Growing Pains: Getting a Business Loan in Today’s Economy
So you want to take the next step with your business and need an influx of capital to make it work. You’ve decided you have to take out a business loan. But, where do you start, what are you required to provide to the bank, how do you know whether you are getting a fair deal, and what type of terms should you expect? You should always have an experienced business attorney discuss your options with you, and definitely have the attorney review the loan documents before you sign them. If you’re interested in starting the process on your own, however, you should start by considering the following issues and preparing the following items:
Get your documents in order. You will need to have your business tax returns for at least the last two years, your profit and loss statement, and your balance sheet ready for review. You must almost always have these documents prepared, or at least reviewed by a certified public accountant. The IRS might accept your own work, but the bank usually won’t. If you haven’t done so already, it’s time to find a CPA.
Expect to give a personal guaranty of the loan. Loans are all about risk, and banks naturally want to minimize their risk. Your business may be an LLC or a corporation, in which you’d be shielded from individual liability if the business defaults on the loan. For obvious reasons, most banks aren’t comfortable with this and will ask you to personally guaranty the loan. This will require more documentation: you will probably need to provide the bank with your last two years of personal tax returns and a personal financial statement.
Honestly self-assess your level of risk: both how much risk you’re willing to accept by taking the loan, and how much the bank would be risking by giving you the loan. Banks will require collateral to secure the loan, but will be equally as concerned about where the money will come from to pay the loan back. How has business been doing lately? Do you have a steady cash flow? Banks will want to know the history of your business, your market share, the breadth of your customer base, and the current level of market competition.
What are your business’s financial ratios? Determine, for example, your ratio of profits against costs and determine how your business’s ratios compare to your industry’s typical ratios. If you assess yourself like the lender will assess you, you will be better able to provide the right answers to your lender. If you have a strong business with strong ratios, find a bank that rewards that with low rates. If your business’s ratios are not up to your industry’s standards, you will need to be able to explain why. Lenders will view your business as a higher risk, so be ready for higher rates.
Shop around. While basic loan terms may look similar from bank to bank, there are likely to be wide variations between various banks, when you get into greater detail. Ask questions about more than just what the interest rate will be.
Communicate with your banker. Once you’ve made your selection, you should treat your new lender like any other business partner. Be forthright and honest about your plans and your situation. The more your lender knows about you and your business, the less nervous they will feel about extending a line of credit to you. Remember that different banks underwrite loans in different ways; if your loan officer needs to present your case to an underwriting committee, then he or she will be in a better position to present your case if you communicate with him or her effectively.
Ask about what covenants will be included in your loan. For example, a bank may require that you keep a minimum balance on deposit with them at all times to give them additional security; they may not allow any changes to the governing structure of the business; or they may require you to purchase life insurance to pay off your loan if you die. These can be negotiated, and you should have a thorough conversation with your lender about what exactly they need and expect from you.
Understand what could constitute a default on your loan and keep your lender informed. There are a dozen little business hiccups that might cause your lender to take drastic actions, like demanding immediate repayment of the whole loan balance. These could include such innocent things as an accidental overdraft of your checking account, even though it’s an innocent mistake you can fix in a day or two. If you and your lender discussed these eventualities, the lender will be much less likely to overreact and call in the whole loan. If you and your lender have built the strong relationship discussed above, then your lender will be much more willing to work with you even if small problems develop.
The key point is that a relationship with a lender should be like any other good business relationship. It will only be successful if it is mutually beneficial to both parties. The bank will certainly structure any loan to assure it is beneficial to them. An experienced business attorney can help you understand the terms of a proposed loan and can help you work through those terms with your bank to make them beneficial for you as well. If you consider the above issues, you’ll be ready to get the loan you need to build your business to the next level.
This article was originally drafted by Axley summer law clerk Jeremy Lyon.