by Brad Owens
Business Consultant for SBDC at USF
No matter how successful a business may be, there are many business owners who find themselves in situations where they need to obtain a business loan in order to take their business to the next level. Whether it’s going from renting to owning the business property or maybe expanding the business internationally, additional investments can be a fact of life.
Obtaining a business loan is often a once in a lifetime experience for a business owner. It can be a daunting and confusing time for those not well-versed in the process. Here are five hurdles that a business owner can often face and information on how to get over them.
Hurdle #1: Business Plan and Financial Projections
Having a well thought out and thorough business plan and financial projection report is essential when applying for a loan.
This is a barrier that mostly effects existing businesses with at least a three-year track record. The lender is going to look at three years of history, plus the current year-to-date, and do a trend analysis, cash flow analysis and debt service coverage analysis. This helps the lender essentially look into a crystal ball that determines how likely the business owner is to pay back the loan.
There are many business owners who seek outside assistance when creating these reports due to the complex and in-depth information that needs to be included. Some spend thousands of dollars for these reports, but it should be noted that there are resources available that will help business owners create these reports at no cost.
If the lender is on the fence and leaning toward a rejection, they may require a U.S. Small Business Administration (SBA) guarantee to help nudge them to a yes. Gaining an SBA guarantee is generally an easy task. The main criterion is to be a for-profit business that is owned by an American citizen or legal permanent resident. They of course analyze the business owner’s credit history and do their own analysis, but most businesses qualify for an SBA guarantee. This litigates the lenders risk enough that they will say yes, because the SBA agrees to cover the guaranteed portion to the lender.
If a business has not been in business for three years, it’s typically a no right away, because it is hard to develop predictions of an outcome. Though there is always an exception to the rule, it is rare that they will accept a business plan or financial projections from a startup and that business owner would definitely require an SBA guarantee to even be considered.
Hurdle #2: Equity Injection
Every single loan requires a down payment. There are many clients who think that even if they don’t have a down payment, they can somehow finagle their way around it and find a lender who doesn’t require it. The business owner assumes the lender will read their detailed business plan and be so impressed that they will just overlook this small hiccup, but that is nonsense. That’s not how it works.
The business owner has to be prepared when going through the loan process. They must plan for the down payment whether it’s the minimum of 10 percent or the more common 30 percent. The down payment can’t be borrowed, but it can be gifted by parents. The down payment must also be documented with three months of bank statements. It’s a very straight forward, upfront requirement.
There is, again, sometimes exceptions to rules. There’re only maybe one or two scenarios for an existing business that has been operating for at least three years. If this business needs a line of credit, they can rely on the equity the business has earned, similar to equity a homeowner develops over time. Similarly, the lender will analyze the financial report, credit scores, income and the value of the business to determine if the business owner is a viable candidate.
Hurdle #3: Credit Score
The credit score criterion is very straight-forward. Most lenders require a score of 680 or above. If a business owner has the minimum, they immediately move on to the next round of the process. It’s that cut and dry. If a business owner is at or below 680, it is typically an automatic no from the lender. If a business has multiple owners, this rule applies to all owners of the business. So, if one owner has a score of 700 and another has a score of 600, it is going to kill any chance of financing. The 700 does not offset it, nor do they take the average the two. If it takes both owners to run the business, then they both have to meet the qualifier.
There is only one way to jump this hurdle if your score does not meet the requirement. You must repair your credit.
Most credit bureaus now offer a tool on their website that will tell you what you need to do to get your score up and how long will it take for that to occur. These business owners have to go back and address their credit issues, get them resolved, and get their score up.
Hurdle #4: Difficulties Associated with Providing Required Documentation
Once a business owner completes the aforementioned steps, they still face an application package from the lender with a checklist of documents required. This can be a very challenging part of the process for some business owners who are not privy to what documentation is required.
Not being prepared, could delay the process significantly. Many applicants think that they can send one piece of documentation at a time and that the lender is processing these documents as they come in, but that is just not the case. The lender will create a file and wait until every document is submitted before they even begin the evaluation process. This can sometimes take weeks or even months, if the borrower is not prepared.
Because obtaining a business loan is something that typically happens once in a lifetime, not every business owner knows what documentation is needed to move forward. It is important to seek guidance before attempting the process. If seeking outside guidance to help you through the process, it is important to find someone with inside knowledge, who can provide the required checklist before the lending process with the bank even begins. This will help you gather all of the information beforehand and allow you to avoid any type of delay with your loan.
It is important to note that there are two checklists involved in the process – the application checklist and the closing checklist. In order to make the process go as smoothly and quickly as possible, it is important to be prepared for both checklists ahead of time.
Hurdle #5: Finding the Right Lender
This is probably the most crucial hurdle in the entire process. If a business owner completes every task, and jumps every hurdle, only to find out that they did it for the wrong bank, they just wasted their time.
For example, if the business is a startup, but the bank they apply to does not invest in startups, then the entire process was for nothing.
Like any other part of owning a business, it is important for the business owner to do research. Again, there are resources out there that can help match the business owner to the right lending source, so they have the best opportunity to succeed.
It may be hard for a business owner to determine the right match on their own because lenders often have a loan goal they must meet in order to keep their job, so they are not going to turn down an opportunity even if they know it’s not a right fit. That’s not an efficient way for the borrower to find a lender. It’s better to know which lender will have the greater opportunity for success, so that you don’t have to do the entire process again with someone new.
Though the process of obtaining a business loan may seem daunting to tackle alone, if you have the right resources in your corner, any hurdle is possible. It is important to remember that there is usually an exception to every rule. If you don’t get approved the first time around, learning from mistakes will help you be successful the second time.
Brad Owens is a business consultant and capital access specialist with the Florida SBDC at University of South Florida, based in the Channelside office in Tampa.