Preparing for a Business Loan
The SC District Office Dispatch sat down with Gregg White, Lead Lender Relations Specialist with the South Carolina District Office, to discuss the information that is essential to obtaining a business loan… which happens to be information that many entrepreneurs don’t provide.
Dispatch: What key piece of advice would you give small businesses that are looking for a business loan?
Gregg: Be prepared. The biggest problem is that borrowers are not prepared when they sit down with the lender. That’s why a lot of businesses get turned down–They make a bad first impression.
Dispatch: What does the business owner need in order to be prepared?
Gregg: They need to provide the financial information, market information, technical information [i.e. the mechanics of the business], economic information and managerial information.
Dispatch: That sounds like the contents of a good business plan.
Gregg: You’re right. But what a typical borrower doesn’t prepare for is the source and use of funds and how the borrower will pay the lender back. And those are actually the two main things that a lender is looking for.
Dispatch: What exactly is source and use of funds?
Gregg: Source and use refers to how much the business owner wants to borrow, how much cash or equity the owner is putting into the business, and how the business will use the loan proceeds.
Dispatch: How much cash or equity does a business need to have up front when applying for a loan?
Gregg: A start-up business usually needs a 20 to 30 percent cash injection. An existing business needs a minimum of ten percent equity.
Dispatch: What should a start-up business do if it doesn’t have enough cash on hand to equal 20 to 30 percent of the loan amount?
Gregg: The business should then wait to save up the cash needed, get a personal loan to cover the cash needed, or find an investor, like a family member or partner.
Dispatch: What about collateral requirements?
Gregg: Collateral is how the lenders protect themselves in case the loan goes into liquidation. Ideally, the collateral would amount to 100 percent coverage of the loan after discounting. We call it loan to value ratios. For example, take collateral like accounts receivable and inventory. Lenders would value accounts receivable at around 50 to 80 percent of their worth on paper, and they would value inventory at around 50 percent of its worth on paper. The idea is that the combined collateral would be equal to the amount of the loan.
Dispatch: Not all viable small businesses are going to meet those collateral requirements or cash or equity requirements. If they are otherwise good candidates for financing, what options do they have?
Gregg: One option could be applying for an SBA-guaranteed loan. The SBA guaranty is like an insurance policy for the lender.
Dispatch: You said that the other thing borrowers often forget is to show how they will repay the loan.
Gregg: Right. Borrowers need to remember that the lender is responsible for making sure the investors or bank stockholders get repaid.
Dispatch: What other advice would you give small businesses seeking financing?
Gregg: One of the SBA’s biggest goals with our partners – like the Small Business Development Center, SCORE and the Women’s Business Center – is to ensure borrowers are prepared when they go in to speak to a lender. Businesses should take advantage of the assistance they offer. And of course, they all provide that kind of assistance for free.