You have a great idea for a business and are ready to work hard. Or maybe you have already started a small business and now need financing to reach your business’s full potential. Applying for a loan can be daunting for even the most seasoned entrepreneurs. In this article, we’ll walk you through the information and terminology you’ll need to know, with the goal of giving you the confidence to discuss your finances with a lender – or understanding the next steps needed to strengthen your financial plan before you research. a funding. .
How strong is your business plan?
Most people think business plans are only for start-ups, but even long-time business owners need to maintain and follow a plan.
Your business plan is the foundation of your entire business, so it should be solid. Learn your industry well: your market, growth potential, competition, and best practices from similar businesses. You don’t need a business degree, but doing your homework before writing or rewriting a business plan will give you a better chance of success.
Whether you are a start-up business or have been in business for a few years, your financial plan should show that you will be able to repay the loan. Two things to consider are:
Revenue projections: realistic estimates of how much money you’ll make versus how much you’ll spend are a crucial part of a business plan. For example, how many units of your products or services do you need to sell to generate enough sales to cover your operational costs?
Debt to service ratio: It’s a way to calculate your business’s ability to repay a loan. Lenders may have varying requirements in this area. For example, many lenders require that your business’ net income (how much your business earns after paying off all expenses) be at least 20% more than the amount needed to pay your debts – or a “debt-to-service ratio of 1, 20”. For example, if you have an annual loan repayment of $10,000, your business net income would need to be at least $10,000 to have a ratio of 1.00, and a net income of $12,000 would give you a debt-to-service ratio of 1.20, the minimum debt-to-service ratio you would need for a loan.
By applying these financial concepts, you can determine the maximum loan that your business can reasonably take out.
Lenders, like ECDI, may ask you to provide equity (how much you have saved for your business as well as the amount of money you have already invested) or offer collateral (an asset you own, such as equipment, a house or a car, which you can give to the lender to pay off the debt if you are unable to make the loan payments). Lenders will have different requirements, depending on the lender and the circumstances.
Are your finances in order?
Get ready now to put these financial elements in place.
Company specific bank account: Do you have a separate bank account for your business? If not, open one now. Not only will separating your personal and business finances save you accounting headaches, but a business account is required to apply for most business loans.
Tax records: Even if you’ve been in business for a while, make sure you’re up to date with your personal tax returns and have easy access to your tax information. If your business has been around long enough to have filed taxes, make sure you have at least three years of paperwork on hand.
Understand your financial health: You don’t need millions in the bank to get a small business loan. If you have some credit problems, be sure to communicate your action plan and show the steps taken with your lender. You don’t need perfect credit or even great credit, but you do need to understand and be able to talk about your financial health and credit history.
Financial records: Established companies must present their balance sheet, profit and loss statement and accounts receivable/suppliers, if applicable.
Documentation: Lenders require various documents to apply for a loan. This includes personal and business records. Click here to view the ECDI checklist to get a general idea of what you will need.
Do you understand the basics of lending?
If you’ve ever bought a car or a house, you’re probably familiar with basic loan processes and terminology. Small business loans have notable differences (such as the time you can expect your loan to close and the need for equity), but use the same terminologies.
Director: the outstanding amount of your loan, excluding interest or other charges.
Interest rate: the percentage of the loan amount charged by your lender over a given period. Interest rate structures may vary by lender. ECDI uses a simple interest rate structure. For example, if you got a $10,000 loan with 6% interest, you would owe a total of $10,600, or $10,000 + ($10,000 x 0.06).
Repayment Terms : the amount you need to repay and the specified time frame for doing so. This includes the number and frequency of installments, i.e. how many payments you will need to make and how often you will need to make them.
Closing costs: an amount you must pay when you receive your loan to cover the cost of the lender’s labor and time. Your closing costs pay for the administrative work of underwriting the loan and the cost of any third-party expenses, such as appraisals.
The five Cs: the criteria a lender uses to decide whether you are likely to repay or default on your loan. Lenders use these factors to determine whether or not you will receive the loan, your interest rate amount, and any other repayment terms of your loan.
- Character: your employment or employment history, past financial activities and credit score.
- Pro tip: Traditional lenders tend to put more emphasis on your financial activity and credit score, while a community lender like ECDI puts more emphasis on your real character as an individual. For example, are you a top chef with a solid business plan and a history of running successful restaurants? Community lenders will take these individual characteristics into consideration, while a traditional lender may consider a restaurant too high a risk for a loan, or may have a high threshold for a borrower’s credit score.
- Capital: your personal savings, your investments and the assets you are willing to dedicate to your loan.
- Ability: your ability to repay the loan and interest.
- Collateral: assets you own that you can offer for payment in the event of default.
- Conditions: the terms of your loan. The terms include the repayment term and any additional steps you need to take to complete the loan, such as financial training or paying off any debt on your file.
What happens if a business owner defaults on a loan?
You must repay a business loan as stated in your terms to avoid default. Failure to pay a business loan can result in significant damage to your personal credit and even seizure of your property and personal property. Monitoring your financial health is one way to reduce your risk of default. This includes keeping good records, calculating expenses versus profits, and allowing for some flexibility in your business plan to meet challenges as they arise.
More importantly, monitoring will allow you to take corrective action if you see a problem on the horizon. Discussing potential problems with your lender may seem like a last resort, but your lender wants you to avoid default as much as you do. They are invested in you and can help you before problems become a major problem. Sometimes your lender can help you restructure your loan or defer payments to avoid default.
What are your financing options?
Entrepreneurs have many choices when it comes to small business financing. Take the time to research what type of lender would be best for you and your business.
Here are some types of funding sources you could use:
- Bank financing: a typical credit extension from a financial institution to cover your business expenses with flexible repayment options.
- SBA financing: government-backed financing programs for small businesses from the Small Business Administration (SBA).
- Community organizations: Local and state economic development organizations, community development corporations, community development financial institutions, and small business incubators/accelerators. These community or not-for-profit entities can often take advantage of programs and financing options outside of traditional bank financing. ECDI, for example, partners with banks, the SBA, and other organizations to administer microloans, among other types of loans.
- Priming: using the resources at your disposal, such as savings or money from friends and family. This may mean little or no borrowed debt and no stake in your discontinued business. Other bootstrapping options include factoring, trade credit, customers, and leasing.
- Other options include crowdfunding, venture capital, and Fin-Tech funding.
Loans can be a complex subject. It is crucial to educate yourself about your options. If these options seem overwhelming, know that you are not alone. Organizations, such as ECDI or your local SBA office, can help small business owners with accounting, legal advice, networking, marketing, and more to help them prepare for the loan. The more you use these resources, the more likely you and your business are to be ready to lend, get a loan, repay it, and thrive.
This multi-part sponsored series highlighting ECDI’s work in Columbus is presented with paid support from ECDI.
Since 2004, ECDI has been helping Ohio entrepreneurs through its one-stop business services model, tailored to meet the needs of all entrepreneurs, regardless of their stage of business. From providing capital to entrepreneurs seeking to grow their business to providing targeted, business-specific educational opportunities to enhance entrepreneurial skills, ECDI works with its clients to meet their unique needs. Whether it’s helping a new client with a business idea or