Startups and existing businesses poised for growth will likely need funding to get their business off the ground or to the next level. Financing, for the most part, comes from banks. The amount to be borrowed depends on several factors, chief among them, a business owner’s credit score.
Do you know your personal credit score? That is the first thing a lender is going to check. To make sure there are no surprises in your credit history, I recommend obtaining a report before applying for a loan. Everyone is entitled to a free credit report each year. You can request a report from AnnualCreditReport.com or FreeCreditReport.com.
Once you have reviewed your credit report and worked to address any issues, you can begin your loan request process. Unlike shopping for a new car, it’s not necessarily a good idea to shop around lending institutions. Each time a loan application is submitted your credit report is accessed. Each inquiry drops the credit score a few points. Someone with a moderate credit score could receive a poor score simply by allowing several lending institutions to obtain a report.
When counseling entrepreneurs and business owners, I ask who they bank with. In most cases, you will want to borrow from the bank where you already have an established relationship. You want to feel comfortable with the business banker or small business lender. It might also be helpful to consult with a networking group or ask for a referral from another entrepreneur.
In terms of financing, the owner of an established business will need to explain and justify why funding is needed. Perhaps your business has a line of credit and needs an increase to cover exponential growth. Increasing an existing line of credit essentially means the lending institution is placing a lien on the assets of the business. Should the business owner fail to repay the debt, the bank could liquidate assets to recoup the costs.
When calculating how much money to borrow, it’s important to project financing needs currently, as well as in the next three- and six-month time frames and up to one year. There is no hard and fast computation to determine how much should be borrowed. A lot of it depends on the individual business. Some may need a line of credit year-round, while others use it seasonally.
In the case of startup or early-stage businesses – those that have operated for less than three years – a formal business plan is required. These lending situations are considered riskier. Because of the added gamble, banks need more guarantees for repayment. Someone who owns more than 20 percent of the business may be asked to personally guarantee the debt. In instances where there are not enough business-related assets, that means including the equity in a home you own into the lending package as additional collateral. For some borrowers, this is a deal-breaker.
Banks also require several years of tax returns, either for the business or for the person seeking the loan in cases of new businesses and startups.
As noted earlier, I recommend reviewing your credit report and having your tax-related paperwork handy ahead of submitting a loan application. It’s also a good idea to consider how badly your business needs the loan weighted against the possibility of bank liens on your business assets and/or personal possessions.