One of the first things that overly-optimistic Small Business Owners realise when seeking funding for their businesses is that banks do not fund business plans.
So, as a general rule, and barring the occasional exceptions, here is a short list of the hurdles a Small Business Owner must clear when he or she is applying for loan for a business from a commercial bank:
1. Collateral: Your business must have hard assets it can pledge to back its application for a business loan. The banks, on their part, will carefully examine the pledged assets to be sure that they are of sufficient value that will reduce their risk in lending to your business.
Where a business pledges its accounts receivable to support its request for a loan, the bank will exercise its due diligence of double-checking the solvency of the companies that are owing the receivables accounts. It is also noteworthy that when the bank accepts to back its loan advance with the accounts receivable of the borrower, the bank is not likely to exceed 50 to 75 percent of the borrower’s receivables.
As mentioned above, the need for collateral may also require the business owner to pledge his or her personal assets, like a personal house, as additional security for a loan to the business.
2. Business Plan: Except in rare cases, a lending bank will require a business plan document in support of a loan application. While it may be in a short form, like a one-page business plan, the bank will almost always ask for a snapshot of the company, its product or service, the market it serves, the managing team, and its financials.
3. Financials Of The Business: These cover current and past loans and debts incurred; bank and investment accounts; and such supporting information like Tax Identification Number and contact address.
4. Accounts Receivable: Comprehensive details of accounts receivable, including account-by-account status, aging analysis, and sales and payment history.
5. Accounts Payable: Complete details of accounts payable, including account-by-account status and aging analysis according to credit terms extended to the business.
6. Audited Or Reviewed Financial Statements: This should contain the latest Balance Sheet of the business, with a listing of assets, liabilities and capital. The Profit and Loss statements should be for between 12 months and three years.
Some banks may waive the requirement for audited or reviewed financial statements. When they do, do not let your guard down. Such banks would often compensate and over-provide for this by insisting on assets, as collateral, with values that are far higher in value relative to the loan amount for which they are pledged.
7. Owner(s) Personal Finances: The bank must obtain financial statements of owner(s) with significant shareholding(s) in the business, which could include signing personal guarantee(s) as part of the loan process.
Personal financial information that the bank may request from owner(s) of the business could include, and may not be limited to, banking details, assets such as real estate, vehicles, etc. and liabilities like loans.
What the foregoing implies is that when a bank insists that a Small Business Owner must add a personal guarantee to the collateral provided by the business, the business owner wonders why. A usual refrain of the bank runs like this: If you, the owner of the business, cannot demonstrate that you believe in the business, by supporting the loan application of the business with your personal guarantee, why should the bank believe in the business by lending money to it?
The Small Business Owner will have a tough task in countering this argument!