In putting together the best possible package to secure a business loan, it's important to know what happens after you leave the bank and the lending officer evaluates your request.
An advantage to preparing an effectively organized loan application, including a well thought out business plan is that it will significantly decrease the time spent waiting for an answer. Much of the time spent in approving a loan can be traced to the banker having to ask the potential borrower for more information or for clarification of the information that has already been submitted.
In evaluating loan applications, there are three traditional C's of credit that are conidered - character, capacity, and collateral.
Character
Character is actually a check on your financial status and personal credit history,
including your previous loan payment record. The theory is that people are
creatures of habit - if you have repaid a loan on time before, you will repay this
one as well. Conversely, if you have defaulted on a previous loan, the danger is
that you'll tend to default again.
Another facet of character is experience in the type of business you are trying to finance, including level of responsibility, education, and business management training. Lenders are particularly concerned that potential borrowers have a solid understanding of financial record keeping, business credit, the importance of collecting accounts receivable, inventory control and turnover, and marketing their product or service.
If your prior business experience is not relevant to your current venture (for example, if your career has been in the corporate world, and you want to start a restaurant), banks will be leery about your ability to run the new endeavor successfully and thus repay the loan.
Capacity
Bankers usually look first to the
cash flow of the business as the
source of funds for repaying the loan. Consequently, preparing a cash
flow statement with future cash flow projections to present with your loan
request is important. Doing so indicates to the lender that you are aware of the cash coming
into your business, and are therefore better able to avoid a cash shortage that
would jeopardize making monthly payments.
Collateral
While cash flow is the primary source of loan repayment, lenders will want a backup
or secondary source as an exit or last resort, should your business not prove
profitable. Collateral - anything of value used as security for
repayment of a debt or performance of a contract - can be real estate, stocks
and bonds, savings accounts, equipment, accounts receivable, or the
cash value of life insurance policies.
Psychologically, lenders feel that borrowers have more interest in repaying the loan if they know that failure to do so will result in the lender taking possession of whatever has been put up for collateral. A lender will also try to obtain personal guarantees so that if you default on the loan, the institution has access to your personal assets.
