U.S. Small Business Administration

Finding financing to start and expand a company is an age-old problem, and most entrepreneurs find it to be one of the greatest struggles they face.

While the process can be time consuming, frustrating and intimidating, if you are informed and well prepared, your chances of securing the needed capital are greatly increased.

In putting together a loan package, ask yourself the following basic questions.  Answers to them, and the information provided to back up the answers, are essential to the lending decision and the rapidity with which it is made.

1) What is the specific purpose of the loan?
Your lender or investor will review your financial requirements among three types of capital acquisition:

• Working Capital - Used to meet fluctuating needs that will be repaid during the company's next full operating cycle, generally one year.
• Growth Capital - Used to meet needs that will be repaid with profits over a several-year period (usually not more than seven years).  If seeking growth capital, you will be expected to show how the money will be used to increase profits sufficiently to repay the loan in the agreed-upon time frame.
• Equity Capital - Used to meet permanent needs.  Equity capital must be raised from investors who will take a risk in return for some combination of dividend returns, capital gains or a specific share of the business.

2) What amount of financing will support my needs?
NOT, how much can I borrow?  Have enough existing capital so that, augmented by the loan, the business can operate on a sound financial basis.  For new businesses, this includes sufficient resources to withstand start-up expenses and the initial operating phase during which losses are likely to occur.  Be able to inject between one-third and one-half of the total capital required.  If you plan to borrow equity from friends or relatives, determine what their payment terms will be.

3) When and for how long will I need these funds?
Most of today's lenders are providing growth capital in the form of asset-based loans, i.e., loans for acquiring land, buildings or equipment which can be used as security.  While the majority of these loans carry terms of three to seven years, some may extend over longer periods.  For financial planning purposes, the entrepreneur should keep in mind that longer loan periods incur larger overall interest costs.

4) How will I generate sufficient cash flow to repay the loan?
Consider the situation from the lender's point of view:  if you were asked to lend someone money, you'd want assurance of being paid back in full, and in a timely manner.

5) What collateral can be utilized, if applicable?
Estimate its value, and be ready to provide supporting appraisals.

6) Will the owners provide personal guarantees?
Having a comprehensive and well-thought-out business plan is essential in obtaining financing.  In fact, without one, even stepping into the bank is pointless.  To lenders or potential investors, it not only provides information and reveals your evaluation of your venture's feasibility, but also reflects your management abilities.  An analytical, objective business plan convinces lenders you are cautious, conservative and capable.  One that is poorly researched, or makes unsupported assumptions and draws unfounded conclusions, shows you are inexperienced and – in their eyes -- reckless.  Lenders receive so many proposals that they cannot afford to spend much time evaluating each business plan.  That means your plan has only a few minutes to make a good impression, and must speak for itself as a sales tool.  One key is to make sure your business plan is as thorough and accurate as possible, and that you can back up all your claims with facts.

The Business Plan Should Include:

• Executive Summary - This portion concisely summarizes the key elements of the business plan which follow, and should convince the lender that it is worthwhile to review the plan in detail.  Include information about the loan being sought in terms of amount, purpose, duration and how you intend to pay it back.
• Company History/Organization/Management - Describe the historical development of the business, including legal form of organization, significant changes, subsidiaries and degree of ownership, and the principals and the role they played in the firm's foundation.  Detail their experience and the management and decision-making structure. Also include an organizational chart, and discuss other key personnel and their responsibilities.
• Product/ServiceProduct/Service - Detail the present or planned product or service lines, including their relative importance (with sales projections, if possible), evaluation (use, quality, performance), competitive advantage and demand.
• Market Analysis/Marketing Strategy - You should be able to estimate how many customers you will have and how near they are to your location, as well as their age, family structure, lifestyle, disposable income and purchasing habits.  Explain why your product/service is desirable to them, the scope of your firm's marketing and selling activities (including pricing policy), and what share of the market you will realistically be able to capture based on the industry analysis that follows.
• Industry Analysis (Competition) - It is equally important to know about your field and have a keen sense of the competition.  List your major competitors by name and describe how closely located they are, what products/services they provide, what they do better/worse, and how profitable/successful they are.  Also elaborate on the industry itself, including an industry outlook, principal markets, industry size and major characteristics.  Describe the effects of any major social, economic, technological or regulatory trends.
• Production/Operating Plan - Explain how the firm will perform production or delivery of service in terms of physical facilities, suppliers, labor supply (current and planned), technologies/skills required, manufacturing process (if applicable), and cost breakdown for materials, labor and overhead.

According to George Solomon, Director of Education and Resource Management for the SBA's Business Development Office, the following items will also be needed to support a loan request:

• Sources and Users of Funds Statement - The potential lender will require a statement of how you intend to disperse the loan funds.  Back up your statement with supporting data.  For example, buying a commercial building will require a preliminary title report, an appraisal, an escrow and title insurance, among other documents.
• Cash Flow Statement (Budget) - These documents (used for internal planning) project what your business means in terms of dollars, and show cash inflow and outflow over a period of time.  If you've been in business for some time, worksheets can be compiled from the actual figures of income and expenses of previous years combined with projected changes for the next period.  If starting a new business, you will have to project your financial needs and disbursements.
• Three-Year Income Projection - This pro-forma projection only includes income and deductible expenses, while the cash flow statement (above) includes all sources of cash and monies to be paid out.  Find out the lender's specific requirements as to whether income and expenses should be projected on an annual or monthly basis.
• Break-Even Analysis - The break-even point is the point at which a company's expenses exactly match its sales or service volume, and the firm neither makes a profit nor incurs a loss.  It can be calculated in either mathematical or graph form, and expressed in total dollars or revenue exactly offset by total expenses.
• Balance Sheet - This financial statement, usually prepared at the close of an accounting period, shows the financial condition of the business as of a fixed date.  By regularly preparing it, you will be able to identify and analyze trends in the financial strength of your firm and thus implement timely modifications.
• Income Statement - In contrast to the balance sheet, this statement shows what has happened to your venture over a period of time, and is an excellent tool for assessing your business.  It enables you to identify weaknesses in your operation (such as the timing of an advertising campaign that did not bolster sales as anticipated), and devise more effective ways to run your firm and thereby increase profits.  Similarly, you might examine your income statement to see which months have the heaviest sales volume, and plan inventory accordingly.  Comparison of income statements from several years will provide an excellent picture of the trends in your business.

As a sole proprietor or principal of a corporation, you may be asked to back up your business loan with personal assets (your house, stocks or bonds).  If you're in a partnership, a personal guarantee must be signed by all principals for repayment of the loan.

It is important to emphasize that businesses with several years of successful operation will find it far easier to obtain financing than start-ups, as lenders will be much more receptive and confident in your ability to repay a loan at that point.  In fact, without a strong business plan with realistic expectations and forecasts, managerial experience and collateral, it may be impossible for a new business to get a loan at all.  Lenders are always leery of extending financing to new ventures or unproven management teams as they represent a high risk of default.

This doesn't mean you can't get a loan as a start-up, but rather that you will have to compensate for the lack of a track record by being strong and well prepared in other areas.  Demonstrate by your enthusiasm and the thoroughness of your business plan that you are committed to the venture and that it will succeed.  After all, when applying for a loan, you're selling both yourself and your business.

Scott McCrea, a consultant with Deloitte & Touche's San Francisco office, advises entrepreneurs to develop and nurture a relationship once credit is granted.  He suggests keeping the lender updated on the company's progress, and staying abreast of the lender's other products and services that may apply to your business.  As the firm grows, you may need to restructure or enhance your credit, and it only makes sense to turn to someone already familiar with, and confident in, your business acumen.

How Banks Evaluate Loan Requests

In putting together the best possible package to secure a business loan, it's important to know what happens after you leave the bank, and the lending officer evaluates your request.

But first a word of warning from Roger Bel Air, author of How to Borrow Money from a Banker and national lecturer:  Banks are in business to lend money and get it repaid -- with interest.  That's their number one priority.  And several key factors are contributing to heightened cautiousness on their part, including concern about a greater number of business failures and losses in the face of an economic recession, and tougher loan examination policies by federal bank regulators as a result of the savings and loan crisis.

"A banker's career is based on not making mistakes," Bel Air stresses. "And determining whether or not the bank will be repaid -- the bottom line in any loan decision – is subjective.  Beyond the facts and figures alone, banks want to see that the applicant has thoroughly reviewed his options, laid the necessary groundwork for borrowing, and prepared a clearly written and well organized loan application.  This is particularly true in today's credit-tight market as lending officers feel a tightening of the screws from regulators, and uncertainty about the future."

Another advantage of preparing an effectively organized loan application (including the all-important business plan) is that it will significantly decrease the time spent waiting for an answer.  According to John Nelson III, SCORE counselor in Rhode Island and vice president of a major U.S. bank, "in about 80 percent of the cases, the formal request is not complete."  Much of the time spent in approving a loan can be traced to the banker having to ask the potential borrower for more information or for clarification of the information that has already been submitted.

In evaluating loan applications, three C's of credit are taken into account -- character, capacity and collateral.

1. Character
   
   Character is actually a check on your financial status and personal credit history, including your previous loan payment record.  The theory is that people are creatures of habit -- if you have repaid a loan on time before, you will repay this one as well.  Conversely, if you have defaulted on a previous loan, the danger is that you'll tend to default again.
   

   Also considered is experience in the type of business you are trying to finance, including level of responsibility, education and business management training.  Lenders are particularly concerned that potential borrowers have a solid understanding of financial record keeping, business credit, the importance of collecting accounts receivable, inventory control and turnover, and marketing their product or service.

   
   If your prior business experience is not relevant to your current venture (for example, if your career has been in the corporate world, and you want to start a restaurant), banks will be leery about your ability to run the new endeavor successfully and thus repay the loan.

2. Capacity
   
   Prudent bankers have always looked first to the cash flow of the business as the way the loan will be repaid, which underlines the importance of preparing a cash flow statement with future cash flow projections before presenting your loan request.  Doing so indicates to the lender that you are knowledgeable about the cash coming into your business and being spent, and therefore better able to avoid a cash shortage that would jeopardize making monthly loan payments.
   
3. Collateral
   
   While cash flow is the primary source of loan repayment, lenders will want a back-up or secondary source as an "exit of last resort" should your business not prove profitable.  Collateral -- defined as "anything of value used as security for repayment of a debt or performance of a contract" -- can be real estate, stocks and bonds, savings account passbooks, equipment, accounts receivable, or the cash value of life insurance policies.

   Psychologically, lenders feel that borrowers have more interest in repaying the loan if they know that failure to do so will result in the lender taking possession of whatever has been put up for collateral.  A lender will also try to obtain personal guarantees so that if you default on the loan, the institution has access to your personal assets.
   
   It's important to note that these days, in the wake of severe economic downturns such as that experienced in the Southwest in the mid-1980s, collateral doesn't carry the weight it used to.  As the president of an Oklahoma bank stated, "In Oklahoma City, you can buy a building today for what it cost to rent one eight or nine years ago."  So banks are likely to require more collateral than was previously the case, and evaluate it based on market -- rather than replacement -- value. companies without enough collateral to pledge ill have to scale back their borrowing needs and make do with less.
   
   One final tip is not to forget "relationship banking."  Once a relationship has been established, and you've explained your business operations and anticipated needs, it becomes far easier to approach a banker when a loan is needed.  This familiarity will make you more credible than a customer who has not taken the time to introduce himself.
   
   And be sure to stay close to your banker, being open and honest about major changes and significant events -- both good and bad.  Because your lending officer has to tell your story to other people in the organization (including his superiors), nothing can jinx the relationship faster than a lack of candor. Feeding bankers regular information is, of course, time consuming when you have a company to run.  But it's all part of building credibility and trust, and will enable you to use your banker's knowledge to help ensure the continued success of your business.

    

    

   *Excerpted with permission from "Small Business Success" magazine, Volume 4, produced by Pacific Bell Directory in partnership with the U.S. Small Business Administration and the Partners for Small Business Excellence.