Most small business owners know that at some point they will likely need some form of small business financing to grow and expand their business in Maryland or anywhere. Many of these entrepreneurs, however, don’t have a great understanding of the different factors that banks take into account to determine the terms of small business financing.
Not understanding the factors that go into the final lending decision puts small business owners at a disadvantage: without knowing what they need improvement on, it’s harder for business owners to take steps to get better terms. This, in turn, increases the cost of borrowing and decreases the speed at which companies can grow.
The good news for entrepreneurs seeking a loan is that the factors that influence terms and interest rates for small business financing are very similar to the factors that influence personal lending terms and interest rates.
In other words, if you can figure out how to make your personal loan terms better, you can do the same for your business.
The most important factor, of course, is your personal credit score. If you run a partnership or corporation, all founders or major stakeholders may need to have their credit score checked. After that, though, there are three main factors that banks use to determine your creditworthiness.
Do you pay your bills on time? Are your vendors or previous lenders satisfied with how promptly you pay back your obligations? Are you in default on any loans? These are some of the questions that banks ask when looking over your previous payment history.
A strong history of making all payments on time and not borrowing more than you can afford to repay makes lending institutions feel more comfortable financing your small business.
How do you build up a strong payment history? A common myth states that the best way to make banks want to loan you money is to make sure that while you repay on time, you always leave a small balance on your account that generates interest. This, we’re confident saying, is probably a terrible decision. Instead, simply make sure that you always pay off balances on time. If you can pay them off early, do so. Banks, especially these days, are looking for safe investments. If they know they can loan you money and have it back when your term expires or earlier, you look like a much safer investment.
Another idea is to pay vendors on account, especially vendors that report accounts payable to an organization like Dunn & Bradstreet. This helps you build up credit easier without having to go through the process of applying for a loan, which can be difficult if you have no previous borrowing history.
Do you spend more than you make? Are you reporting a profit regularly? Can you afford payments on the loan after paying operating expenses? These questions help banks understand whether your cash flow, both past and future, can comfortably sustain repayment on your small business financing.
Banks will want to look over your past accounting to make sure that you are spending money responsibly and that you have high enough margins to cover the loan, as well as possible unforeseen expenses. They will also want to take a look at your projections and compare them to your past spending to see if you will continue to operate at a profit over the term of the loan.
The best way to pass this requirement with flying colors is to spend less than you take in, and keep good records. It also helps to use a reporting service that can keep track of your historical profits and losses. Having a verifiable way to show positive cash flow can be a good way to make sure you get the best rates on your small business financing.
How are you going to use the money you get? Who controls the bank’s money? What kind of projected return do you see on the loan? These questions help banks get a feel for whether you have thought your loan all the way through, as well as being able to gauge whether you will be able to pay it all off by the end of the term.
Make sure that your business plan is rigorously researched and supported by evidence. If you have projections for how the financing will make money for your company, be ready to support those projections with hard evidence. It also helps to have a loan point person, especially in corporations with multiple co-owners or partnerships. This gives the bank assurance that the money will be spent the way you say it will be, and that one single person will be responsible for preventing mismanagement of funds.