Most small-business owners need a bank loan at one time or another, and applying for one involves much more than filling out paperwork and saying a prayer. Among other things, you need to consider the state of your personal and business finances, how you’re going to repay the loan, and how much money you actually need.
Here are some of the key questions you should ask before starting an application:
Is it likely I will qualify for the loan?
You’re only going to hurt your credit if you apply for a loan you won’t get. “Just like if you get declined for a personal credit card, it makes it more difficult to borrow in the future,” says David Gass, a business consultant and coach in Meridian, Idaho. “If you get turned down, it looks to the next bank like you’re a bad risk.” He suggests asking lending institutions about their specific requirements before applying. Many will let you know the minimum credit score they require, the cash flow you need to show, and other qualifying factors.
How much do I really need?
Before you approach the bank, make sure you have a good handle on how much cash you actually need. The best way to determine this is to create a monthly cash-flow projection. Does your customer pay you in 60 days, but you have to pay your vendors in 15 days? If so, you might need extra money to tide you over. “It will reflect poorly on you if you come in to the bank asking for $50,000, then they ask you to create a cash-flow projection and you find out that you actually need $100,000,” says Adam Hoeksema, co-founder of Muncie, Ind.-based ProjectionHub, a Web app to help entrepreneurs make financial projections. “You should know how much you need and how you will use the funds before approaching the bank.”
How much can I borrow based on the asset I’m using for collateral?
Business owners often think if they purchase a piece of equipment for $100,000, they should be able to borrow $100,000 by pledging the equipment as collateral. But banks usually don’t agree, Hoeksema says. “Banks will value your asset below what you think the value should be, and then they will only lend up to a certain percentage of the value of the asset.” For example, banks might lend up to 70 percent of the value of a new piece of equipment, and maybe only 60 percent for a used piece of equipment.
Do I have adequate cash flow to repay the loan?
Your banker will probably ask you to provide financial projections for the business. Make sure to include your debt repayment plan in those projections. Bankers are going to be looking for businesses that have some wiggle room, and you may need to show available cash flow that is three times greater than your debt payment requirements, Hoeksema says. “They don’t want to see if you lose one customer, you won’t be able to make your loan payment this month. If your projections show that you have very little room for error, you are likely to scare them away.”
Will the money help my business grow?
If you’re borrowing $10,000 for payroll or other routine operating expenses, you’re not generating more revenue from the loan and could find yourself in the same spot three to six months from now. Instead, you should put borrowed dollars into the parts of the business that will generate more revenue over time and help reduce future borrowing needs, Gass says. “If I take that dollar and leverage it, put it into sales and marketing and drive more revenues — $1 driving $5 — then it’s worth it. It’s all about growing the business.”
How good is my business credit score?
Most people know their personal credit score, but very few know their business score, says Rohit Arora, CEO and co-founder of Biz2credit, a New York-based company that arranges loans for small businesses. As with personal credit, you can find your business credit score through Experian, Transunion or Equifax. If the score isn’t as high as you think it should be, it might be because there are outstanding liens against your business. Also, check to make sure your vendors are reporting your payments. You can try to boost your score by reducing the balance on your business credit cards or requesting a credit-line increase to lower the percentage of your available credit in use. “The lender is going to check your business, and your score is the final arbiter of whether you get the loan or not,” Arora says. “Even if you have stellar personal credit and good assets, if a lot of business contacts are saying you’re paying them late, that’s going to scare off lenders.”
Are my personal finances in order?
Bankers may want to look at your “global financial statement,” including personal information like outstanding student loans, personal credit card debt and mortgage payments. Until your business reaches a substantial size ($5 million to $10 million in annual revenue or more), the bank is going to rely heavily on your personal financial statement and personal credit score to determine the creditworthiness of your business. “If you have a $200,000 mortgage on a house worth $250,000, and you have $200,000 in student loans, the bank may not see you as a good candidate for a loan,” Hoeksema says. “If you have a lot of personal debt and very little collateral that you can provide to the bank, you may need to find a strong co-signer.”
Do I have all the documentation I need to apply for the loan?
Arora says some studies have shown that as many as four in five loans never close — “not because the business didn’t qualify, but because of the paper chase.” When applying for a business loan, you will need a lot of documentation. For example if you’re seeking a Small Business Administration loan, Arora recommends you provide the last three years of business and personal tax returns, personal financial statements and financial projections for the next 12 to 24 months. “If you go to the [lender] and are not fully prepared, not only does it make you look unprofessional, but by the time you get the documentation in place, it might be outdated,” he says.
Does the loan have a prepayment penalty?
When you take out a loan, find out if you’re free to pay it off early without any penalty. Some states allow lenders to charge prepayment penalties, in which case you should try to negotiate a compromise. For example, you could agree to a penalty only if you pay off the loan in a relatively short period of time, say, within six months from the time of the loan. “Prepayment is especially valuable if you believe your business may grow soon, and you may need a larger line of credit,” says Jeanne Brutman, a New York-based financial planner for small-business owners. “By having good excess cash and a paid-off or [paid-down] line of credit, it shows the lender you are responsible with debt and can handle an increase in your total credit.”
If I die, how will the loan be repaid?
It’s something most people don’t like to think about, but in the event of your death, an unpaid business loan can affect your family. “Most people think, if I die, the bank is out of luck, but that’s not true,” Brutman says. If you leave a large life insurance policy, for example, the bank may come after that. Find out what a lender’s policy is in the event of your death to best determine how to protect your family. “Most business owners understand that if they’re collateralizing their house and the business fails, they could lose their house,” Brutman says. “But they may not understand that if they die, it doesn’t cancel out their debts.” It may be best to put your assets in your spouse’s name, if the spouse doesn’t have an ownership stake in the business. Brutman also recommends personal property and casualty insurance coverage, which in the event of your death, takes business debt into consideration.
10 Tips You Must Know When You Seek For A Bank Loan In Nigeria
Every business at some point in its operating cycle will require some form of finance to pay its short term indebtedness or to fund new projects or business plans, or to acquire operating assets. Individuals at some point in their life may also need bank loans to help fund the purchase of a car, mortgage for a house or buy house hold appliances.
- You need to formally apply to a bank for a loan – When most people think of approaching a bank for a loan, they commonly ask for a business plan. However, not all businesses require a business plan. But all loans must require that you apply to the bank formally as such it is important that you are able to articulate your needs in your application letter.
- Banks charge interest on a per annum basisand they are not fixed– Banks do not charge interest rates per month but per annum. What this means is that when a bank offer a 20% interest on a loan it is per annum and not per month. For example, when you apply for a loan of N1million for a 3 month tenor at an interest rate of 20%, your interest will be N50,000. Which is 20% of N1million apportioned for just 3 months out of the 12. However, it can actually be lower depending on how often you repay the principal. Meaning if you repay N300,000 at the end of the first and second month and N400,000 for the third month your interest will be 20% of N1m for the first month =N16,667. Second month will be 20% on N700k for one month= N11,667 and finally N20% on N400k for one month = N6,667. The total is now N35k. The interest rates offered to you is also not cast in stone as banks often have a caveat in the offer letter that allows them to increase the rate whenever they feel the market conditions require it.
- Different banks offer different interest rates and terms and conditions – Just the way the price of goods and services differ in the market so does the interest rates and terms and condition banks offer. Whilst some might favour you in terms of lower interest rates they might offer shorter repayment period. This takes me to the next point;
- Never ignore the terms and conditions – When gives you an offer letter they aways include a set of “Other Terms and Conditions” or “OTC”. Usually, they differ from the conditions like collateral, interest rate, tenor (Terms and Conditions or TC) that most people prefer to look at. The issue however, is that when a loan goes bad and a bank takes you to court it is not the TC that often matter. The OTC is probably more important as it typically contains those issues that determine what the bank can do in the event of a default.
- Banks always ask for a collateral or some form of security – Banks no matter the type of loan you ask for will ask for some form of collateral. It could be a landed property, asset or even your personal guarantee. Sometimes they remember to register claim to these collateral in the court and sometimes they don’t. When they don’t they are at risk to loosing claim to the asset in times of default. But don’t be fooled the court may still recognize an encumbrance even if it isn’t registered.
- Defaulting on repaying your bank loans when their due doesn’t mean the bank will take over your business – Yes, banks like to avoid the court as much as you do and quite frankly want you to succeed because your success and theirs is directly proportional. If you can’t pay back all of your loans, it is better to pay a portion of it that you are able to than not pay at all. Judges often take cognizance of that which positively helps your case. So when you default in repaying any portion of your loans endeavor to approach the bank and seek a new deal
- You can always attempt to refinance or restructure your loan – Following from above, you can always approach your bank to restructure your loans if you think the current terms are not favorable to you. And it is not also when your loan is bad that you can approach a bank. You can also approach them when your business is doing well and your are servicing your loans promptly. Business are such that the owners must constantly seek ways to improve its operational conditions you cannot just rest on your oars. Refinancing your loan involves approaching another bank to take over your existing loan as a new lender. You should utilize this option when the new bank offers your better T&C.
- You can ask your bank for a moratorium – A moratorium is simply a bank permission to a borrower to suspend repayment of principal for a period of time. Because some business ideas require time to start making money despite borrowing from a bank, it makes sense to give the business some time and not burden it with huge cash outflows that it could better use in growing the business. Banks recognize that and will often allow borrowers a period of grace (one month, three months, one year etc) where they only pay interest and resume paying interest and principal at the end of the moratorium.
- The biggest threat to defaulting is not your interest rate but your Debt Service Coverage Ratio(DSCR)- Imagine two guys Mr A and B each borrow N1million but with Mr A told to repay over one year and Mr B over N3 years.They both get charged 20% per annum interest rates and will repay principal and interest at equal installments. Mr A will have to pay a total of N92k every month for one year till the loan is repaid whilst Mr B pays N37.1k every month for the next three years. Now assuming they both generate cash of N100,000 every month in their business who do you think will go default sooner should there be a sudden drop in revenue within the first year? Certainly it is Mr A, even though he pays less interest (total of N111.6k) compared to Mr B (N337.8k) over three years. This is because Mr A has a DSCR of 1.09x compared to Mr B with 2.7X. Provided Mr B’s business earns a return on his investments that is over 20% he almost sure to make a profit despite paying higher interests.
- Banks have hidden charges – Apart from the interest rate bank charge, they also charge you fees and C.O.T. But off course we are familiar with these. However, banks also have other cost which they mostly do not tell you when you apply for a loan. For example, they deduct taxes whenever they charge you C.O.T or WHT when they are paying you an interest. They also charge you punitive interest rates whenever you default in payments even though your loan agreement provides a less punitive rates for such. It is important to always ask your accountant to conduct a monthly spot check on charges when they prepare bank reconciliation reports.
The post above and its ensuing comments, if any, is purely the opinion of the writer(s). It therefore should never be considered as an investment advise of any sort. If required, readers should please consult a competent professional financial adviser for any investment decision.