Assess situation before seeking a business loan

Question: What are some of the problems small-business owners encounter when they are looking for money to open and grow their operations?

Answer: It’s not unusual for startup costs to be higher than expected for a new business and it can take some time to build up the revenues to meet the projected cash-flow targets. This reality alone can make lenders wary of making a loan to a venture without a documented track record.

As a result, small-business owners may be reluctant to approach a lender or be uncomfortable knowing what to ask for and how to clearly articulate their funding needs. It can be a big undertaking to put together a viable financing application to get a loan approval. To increase the likelihood of a positive response to your funding request is to be prepared and submit a complete loan application with appropriate documentation. Free expert assistance is available from U.S. Small Business Administration resource partners like the Hawaii SBDC, SCORE and the Mink Center for Business and Leadership, a women’s business center in Honolulu.

Q: How can a small-business owner best prepare to talk with a lender and what should he or she include in the request?

A: Before you seek financial assistance, you should thoroughly assess your current financial situation to determine your capital needs and cash-flow condition.

Include your business vision, history and background, resumes for the principal owners and/or managers, marketing plan, and financial information including projections of income, expenses and cash flow. As a new or expanding company, the research and assumptions you used to develop those financial projections should be clearly outlined as well. You should also be sure to report your investment of any capital and resources into your venture to confirm that you have “skin in the game.” All lenders will want to see a solid, lean, well-thought-out business plan to support their credit decision.

The loan application forms may vary depending on the bank and the type and amount of the loan. Generally, the banker will ask for financial statements, tax returns for three years (personal returns as well if you are still considered a new firm), and information on any debts, leases and accounts payable and receivable. Because the banker will pull your credit report with your application, it is wise to review your credit history and score to deal with any discrepancies in advance of submitting your request.

Armed with your financial assessment, business plan and documents, consider what type of loan you would choose. If your business needs fixed assets like a vehicle, large equipment or site improvements, think about a term loan, where you receive your entire loan amount upfront and you have set monthly payments. If your needs include payroll, marketing or seasonal cash demands, a business line of credit where funds are used only as expenses occur may be right for you. Talk with your lender about the term of the loan, interest rates, adjustments or increases and any payment penalties as these can change with different financial products.

Q: How does the bank evaluate the application?

A: The loan officer and the bank’s credit division will analyze the loan request, evaluating your financial standing and comparing industry ratios and local market statistics. A complete application can speed the review process and get a response quickly.

One easy way to understand what lenders look for is referred to as the five C’s of credit: character, capital, capacity, conditions and collateral.

Character is one of the more subjective measures of the borrower’s willingness and ability to repay the loan. Personal credit history, references and work experience are evaluated and used as a way to understand how reliable an applicant has been in repaying past loans.

Capital is a measure of the borrower’s investment in the business through an initial cash infusion, retained earnings or other assets of the business owner. Bankers look more favorably on the borrower when owners have invested in their venture.

Capacity is an evaluation of the borrower’s financial capacity to repay the loan. The bank wants to make sure the business will generate enough cash from daily operations to cover loan payments.

Conditions are a measure of the overall economic environment globally, locally and in your industry, and how that may impact your ability to repay your loan.

Collateral is the safety net commercial lenders rely on if the company runs into trouble and cannot repay the loan. It may be real property, inventory or other financial resources pledged by the borrower. While no bank really wants to liquidate collateral, lenders require some recourse if a loan should default.