Want to borrow money for your business? Have answers to 7 questions
In his books Borrowing for Your Business and Borrowing to Build Your Business, former banker George M. Dawson addressed seven questions typically asked in any borrowing situation. I believe these seven questions can help any commercial borrower better understand how lenders evaluate their loan proposal. Below is a discussion of the seven questions.
First, how much money do you want? Some borrowers fail to determine how much they really need. Lenders want to know that the borrower has taken the time to figure this out as accurately as possible. Don’t forget to allow for contingencies, because the unexpected can happen. It is important to borrow enough to avoid going back to the lender to ask for more right away. Borrowing too little can be enough to get you into trouble. Preparing accurate cash flow projections with assumptions will show you how much you will need to borrow.
Second, what are you going to do with the money? Lenders want to know where the money is going or how it will be spent. Simply saying “working capital” does not provide much reassurance to the lender. List the categories the money will be used for and how much will be needed for each category. Examples are equipment, renovation, lease improvements, furniture, fixtures, inventory or debt consolidation.
Third, why is this loan good for your business? You will need to show why your business will benefit from the loan proceeds. Lenders like to make performing loans, meaning loans that result in higher sales or margins and lower costs. Loans to start a business, business debt consolidation or the purchase of a business are also examples.
Fourth, why do you need their depositors’ money to do this? Lenders like to know why you need to borrow. In most cases, it’s for good reasons, like starting a business, buying seasonal inventory, or buying additional equipment. For an existing business, lenders want to see if the business is generating profits to pay ongoing operating expenses and if the loan will not be used to pay those expenses or pay a tax liability. Keep in mind, especially when starting a business, that lenders will require an equity or cash plus asset investment of 15-30% of the total transaction. This is to make sure you have something at risk. They will also ask you to sign a personal guarantee and they will check your credit history.
The fifth and sixth questions are somewhat related. When are you going to repay it and how are you going to repay it? Lenders want to see through conservative cash flow projections that the business will have the ability to repay the loan. They want to see adequate collateral pledged. They will assess whether you have enough experience in the business to make the right decisions. They will also assess the health of your industry, economic conditions, and the extent of your competition.
Finally, the seventh question asks, what if your plans don’t work out? Show in your loan proposal that you have anticipated what could go wrong and your plans to resolve these issues if they do occur. Indicate the risks in your industry and the risks of an economic downturn. Lenders will be reassured to know that you have thought about these issues and have plans to address them. In the case of a business start-up, secondary sources of personal income are important in case the cash flow of the business shrinks.
Don’t forget that the business advisors at the Small Business Development Center can always help you develop a loan proposal free of charge and help you understand the business loan process.
Business Tips was written by Dave Erickson, Director and Certified Business Advisor IV of Angelo State University’s Small Business Development Center. For more information on the subject of this article or the services of the ASU SBDC, contact him at [email protected]