Steps to take before knocking on a lender’s door
Entrepreneurs should have business plan ready and clear reasons they need the money
Raising capital to finance a business venture can be a daunting process in any economic environment. Yet it’s a necessary part of an enterprise. Whether starting a business or expanding an existing one, there are certain funding requirements entrepreneurs must contend with.
By taking the following steps, small business owners can improve their chances of finding the funding they need to get their business venture off the ground and growing. 1. Determine what the funding is for Successfully managing a small business can be capital-intensive. It helps to have a clear idea why the funding is needed. “Make sure you understand the ‘why’ behind the request for financing from your credit union or bank, and how this financing will improve the financial performance of your business,” says Geordan Robertson, director, small business, at Meridian, an Ontario-based credit union.
Whether setting up shop or scaling up a business, entrepreneurs may need to consider a range of operational expenses. “Small business owners might need to beef up staffing, invest in updating equipment, expand their facilities, invest in marketing, or deal with an emergency,” says Jeff Mitelman, CEO, Thinking Capital, an alternative financing firm for small businesses.
In some cases, the need for financing could arise from “shareholder buyouts and capital needed to meet contract demands,” says Robertson.
Not all borrowing is good. Business owners should steer clear of borrowing for unsound reasons, such as funding recurring losses or for investing in non-essential business assets. 2. Do your homework “Work with a team to do your research and put together a solid business plan, complete with three years of financial projections,” says Robertson, who recommends working with a banker, a lawyer, and an accountant, at the very least.
Also, different lenders may place greater priority on different key factors when it comes to evaluating a loan application. “Before you begin to submit any applications for additional financing, it helps to be informed about the requirements for small-business loans and what factors lenders are likely to consider in making a decision,” says Mitelman.
Typically, the four factors that are routinely looked at most closely include credit history, the borrower’s capacity to repay, why they need the money, and the relationship between their current debt and their revenue or sales. 3. Have paperwork ready There’s a fair amount of paperwork that’s required of business owners applying for funding. Putting in some legwork prior to approaching a financial institution could go a long way in ensuring the process is smooth and swift.
“The most important first step is to have a written business plan ready that clearly defines your objectives, strategy, market potential, competitive analysis and your financial targets,” says Ian Penny, vice-president, personal and small business banking at CIBC.
The lender needs to know that the borrower’s business is a reasonable risk for the loan to be approved quickly. “Be ready with documents to support your company’s financial condition and operations, such as business bank statements, credit and debit processor statements, and incorporation or proof of ownership,” says Mitelman.
A thorough preparation helps busi-
A well-crafted budget, supported by credible financial projections, is essential to back up capital requirement assumptions
ness owners if there are additional due diligence questions from their financial institution during the application process, says Robertson. 4. Know how much to borrow Make a reasonable assessment of how much money is required. Underestimating the size of a loan could lead to working capital constraints and a negative cash position, while overestimating could make lenders wary of the borrower’s business plan and reliability.
“Be realistic about how much you’d like to borrow, based on your business plan, as well as your sales and revenue, as you’ll need to be able to demonstrate the repayment of the loan,” says Penny.
A well-crafted budget, supported by credible financial projections, is essential to back up capital requirement assumptions. It also shows the financial institution the applicant has done his or her research. 5. Consider collaterals and a security pledge Traditional banks often require collateral of your personal or business assets. “A key part of the decisionmaking process for a financial institution is assessing the ability of the borrower to service the debt being requested,” says Robertson. In other words, it’s the capacity of the business owner to make regular payments without implications for existing obligations or business operations.
Penny says, “Understanding what your cash flow is provides an indication of your ability to repay what you have borrowed.”
Past and projected financial statements are critical, too. “Some form of a personal net-worth statement for each owner of the business along with supporting documentation, including tax returns, notices of assessment, and credit report, will be needed before approaching the lender,” says Robertson.
Business owners should also be willing to stand behind their business with a personal guarantee.
“Are you able to pledge security?” asks Penny. “Depending on the amount of financing, a financial institution may require collateral, (which) could be real estate, investments, inventory or receivables.”