There are five basic lending factors that all financial institutions look at before they will agree to loan you money for your business.
By: Hitesh Khan/
1. Credit history. One of the primary lending factors lenders look at is the condition of your personal and business credit. This is reflected in your credit score. Before you even start shopping for a loan, request a copy of your credit report. Review it carefully for mistakes, and resolve any discrepancies before you start the application process.
Your personal credit score is associated with your personal identification number, but business credit reports are tied to your business’s unique identity number.
2. Vested interest among important lending factors. Business loan applicants should have a reasonable amount of equity invested in their businesses. Lenders want to know that you will work hard to make your business a success. When they see that you have invested a substantial amount of your own money in your venture, they will assume that you will work hard to make it a success.
Also, strong equity with a reasonable amount of debt can help a business weather tough economic times. Little or no equity leaves a business vulnerable, increasing the risk of default.
3. Working capital. Working capital is your current assets less your current liabilities. Working capital can also be thought of as cash on hand, or what is available to pay current debts and keep your business running. A lack of adequate working capital increases the risk that your business will fail, and makes lenders much less likely to issue you a loan.
4. Ability to repay. Banks want to see two sources of repayment: cash flow from your business and a secondary source — typically collateral. Lenders will look at your past financial statements, including those of any business partners.
Financial institutions who look into several lending factors, will want to see your:
- Personal assets and liabilities
- Personal tax returns for the past three years
- Balance sheets for the past three years
- Profits and loss statements for the last three years
- Accounts receivables and payable aging
If your business has consistently made a profit, you are more likely to get approved. But if your business has not been consistently profitable, you can increase your chances of getting a loan by including detailed information of new opportunities, new contracts, or other information showing that your company is not a “risky business.”
Before you decide to personally guarantee a small business loan, think about what a personal guarantee means. The guarantee applies only to you, not to your business partners nor to your managers. It means that you are declaring an individual pledge to make good on the loan, usually without exception.
Depending on how your contract is written, you may be responsible for the loan even if your business is protected by limited liability laws. Many lenders require borrowers to personally guarantee a loan or secure it with personal assets if your business is organized as a limited liability entity.
Many lenders also require evidence of collateral and is among important lending factors. Collateral is required for most business loans, although the lender does not necessarily decline a loan where inadequate collateral is the only unfavorable factor. Collateral can be business assets and personal assets outside the business. If you plan to purchase equipment and other assets with borrowed funds, you can assume that this will be used as collateral for the loan.
5. Experience and character. With a few exceptions — franchises are a notable one — you should have experience in the type of business you plan to run – and it is among important lending factors. If you don’t, lenders will expect you to hire or partner with people who have appropriate experience. At the very least, you should be able to point to business acumen and managerial experience.
The weight given to a lender’s assessment of a borrower’s character can vary tremendously between lending institutions and between individual lending officers. Many small businesses have found more success “selling” their reputation and good character to smaller lenders.
Improving Your Character in Front of Lenders
As a general rule, the following traits are considered the most important when a lender considers your character:
- Successful prior business experience
- An existing or past relationship with the lender (e.g., prior credit or depositor relationship)
- Referrals by respected community members
- References from professionals (accountants, lawyers, business advisers) who have reviewed your proposals
- Evidence of your care and effort in the business planning process
Many banks consider the amount of investment the owners themselves are committing to the business as evidence of a borrower’s “character.”
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