are going to want to see the types of assets being purchased and sold on an ongoing basis.

This business plan should be a comprehensive document that follows a three-year to five year time frame in order to showcase exactly how these funds will be used as the principal balance is being paid down. The interest rates that are associated with asset-based lending are typically lower than that of a company that may need just a working capital line credit in order to develop or expand their operations.

There are a number of independent asset-based lenders that operate not in the capacity of a bank or traditional financial institution. These lenders often acquire a large-scale line of credit and in turn provide loans to individuals who are looking to purchase specific types of assets. These types of lenders are very popular among automotive lenders as well as companies that engage in the buying, rehabilitation, and sale of real estate. Given again the low-risk nature of this type of lending – a number of independent agents have entered the market with these types of financial products. These companies typically make their money not only from the interest charged on an ongoing basis, but also from upfront fees that are associated with originating loan.

Of course, a certified public accountant should always be brought into the loop when determining whether or not these types of debt instruments are appropriate for any specific type of business venture. Most importantly, the CPA can also provide the entrepreneur with a depreciation schedule in order to make sure that the tax consequences and tax liabilities associated with buying and selling the assets using an asset-based loan are appropriate even with the entrepreneur is seeking to accomplish. The CPA should always be involved with any major business decision as it will provide a significant amount of insight as to the day-to-day operations of any business and any tax liabilities that may be accruing due to entrepreneurial activities.

For startup business – an asset-based loan may be the way to go given the relative ease in which they can be acquired. Additionally, many asset-based lenders will provide capital against an established asset such as a home in order to provide capital for startup business that is not necessarily going to be doing a lot of trading in tangible goods. Other alternatives include using a home-equity line of credit in order to fund entrepreneurial ventures, but this does come with some risk.

A Bank Loan Versus an Investor

One of their frequent questions that we get is what are the primary differences between sourcing capital from an investor force versus sourcing capital from a banking institution. First, as it relates to banks these companies are in the business of providing loans. They want to see that the amount of money that they are going to lend to the individual is going to be repaid and will be fully collateralized by assets are being purchased. A very common example of this is a mortgage where a bank lends an individual money to purchase an income producing property with the intent of having the property service collateral and the income generated from rental serving as the income to repay the financial instrument. At the end of the day the bank is not receiving an equity interest in the business and they will not participate in the capital appreciation. For instance, if a real estate investor seeks to purchase a one million-dollar property then they will typically put $200,000 down and borrow the remaining $800,000 via a 30 year mortgage. As the mortgage is paid down and as the property appreciates in value the bank only continues to receive the monthly interest and principal payments that was agreed to by the borrower.

Conversely, if that same real estate investor wants to source the money from a private investor and typically the investors going to want a percentage share of the equity based on how much money they are contributing. In this case, an investor could put the hundred thousand dollars and set up a mortgage and they would receive an 80% ownership stake in the business. One of the reasons why many people will source capital for a bank rather than investor is simply so that they are able to control the amount of income that they are receiving. Additionally, the conservative use of borrowed funds allows for the amplification of a return on investment. Returning to our example above, let’s assume that the real estate investor has the entire $1 million of capital on their own. A generous capitalization rate for income producing property is about 10%. As such, in a scenario where the entrepreneur purchases the billing out right they will receive a 10% return on investment each year. However, by borrowing the funds with a significant down payment this return on investment is amplified four times given that the income produced is not only covering the mortgage but it’s also producing a significant amount of income as it relates to the down payment. This is one of the reasons why many individuals will seek to borrow funds before they approach a private investor. Of course, one of the key elements to borrowing funds that the individual must have an appropriate down payment as well as a credit score that satisfies the bank. These days a FICO score of 700 is typically the minimum credit score that is accepted by most financial institutions as it relates to lending.

As it relates to credit scores, most investors do not care too much about this aspect of an individual’s personal life. However, some investors do want to see that the individual is not marred with debt or has significant other financial problems before they provide the capital necessary to launch or expand a business venture. An entrepreneur that has significant financial issues typically will be focusing significantly on that and not the continued expansion of their business operations. As such, if an individual is approaching investors for a project and they can expect that a financial partner would one understand the personal financial situation before going to business with them.

One of the other things that needs to be made aware of is that when you are working with investors is that they are going to want a significant amount of equity as well as a significant amount of control over the business. This is especially true when working with investors like venture capital firms and private equity groups that almost always taking majority interest in the business. In the event that things do not go as planned these organizations will typically take control of the business and throw out the original entrepreneur. This is one of the ongoing risks associated with working with a private equity group or venture capital firm. Additionally, for very large investments it will typically want to have several seats on the board of directors. This ensures that they are able to continually oversee their investment and make any adjustments to management as needed if things are not going as planned. As such, it is important that an entrepreneur that is seeking venture capital for a in injection for private equity group retain a qualified attorney so that the entrepreneur is aware of all the clauses associated with the investment. This is one of the key issues that entrepreneurs can have when they are so hungry for the actual money that they forget that they need to be able to make sure that what they’re doing is economically viable. If one venture capital group is likely to put up funding for a specific project and it is also likely that several others are willing to as well given the very low capital rate of successfully raising money.

In closing, it is far easier for an entrepreneur to work with a lending institution given that the terms of repayment are usually flexible and are easy to deal with. Investors have significant expectations as it relates to returns on investment and expanding operations. As such, all these factors into aide when determining whether or not to raise capital from bank or from a private funding source.