How to get a business loan
Great tips on how to get the best business loan
Why get a business loan?
Sooner or later most small businesses need to know how to get a business loan, whether to get the operating capital for business startup or to finance an expansion.
When applying for a business loan, it's essential to prepare a detailed business plan and fully inform the lender about your proposed business financing need. This information helps the lender to provide you with the right type of loan and advice.
Decisions to make when applying for a business loan
Deciding that your business needs a loan is only the first step. There are a number of things to consider before you approach a lender:
Decide what the money is needed for. There are good and bad reasons to get a business loans. Good reasons include financing a piece of equipment, real estate, long term software development or large seasonal sales variances. Bad reasons include financing ongoing losses, office build outs, or acquiring non-essential business assets.
how much do you need to borrow? While this may seem obvious, how much you want to borrow will direct what type of business loan you should be applying for. It certainly isn’t a great idea to go to the bank and ask “how much can I borrow?”. Most small businesses don’t ask for a large enough loan. Underestimating the amount of money can lead to problems with a lack of working capital sooner than planned. Overestimating can make lenders question the business owner’s assumptions and credibility. Have a well thought out budget that is supported by financial projections (profit & loss statement and a cash flow statement) that is reasonable and shows that the research was done.
how long will you need the business loan for? The term of the loan will also effect what type of loan is best for you.
can the business afford to repay the loan, interest and any one-off or ongoing fees that come with the loan? The short answer should always be yes but how will you demonstrate this to the bank?
what security can you offer the lender for the business loan and how this affects the interest rate offered.
How you apply for a business loan matters
Start by considering the lender's point of view when you apply for a business loan. You want money. But he or she is most interested in the answers to these two questions: "What are you going to do with the money?" and "Are you a good risk?", and to make a successful business loan presentation, you need to come up with the "right" answers to these two questions.
Answering the first question means being fully conversant with all the details of your business plan. It's important to be able to point to the relevant financial statements, charts or graphs that will help convince the lender that you need the business loan you're asking for to do what you want to do. Lenders will ask for a lot of in-depth information about the financial history of the business. It's also important for you to create a convincing and detailed business plan which should include a profit and loss budget and cash flow forecasts.
Answering the second question when applying for a business loan means having already given some thought to the credit risk you represent to the lender and being ready to address their concerns.
The information you use to build your business plan may also be needed by the lender to assess your project. This includes both the past and future plans for your business, the people working in it and the market itself.
The outcome of your application to get a business loan is strongly influenced by how well your proposal is researched and how well it is presented.
Risk assessment of a business loan
Banks and other lenders will look at your business's risk profile when considering your business loan application. Understanding what lenders look for and what they consider risky will help you present your business in a favourable manner.
As a general rule, lenders look for:
the level and nature of your security (what you're offering to give them if you can't repay the business loan)
your ability to make regular loan repayments (cash flow risk)
your ability to ultimately repay the business loan (business risk), including any other debts you might already have.
You need to be able to assess the level of cash flow or business risk in your specific circumstances. A projection of the cash requirements of the business is most important to a lender, as it is the actual cash left after expenses that will repay the loan, not income. It also shows you are an effective manager.
The higher the operating cash margin, the better the chance is for a business to survive slower market conditions and ensure long term survival and growth. In the final analysis, most lenders give money based on the company’s cash flow since it measures the ability to successfully repay the business loan.
For a more in-depth article on how to get the best interest rate on your business and commercial loans, click here.
Your expertise and experience in your chosen field greatly effects the banks perception of the risk. Because the success of your business is dependent on this to some degree, any potential lender will want to know more about you. Be prepared to talk about yourself when you apply for a small business loan - your background, your expertise, and even your aspirations.
How to get a business loan - A lender's perception of risk
The following factors can influence your lender's perception of risk when you want to get a business loan. If a number of these areas apply to you and your business you may need to consider another source of financier. At Just Business, we specialise in finding the right bank for these circumstances.
start up businesses incorporate financial, business and management risk
lack of security
lack of business history
industry sector, factors will include levels of competition, barriers to entry, profitability profile and current economic conditions
highly seasonal businesses, for example swimwear and agriculture. You'll need to demonstrate how you'll deal with cash flow pressures in the off season
lack of planning, market knowledge and finance skills
poor credit history.
Be Careful! Before entering into a payment arrangement with the Tax Office, businesses should discuss this with their current or future lenders. Many businesses are unaware that entering into a payment arrangement with the Tax Office or other government agencies may adversely affect their current and future financing arrangements especially when you want to get a business loan. For instance, a lender may not lend to a business if it is currently in a payment arrangement.
Things to Consider when choosing the right business loan
How do you want to access the funds you borrow when you want to get a business loan
If you need to access the funds on a semi regular basis to help with cash flow to keep the business operating while waiting for your customers to pay for goods, 'at call' loans such as an overdraft or line of credit are designed for this purpose. If you are an importer, then a form of trade finance might be even more suitable. However, if you need the funds to buy a new business or equipment to expand your existing business you will need the funds 'upfront'. This is can be know as a commercial or business loan and provides you with the entire loan amount all at once.
Business Loan terms
Business loans provided upfront will need a portion of the loan plus interest paid back at regular intervals. The repayment amount will depend on the term or length of the loan. To determine the loan term suitable for your business you will need to calculate how much you can afford to service the loan. Be aware that the longer the loan term the more total interest you will pay. Loans that are at call have no fixed terms.
Fixed or variable interest rate on a business loan
The choice of rate will affect the stability of repayments, overall cost of the business loan and the loan features available. With a fixed rate business loan the lender bears the risk of interest rate moves, while with a variable rate you will bear this risk. Ultimately, the choice of variable or fixed rates will depend upon how much free cash flow your business generates after you have paid all your expenses, including loan repayments. If your business has a low profit level, a variable rate loan repayment may rise beyond your ability to pay.
For more information on how are business and commercial loan interest rates calculated, click here.
Security for a business loan
Business loans can be secured or unsecured by various types of assets, including residential, commercial, rural property or business assets. Alternatively, some business loans are unsecured by any asset. Lenders give unsecured working capital lines and term loans to businesses which are over 2 years old and have a reliable record of incoming accounts receivables.
Generally the less you provide for security the higher the interest rate will be. Be aware the lender has the legal right to seize any property or asset you offer as security if you can't repay a business loan on time.
How much money you're personally willing to put into the business matter more than you think. It’s not just the fact that your borrow amount decreases. Being willing to risk your own money shows the lender that you're committed to the enterprise.
Fees of a Business Loan
There can be fees which can make a business loan less attractive than it first seems. These include one-off fees such as establishment/application fees, exit/discharge fees and early termination fees or regular fees such as service fees or line/credit advance fees.
How to Get a Business Loan? Be Prepared
Your chances of getting a business loan will be greatly improved if you have all your documents in order and are prepared to meet the lender's concerns about loaning you the money. Think of it as a presentation to an important client or customer, and you'll have a better chance of success.
The information provided here will provide you with a range of possible finance options. It is important to seek advice from an expert before approaching a lender for a loan.