Things to consider when taking out a business loan

by Andrew Saluk

Here are some useful tips you can use to be better prepared when seeking a business loan.

There are three main components banks review when underwriting your loan application. The knowledge and understanding of these issues can greatly increase your chance of success while also save you the time of applying for a loan program you may not qualify for due to your current situation.

The three main components are:

• Your personal and business credit history (Your payment history on your current debt)

• Income (Can you document the ability to repay the loan request)

• Collateral (What assets can you pledge to secure the loan?)

Credit

The first item reviewed by the lender is the personal credit history of ALL principles of the company – the general guidelines are any individual who owns greater than 20% of the company. A low credit score from any of the principles will most likely result in a decline of the loan request. The business credit history is also reviewed.

Therefore you must be familiar with what is in your credit report. There are many online resources to get a copy of your credit report to confirm accuracy of the payment history. If there are errors contact the credit bureaus directly with written documentation to have them corrected. Independent research has shown that many credit reports have errors.

Another part of your credit history that is reviewed by lenders is the relationship of available debt to utilized debt. If you are using most or all of your available debt the lender will need a mitigating factor to increase your debt levels.

Other factors that are part of the credit review process:

• Amount of Financing Requested

• Industry

• Type of Business

• Time in Business

• Size of Business – Sales Volume

• Type of Collateral

• Loan to Value Ratio

The use of loan proceeds will also weigh into the underwriting decision. Certain businesses and industries have more common lending needs than others. Working capital and other unsecured loans are generally looked at more closely than secured loans like real estate or equipment financing.

Knowing exactly what you are going to do with the money by having a specific purpose will increase the comfort level of the lender.

Income

Loan approval is granted on the borrower’s ability to pay back the loan as evaluated by the lender.

You must be able to provide your income statements or show a record of your earnings for a period of time. You need to have a good earnings history and show the lender evidence of it.

The amount of documentation depends on the size of the loan request. Most lenders have breakpoints where the list of financial statements increases. These breakpoints are usually as follows:

• Loans up to $100,000
  - 1 Year Personal and Business Tax Returns

• Loans over $100,000
  - 2-3 Years Personal and Business Tax Returns
  - YTD Interim Financial Statements
  - Current Balance Sheet
  - Aging Reports
  - Personal Financial Statements on all Principles

The analysis of these documents must show the ability of the principles to pay their current personal and business debt as well support the additional debt request.

Collateral

Your credit report and current financial status can only show so much; since all of these documents show your recent payment and income history there is no way for the underwriter to predict the future. Therefore a lender may also want to see that you have assets to pledge as collateral should their be a downturn in your business or drop off in your income.

Types of Collateral:

• Real Estate – Commercial or Residential

• Inventory

• Equipment

• Receivables

• Business Assets

Collateral requirements vary depending on the type of loan, size of the loan and use of proceeds.

Collateral is generally taken as an abundance of caution, NOT as the primary repayment source.

In summary, the steps to qualify for a business loan are quite simple:

• Show that you have a particular purpose for requesting the loan

• Ask for only what you need

• Prove to the lender that you are able to pay back your loan by showing income statements

These are general parameters to assist you in beginning your quest for business financing. Since all businesses are unique in their structure and style it is important to discuss all lending needs with your business advisor of banker before making any decisions.

As a member of the Small Business Advisory Committee of the Huntington Chamber of Commerce I would gladly answer all of your lending questions and aid you in structuring your lending request to optimize your success rate.

This article was prepared by Andrew Saluk, a Business Banker who is a member of the Small Business Advisory Committee, a voluntary organization of the Huntington NY Chamber of Commerce.

Business advice is available free to everyone.

Please visit the website at www.smallbusinessadvicefree.com for additional information. To arrange a consultation please call 631 423-6100 or email advice@smallbusinessadvicefree.com to schedule an appointment.

© Andrew Saluk 2009