Borrowing to Finance Your Business

Entrepreneurs & Their Communities August 05, 2013 Print Friendly and PDF

At some point, most small businesses need to look for a loan. While the reasons for needing a loan vary, nearly every business will face a time when bootstrapping or personal savings just cannot cover the need. While taking on debt can be a stressful decision, you should keep in mind that well-managed borrowing is actually an important tool in the business manager's toolbox.  The trick is, of course, knowing when to borrow and for what reasons.

Why to borrow

Some common reasons to consider a loan for your business include:

  • Buying or launching a new business
  • Expanding an existing business
  • Adding a new enterprise
  • Adding value to an existing product
  • Increasing efficiency
  • Purchasing equipment or infrastructure

When is borrowing a good idea

Many of the horror stories that surround small business loans are the result of borrowing for the wrong reasons. Here are six questions to ask yourself before approaching a lender:

  • Will borrowing this money move my business closer to my goal?
  • Is borrowing this money resolving a problem (versus temporarily fixing a symptom)?
  • Can the loan be repaid without creating a negative cash flow for the business? 
  • Have you considered at least two alternative actions to this loan? 
  • Will borrowing this money likely to create a new problem?
  • Is my family and/or management team supportive of this action?  

Choosing the right lender

Ideally your lender should be someone you know and trust. While the interest rates on a loan are important it may not be the most important consideration. In some cases it may be worth a slightly higher rate in order to do business with a company that you trust and that is willing to work with you. Some key criteria for selecting a lender include:

  • Is the lender easy to reach by phone or email? Does he/she return messages promptly?
  • Does your lender provide you with written documentation of the terms and repayment expectations? Are they clear on the timing of when a decision will be made and how you will be notified?
  • Does your lender answer your questions in clear, easy-to-follow language? Are they willing to spend time explaining how the loan works?
  • Are the rates and terms of the loan competitive?  
  • Has your lender taken the time to really understand your business? Do they ask good questions? Are they prepared?

Preparing to meet with a lender

Once you have determined that you are ready to pursue a loan you should begin preparing your best case. Remember that lenders want to make good loans. They want you and your business to succeed but most important to them is that the loan will get repaid. Presenting yourself as a knowledgeable professional will help you close the deal:

  • Check your credit report and resolve any errors
  • Develop a habit of good record-keeping
  • Hire professionals (accountants, attorneys, etc.) to help you manage your business
  • Know your values and goals as they relate to your business
  • When problems arise address them openly and honestly -- denial is not a good management strategy

Common mistakes that result in denial of credit

  • Providing an incomplete or inaccurate application
  • Not providing information in a timely manner
  • Not providing a clear explanation of how much money is needed and how the funds will be used
  • Withholding personal guarantees (this is especially true for startups and smaller businesses)
  • Having no experience in the industry where you are trying to build your business
  • Not knowing your personal and business credit rating
  • Not showing efforts to improve your credit rating
  • Not having a solid business plan with reasonable projections

Any of these mistakes can easily result in a denial. Lenders understand start-ups and the cyclical nature of businesses but they may not know the specifics of your business. You must be willing to reveal information about your operation and be prepared to educate your lender so they can make a good decision. You also need to have a solid plan for the future. Finally, if your business has had some financial struggles, what the bankers want to see is that the business has corrected the situation and it has a positive outlook for the future.

Do your homework prior to meeting with any lender. Make sure that your team of support professionals, such as your certified public accountant and attorney, have taken a critical look at your plan and asked you the tough questions. This just helps you prepare to discuss your needs and plans with a lender.

Once you have established a relationship with a lender be sure to stay in regular contact. Your need for additional capital should not be a surprise but should be something you and the lender have already discussed. Bankers want to see strong businesses. They are very willing to provide guidance and talk possible solutions to challenges that occur. They understand the business cycle and keep up with the challenges and opportunities that their customers face.

Getting the funds you need for your business can be challenging. But with proper homework and networking with your mentors, it is not the impossible dream. Avoid the common mistakes and come prepared to the meeting with a solid plan on paper that you can verbalize to your banker.

 

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