As the builder of a small business, you wear many hats. It’s like you’re the producer, director and star of a small independent movie that isn’t quite on the big screens, and your success or failure depends on your ability to maintain confidence in your vision and do many things well at once.
As producer, one of your jobs is to raise money for the project. Successfully raising money means knowing what a potential lender will ask you before you commit to a meeting or lengthy application process. You want to get yourself and your business affairs in as much order as possible so that you can tell the lender all the things that he or she needs to hear to make up his or her mind about your potential as a borrower.
Here are six questions a lender will typically ask you.
1. How much money do you need?
While this question may seem obvious, it’s sometimes the obvious questions that prove most difficult to answer. A lender won’t ask you how much money you want—they’ll press you for what you need. Lending money is a cautious, prudent, conservative sort of business. Lenders want to see that, where finances are concerned, your business is the same. Ideally you should be able to show a lender that you’ve thought this question through to the last cent, that you’re borrowing only what you need.
2. What does your credit profile look like?
This one’s important because it can make or break whether or not a lender will even ask the next 4 questions. Depending on what lender you choose, they may pull both your personal and business credit reports or scores. If these are both solid, they’ll move onto the questions listed below. If you have derogatory marks on your credit report, they may ask about those as well.
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3. How will you use the money?
This question is really about how you’ll use the money to build your business. If you need to buy a truck, for example, it won’t be enough to simply say you’ll use the money to buy a truck. You should be able to explain how a truck is integral to your small business.
Here, lenders are looking for an answer that will assure them that you can pay back the loan. For example, “working capital” or “expansion/growth opportunities” are good answers to this question—they ensure the lender that their investment will increase your revenues. Loan requests for “repaying old debts,” on the other hand, will likely be rejected.
4. How will you repay the loan?
Great question! You’ll repay the loan with the proceeds of your booming small business, of course. But a lender will need more assurance than that. They’ll want to see that you have enough assets, savings and personal collateral to (a) survive the ups and downs of business life and (b) still repay the loan. They may ask if you have current or past loans, any outstanding business debts, and they will likely want to take a look at your previous business or personal tax returns.
5. Does your business have the ability to make the payments required under the loan?
For an existing business, proof of solid cash flow sufficient to the terms of the loan will go a long way towards securing the loan. A lender may ask to see a balance sheet and profit and loss statement from the previous year. A new business owner’s best bet is to show that they’ve been profitable in a comparable business venture in the past, or have a strong expertise and have done their research in the particular industry of the business.
6. Can you put up any collateral?
Collateral is something (such as a house or inventory) you pledge as security for the loan in the event that you cannot repay it. If you don’t repay the loan, your lender takes the collateral. Collateral will be extremely important if you are hoping to secure a bank or SBA loan. Other alternative lenders may not ask for collateral, but they may ask for a personal guarantee on the loan. With a personal guarantee, you agree to be personally responsible for the debt if worse comes to worst and your business is forced to default. Unlike collateral, a personal guarantee is not tied to a particular asset, however it does put the business owner in a tough spot to pay back the loan should the business not pan out as expected.
To a small business owner just getting started, some of this may seem unfair. But it might help to put yourself in the lender’s shoes: thousands of people apply for business loans every day, and it’s impossible to predict a winner based on nothing more than a good idea and a business plan.
Happily, there are proven ways get ahead of the game before you submit loan applications. For example, you can build business credit and repair bad personal credit, as well as prepare the documentation listed above and proof of collateral. The more you read, research, plan and prepare, the better the chance that your vision for your small business will be recognized and supported by lenders down the road.