Former head of the Joint Chiefs and Secretary of State, General Colin Powell said, “There are no secrets to success. It is the result of preparation, hard work, and learning from failure.”
I’m convinced this is particularly true when seeking capital to finance a small business. One of the top three reasons small businesses fail can be attributed to an inability to adequately capitalize. In other words, a lack of adequate cashflow to fund working capital and fuel business growth.
If your small business happens to be a very sexy tech company that can scale up exponential revenue growth with the influx of a little cash, you’ll likely have venture capitalists and angel investors knocking on your door anxious to give you money. If you happen to own a lucrative cash cow of a business, you can probably fund growth and expansion through cash flow. Unfortunately, most small businesses don’t fit in either of those categories and rely on debt to occasionally augment cashflow for working capital and fund expansion.
Understanding the need to obtain financing through debt requires that small business owners need to understand how bankers and other lenders will look at your business when you approach them for a loan. We recently talked, in general terms, about what to do after the bank says “no.” Today, we’re going to get a little more specific. Some of what I’m going to suggest will likely be more applicable when speaking with a banker, but whether or not the particular lender you speak with today needs this information, it’s likely the lender you speak with tomorrow will.
Here is some specific preparation you’ll want to make before you start looking for a loan. Some of this will likely seem pretty obvious, but there might be a few surprises. Most of this advice is the result of speaking to lenders, hard lessons learned by experience, and conversation about this topic with my colleagues.
- Learn the vocabulary—Like every industry, financial services generally and lenders in particular, have a jargon unique to what they do. You’ll want to understand the difference between simple and compounding interest, what are accrued assets, and what does amortization mean to name just a few. You don’t need to be an expert, by any means. But you will want to be familiar with the basic terminology the loan officer will be using. What’s more, if they use a term your unfamiliar with, speak up. Any reputable small business lender will want to ensure that you understand exactly what you’re doing. I spoke with a borrower a while ago who didn’t completely understand the terms of a short-term loan and found himself in trouble at the end of the term. Make sure you understand every word.
- This is business, but it’s also personal—For most small business owners, your business financial statements aren’t going to be enough. Lenders will also want to see your personal financial statements too. You’ll want to include tax returns, accounts payable and receivable, along with your aging payroll reports. Don’t take for granted that your most recent tax return or P&L will be sufficient either, you should be prepared to talk about at least the last three or four years (if you’ve been in business that long). You should also know that most traditional lenders, like a bank, will want to see a history of at least two years; and even alternative lenders will want to see at least a year. With that in mind, even if your business doesn’t do much or any revenue in the first year or two, it is in your best interest to start keeping financial records as soon as you start doing business to demonstrate how long you’ve been in business rather than how long you’ve been generating revenue.
- Do you have any collateral?—We recently outlined the Five ‘C’s of small business lending: Character, Credit Score, Capacity, Capital, and Collateral. Depending on the lender, some weight all of these things differently when evaluating you for a small business loan, but having the right collateral makes the entire process a lot easier. However, having collateral and making it easy for your lender to evaluate it’s value are two different things. For example, if you were planning on using a piece of real estate as collateral, it would be a good idea to have photographs and a recent appraisal when speaking with the lender. If you intended to use your daily credit card transactions, it would be a good idea to have monthly statements for the past 12 months demonstrating that you have a regular and consistent volume of credit card transactions.
- Can you talk about industry averages?—They may have different risk tolerances, but I’ve never met a lender who wanted to throw good money after bad. They tend to shy away from troubled industries—unless you can show them how what you are doing is more successful than industry trends. There are some industries though, that are appealing to some lenders over others. If you can determine which lenders specialize in your industry, you’re odds of success greatly improve. Most industry groups supply the kind of information to their members, which could likely help you build a stronger case. Remember, anything you can do to make lending to your business appear less risky makes it more likely your you’ll get the financing you need.
- Have your elevator pitch dialed in—Many lenders are going to want to learn more about your business. I’m surprised at how many business owners can’t articulate very well what they do. One of the exercises I think helps is writing a page, a paragraph, and a sentence about your business. You’ll likely go through several drafts, but start with the page. Take the entire page to describe what you do and why it’s relevant to the market. When you’re done with that, tackle the paragraph. If you’re like most people, it will be more challenging than the page. Once you feel good about that, tackle the sentence—which will be the most difficult. Once you’ve completed this exercise, you’ll be ready to tell people about what you do any time you’re asked. It’s a good idea to keep these documents as reference and maybe even include them within the information you’re going to share with the lender.
- Share your roster—When you think about how your business is really the sum total of the experience of your leadership team and their ability to execute a well-reasoned plan, you’ll understand why the lender may be interested in that experience. Not all lenders are interested in that level of detail, but the bank certainly is, and the act of collecting all that information will give you the confidence to extol the virtues of your management team at a level most business owners can’t. This is more information you will want to include with the information you give the bank.
- What other pies do you have your fingers in?—If you have a business interest in any other business, you’ll want to make sure you have that information available too. This also includes any of your key leadership.
- What’s the plan?—This is the one thing every lender I ever speak with says they wish more small business owners would provide. Why are you seeking a loan? What are you going to do with the proceeds from the loan? What positive impact do you expect to see from the extra cash? What are your contingency plans should something not work out as planned? This is something that should be casually put together either, it should be a formalized document that demonstrates that you’ve given this more thought that a conversation with your business partner at the diner down the street. In reality, this is a critical part of your sales pitch and you should treat it that way. It doesn’t have to be a PowerPoint presentation, but I don’t think it would hurt. It does need to be a formal document of some kind that outlines your answers to the questions above.
As you can see by the above list, this isn’t a shortcut to small business financing by any means, but it is a secret many small business owners don’t know. The best case scenario is sitting across from the banker (or other lender) armed with the information you’ll need get a quick approval and a loan. Worst case is a greater understanding of your business and where you need to spend some extra attention to help you business grow and thrive. I see this exercise as good for your business regardless of the immediate outcome.
The other day we talked about what you should do if the bank says “No.” These suggestions are by no means a guarantee you’ll get the loan you’re looking for, but knowing what the lenders want to see gives you a leg up and will improve the odds if you have the right answers.
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