At one time or another, most business owners seek business loans to fund their companies. There are many ways to finance a business, but a loan is one of the most common methods. This week’s newsletter discusses how to how to get ready to apply for funding; how to apply for a loan; and how to talk with a loan officer.

A basic tenet to bear in mind is that you shouldn’t wait until you need money to borrow money. Start identifying cash flow problems you might have and begin the process far in advance. It’s a good idea to establish lines of credit regardless of whether you need the money now or not.

Answer These Basic Questions First

First, you’ll need to answer a few questions before you begin the process of selecting a lending institution. The primary question to answer is to know how much money you really need. In addition to knowing how much money you need, the lender will also want to know exactly how the loan will be used. Be prepared to discuss the actual need for the loan and how you’ll use the proceeds.

Of course, the best way to determine the answers to these questions is to develop a basic business plan that includes financial projections. Not only will this help you answer these questions, but your banker will most likely ask you for a business plan. If you’ve not yet finished your business plan, find out how to quickly write and complete a no-frills, basic business plan.

A lender will look at the “Five C’s” in determining whether you and your company are good risks. Think about each of these “C’s” and be prepared to discuss each one with loan officers:

Credit History: Your credit must be good. Take the time to review your credit file with the three major credit bureaus and know your FICO score before you meet with any lenders. Your personal credit history will be considered if the business is small or relatively new. Like most loans these days, many small business loans are based almost entirely on credit scoring. The better your score, the more likely you are to receive a business loan with favorable terms.

Capacity:  Capacity is simply your ability to repay the loan. Your cash flow must indicate that you have sufficient means to make your loan payments.

Capital: The bank will look at the amount of capital that’s gone into the business, primarily at how much money the owner has invested in the company. Banks like to see that an owner has been willing to invest in their own company. Additionally, the bank will look at the amount of equity in the company and its net worth.

Collateral: To further reduce the bank’s risk, you may be asked to put up personal collateral to secure the loan. If you default on the loan, the bank could seize the asset to satisfy the debt. Quite often, small business owners are asked to use their personal real estate to secure a loan. This can be very risky for the business owner if the business should fail. Other forms of collateral can include inventory, accounts receivables, and equipment.

Character: The bank will look at your personal character and business history to help assess the risk of loaning money to you. Put your resume together, along with a list of references that you can present to the bank.

Selecting A Bank

After you’ve answered these questions and written a basic business plan, you’re ready to begin talking with loan officers. It’s a good idea to start by creating a list of banks in your area that offer business loans. If you think you might qualify for a Small Business Administration loan, then call several banks in your area that offer SBA loans and speak with the SBA loan officer. Make a point of talking to at least three loan officers. Shopping for a business loan is the same as finding the best loan for a house or a car – you’re looking for the best terms you can get.

When talking with each bank, find out the bank’s rules for business loans. Ask what type of businesses the bank finances and find out the bank’s minimum and maximum loan limits. Ask specifically what type of collateral the bank will accept. The bottom line is to determine if you and the bank are a good match. If not, keep calling other banks and lenders until you find a good fit.

If your business is relatively small, you may want to focus on local community banks that are eager to develop long term relationships with local small businesses. When talking with these loan officers, always be truthful and upfront about your situation and the risks involved in your business. Your banker can be an excellent sounding board and mentor for you as you grow your company.

After you’ve narrowed your choices, consider setting up a bank account with that bank and begin developing a relationship. After you’ve set up an account, apply for a short-term loan and then repay the loan quickly. This will help establish your credibility and credit worthiness. You won’t be a stranger to the bank when you’re ready to apply for a business loan.

Applying For A Small Business Loan

When you’re ready to apply for a business loan, call the loan officer and make an appointment to go in and discuss your business and your loan needs. Ask to have a loan application sent to you and bring the neatly prepared application with you to the meeting, along with a copy of your business plan and copies of your financial summaries. Take time to rehearse discussing your business prior to your meeting.

For your meeting, dress in business attire and don’t be late. Try not to take more than thirty minutes of the loan officer’s time. Your presentation should include an overview of the business and you should be prepared to answer negative questions. Always be positive and even-tempered. If the loan officer offers any terms, ask for them to be put in writing. As with any business meeting, call the loan officer the next day and thank the banker for their time. Take the opportunity to inquire as to the next steps in the process and when you might have an answer regarding the loan.

If your loan is rejected, ask why the loan was turned down and if the problems are correctable. Generally, rejections are indicative of businesses that have serious issues to address and are too risky for the bank. Take steps to correct these issues before submitting applications to other banks.

I wish you the best of success in your venture.