You may have an idea that your convictions tell you will be a successful venture. But finding the funds for the project can be daunting for aspiring entrepreneurs. Traditional banks tend to have restrictive rules, especially for a new business.
Lending institutions are skeptical about new businesses. So collateral is often a requirement. In essence, they are leasing out their customer’s deposits. They, therefore, feel they can’t afford to risk the money. But there are other alternatives that entrepreneurs can tap to fund their business ventures.
In this article, we’ll be looking at some of the challenges of getting a business loan from a traditional institution. We’ll also consider some of the options you could capitalize on to increase your chances of getting financing for your venture.
Challenges of Getting a Traditional Business Loan
Your lender will want to review your assets thoroughly. That means that even when they accept your assets, they do it with a lot of skepticism. If you have an account receivable, the companies that owe you will be carefully vetted. If you want to use your inventory as collateral, most lenders will give about 50% of its value.
The other option that businesses have is to use personal assets such as house equity. By using your asset as security, the lender can minimize their risk. As a result, home equity financing can have attractive interest rates.
A home equity loan will usually be up to 80% of the value of your property. The bank will also review your credit history and the health of your debt-to-income ratio. The lender may also evaluate your employment status to determine if you can pay on time.
One disadvantage of home equity loans is that declining property value will affect your equity. That could be a concern for many homeowners since this type of loan takes considerable time to repay. You could face foreclosure if you can no longer fulfill your repayments, which means you risk losing your home.
Commercial loans have terms that are similar, but also considerably different from home equity financing. Instead of using your home as collateral, a commercial business loan may include your assets. In such instances, your business must have significant assets that can serve as security.
One important advantage of a commercial loan is that the amount can be much higher than home equity financing. You can get up to $5 million depending on the lender’s evaluation of your business. They have attractive interest rates which can be as low as 6%. Most banks usually provide a variety of packages to ensure you find one that suits your business needs.
One of the disadvantages is that commercial loans usually require a long application process. Delays can impact the progress of the business. Unlike with home equity financing, interest rates may change based on market dynamics, and it could be affected by fluctuation of the local economy. Additionally, the strict application process often has rules that lockout young aspiring entrepreneurs.
Putting together a business Plan
It is natural for lenders to want to understand how you run your enterprise. They do not want you to default on your payments so that they can take over your company or assets. But at the same time, they need to carefully assess the viability of your idea before they can give you a business loan.
Most lenders today will require a business plan before you can access financing through their institutions. Some banks may require a lean version of your plan, which includes the basic elements, such as mission statement, marketing strategy, accounting, and sales.
It is important to note that a bank usually has a unique perspective on business plans as opposed to an investor, such as a capital venture firm. The lending institutions are not as interested in fancy projections. Instead, they want to know you have the means to pay back, even if the project does not go as planned.
As a result, the bank will usually consider the following key elements of your business plan.
- Management: A lot of lenders will pay close attention to how the entrepreneur manages their startup. Having above-average management skills means that you can properly coordinate resources to deal with cash flow issues. It also means you have contingencies to address marketing, accounting, and legal problems when they arise.
- Cash-flow: Your plan should also demonstrate that you can manage capital and eliminate cash flow problems. Most lenders will want a detailed write up with supporting documents before they can give you a commercial business loan.
- Marketing Strategy: Other than cash-flow problems, another important issue is marketing. Market dynamics pose a threat to your business. If the product has no real basis in the market, the startup will find it hard to get clients, and the bank will lose its money. There are more than 32 million businesses in the United States. It takes effort to come up with a promotional strategy that stands out. That is particularly true today when digital platforms have increased the competition between brands.
- Properties as Collateral: Most banks will require collateral before giving a business loan, especially for a startup venture. Unless the entrepreneur has a good credit rating and has had a relationship with the organization, the lender will often require that you attach assets. The property you list in your business plan may include office furnishings, equipment, land, buildings, and inventory.
Presenting the Best Character
Conventional lenders will also evaluate your character to determine if you can pay. You ought to present the best qualities to demonstrate your integrity, focus, and skill. In particular, the lender may be looking for the following characteristics.
- Understanding of the Business: Your understanding of the business will be reflected in the plan. During the application process, you may have to meet with the lender to answer questions about the model for your venture.
- Co-Signers: If you do not have a good credit history, you can get other entrepreneurs to cosign your business loan. You can add other professionals such as accountants and real estate law experts as references to boost your image. Small community banks may be more receptive to references from reputable local members of the community.
- Business History: If you can present evidence of running a successful business, you can improve your chances of getting a loan. Your experience shows that you understand the challenges and can steer the enterprise through the rough storms.
Insurance for Your Assets
Depending on the type of loan, the lender may require that you provide insurance. Policies guard against risks that could compromise your ability to pay a business loan. For example, if you want financing to buy a car, the lender may want your auto insurance to be comprehensive.
A comprehensive policy guards against collision, as well as other factors that may force you to seek repair. If auto insurance is comprehensive, it will have coverage for contact with animals, damaged windshields, etc.
By requiring full coverage during the application, the lender ensures the asset is protected against property damage. Different banks and loan packages may have varying requirements. It will be helpful to include insurance documents for your assets when applying for financing.
First, insurance indicates that your assets are sufficiently covered against accidents or disasters. Secondly, it is a good reflection of your character and the image of your business. It shows you are serious about fulfilling your obligations.
Improving your Chances of Getting a Business Loan
Most commercial financing options have stringent terms to reduce the risk for the lender. You need to keep that in mind when making your loan application. The following are some tips on how to enhance your application to improve your chances.
Reviewing Your Credit History
Before making your application review your credit history. Most banks will want to evaluate your history for at least the past three years. The earlier you perform an assessment, the more time you will have to correct errors made by the credit reporting agencies.
If you notice a mistake in your report, first contact your creditors. The process is more likely to progress faster when you take the initiative to undo the error.
Another aspect of your credit history that is critical to securing a business loan is trade experience. Before the lender can even consider your credit-worthiness, they need to assess your performance with other entrepreneurs.
If you plan early, you may have time to organize a trade credit with another business. That way, you can have a strong credit history by the time you apply for financing. Most banks will want at least three or four references to your trading history.
When you use personal assets as security for your loan, the lender may apply the loan-to-value ratio. The ratio determines the amount of money you can get against the value of the property. There are certain factors such as the type of assets attached that could also influence the ration.
Some of the key factors include:
- The State and Condition of the Property: The percentage of the value of the collateral you may secure will often depend on the state of the property. If it is occupied, and well kept, it may attract up to 75% interest. If there are signs of neglect, your amount could decrease. For example, if your home air conditioning system looks like it requires HVAC maintenance, the proportion of the collateral may only be 50%.
- Equipment and Machinery: Different lenders may have varying criteria for calculating the value of machines and equipment. Sometimes, the newer the equipment, the more you can get from it. At other times, the lender may value older equipment. That is because new machines start to decrease in value as soon as you start using them. The criteria may apply to cars and farm machinery, which devalues at a fast rate as soon as you leave the showroom.
- Accounts Receivable: Lenders will usually review the age of the account. So it is important to check your account before applying for a business loan. Keep in mind that other transactions in the account by third parties could affect your ability to access financing.
Another important aspect of your business you ought to improve is cash flow. Banks will want to evaluate your cash resources and expenditure and how they move daily. Your lender can gain insight into how well your business is doing in the market and your financial cycles.
You can increase your chances of getting a loan by making the following changes:
- Settle your debts: If you have the means, settle any existing debts. For outstanding debts, you may talk to your creditor to extend the term. Many creditors will agree to a renegotiated deal, as long as you commit to paying on time.
- Increase Income: If your cash flow is constrained, you can review your services and products to determine if there are ways to increase revenue. It could be that the pricing of your products is too low.
- Eliminate the Non-Essential: If you do a thorough evaluation of your account, you may find that there are expenses you could do away with. Too much inventory can increase your expenditure, so you may want to consider reducing it. Certain things are essential, like hiring a design build remodeler, but it could be postponed to the future.
- Talk to your accountant:Talk to your accountant and find areas where you can enhance the cash flow. A qualified accountant will use techniques and strategies for taking advantage of tax credits. You may also try to collect any overdue debts. The longer it takes to get payments, the more unlikely the receivables are going to be paid.
All in all, you need to do a lot of planning before applying for financing. Take time to check your accounts and ensure everything is in order. Make a point of understanding the requirement of your bank. Research your industry and even attend a business coaching conference when you can. You can also talk to a lawyer if you have any legal questions. Always remember that the more preparation you do, the higher the chances of you getting a business loan.