It’s common for small businesses to slip into bad habits that limit their ability to get funding. From unscreened customers to generous payment terms, here are some of the most common reasons lenders will not loan to small business owners.
1. Not putting profits back into the business
When you hear these pleasant words from your accountant, “You should take a draw before the end of the year,” think again. Building equity in your business has a positive impact on your ability to get funding. A lender always looks at your debt-to-equity ratio. The more equity you have, the better your ratio. If you believe you will be able to grow the business next year, and will need financing to make it happen, manage your debt-to-equity ratio as carefully as you manage your personal taxes. Good habit: Keep your business solid by re-investing to support growth.
2. Allowing your customers to run your business
Many small businesses leave the setting of critical business practices to their customers. If you do not set clear payment terms and establish a pattern of following up to collect, your customers will assume they can pay you when it best suits their business. Following a policy of credit checks on customers and a consistent collections process can make running the cash side of your business much easier. If you are seeking working capital funding, your receivables will likely serve as collateral. Being a good steward of your collateral means a history of dependable receivables with few disputes. Good habit: Establish fair terms with your customers and follow up – consistently.
3. Blowing off formal financial statements
You might believe that you know every aspect of your business and creating a formal Income Statement and Balance Sheet every month is not necessary. However, if you intend to get a working capital loan, accurate and timely financial statements are vital. Additionally, taken together, the revenues, expenses and balance sheet need to make sense. If you are not confident that you know how to read and interpret financial statements, seek the help of an accountant or business consultant. Your financial statements are like a first impression to a lender. Good habit: Be disciplined about preparing accurate and timely financial statements each month.
4. Winging it instead of ‘writing’ it
It’s not uncommon for small business owners to take a cowboy mind-set to running the business. You may see yourself as the Good Guy whose word is as good as a contract and who can keep important decisions and plans in your head. While we hope that is true, lenders and other businesses judge you by your business practices. Guard your reputation as a professional, organized business person by putting your relationships in writing. For example, quotes should always be in writing. When dealing with vendors, negotiate a payment schedule, put the agreed terms in writing and then pay on time. If you are going to pay late, check in with your vendor and let them know ahead of time. Your credit score will thank you. Be diligent about clearly recording in writing loans to and from owners and other related parties. Sticking to the practice of putting your agreements in writing creates the impression that yours is a well-run business and helps the lender make a fast and favorable decision. Finally, have a written business plan. A business plan, even a brief one, demonstrates to the lender that you have a plan to repay the loan. Good habit: Be disciplined about keeping a record of all agreements and transactions in writing.
5. Being standoffish about pledging your assets
Often we see business owners who are reluctant to sign a personal guarantee or pledge collateral when seeking funding. It’s natural that a business owner would want to protect himself and his family. But a lender is different from an investor. An investor puts up capital, knowing there is a risk that they will not get their money back. In return for that risk, the owner guarantees them a share of the business’s success. A lender, on the other hand, does not expect a share of the business. They expect to be repaid. By signing a personal guarantee and pledging collateral, the owner assures the lender that the loan will be repaid. Good habit: Be realistic about the underlying risks and expectations when seeking capital.
(By Dan Drechsel, from “Small Business CEO”)