Starting a small business or expanding your existing one can be an exciting opportunity. Of course, a key component of any small business plan is financing. But just what do lenders consider when deciding whether to approve a small business loan?
When looking for a small business loan, you’ll need to prepare a written proposal that will do the following:
- introduce yourself and your business
- specify how much you wish to borrow
- describe what you will use the money to finance
- indicate how you plan to pay it back
Here are the major factors lenders consider when they assess your request:
Your business plan
If you’re starting a new business, it’s essential to show that you’ve got a workable strategy. There are many books, seminars and consultants that can help you prepare a solid business plan, which should demonstrate your knowledge and experience as well your projected revenues. If you’re borrowing to expand an existing business, provide financial statements for at least the past three years, major legal documents (lease contracts, articles of incorporation, etc.), and describe how you plan to grow your business with the money you’re borrowing.
Your ability to repay
A lender will want to know how long you will need to pay back the loan and will ask you to demonstrate your means of doing so. This will be the major factor in determining the amount you’re approved to borrow. If you already have a business, you’ll be asked for an income statement that shows your past performance. A new or expanding business will need to provide realistic income estimates for at least two years. Lenders will also want to know your backup plan if those projections fail to be accurate.
Backup plans can fail too, so lenders will want to know how you can secure the loan. For an established business, you can provide a recent balance sheet that lists all assets and liabilities. If you’re the sole proprietor of a new business, however, you may be expected to secure the loan with your personal assets. Make sure you understand the risk this involves, especially if you are securing the loan with your home.
Your credit history
As with a personal loan, lenders will look at your credit history to see if you have reliably paid back what you’ve borrowed in the past. Before shopping for a small business loan, it’s a good idea to check your credit report to make sure the information they have on file is accurate.
Your personal stake
Lenders will want to know how much of your own equity you have put into your venture. Investing your money in a small business shows that you’re committed to its success. As a rule of thumb, the ratio of debt to equity in your small business should not be more than four to one. In other words, if you want to borrow $40,000, you should already have $10,000 of your own money invested in the business.