Entrepreneurs often start with an idea and then, in order to get the business off the ground, need an infusion of capital. With traditional banks and, increasingly, online lenders willing to supply funding, in many ways the process of applying for small business loans has become easier. However, it is still requires borrowers to do their homework in preparing a loan application.
Approval rates for loans from big banks and institutional investors, who have increasingly become involved in the small business credit marketplace, are climbing, according to the latest Biz2Credit Small Business Lending Index (November 2017 figures). Even companies with bad credit can find success in the current small business lending market. However, a borrower needs to complete the application thoroughly and avoid the errors that most frequently doom funding requests.
Fortunately, many common mistakes are avoidable. The first step is knowing what the mistakes are and then realizing how to fix them.
Mistake No. 1 – Incomplete Loan Application Package
Be sure to include everything that the lender will ask for in the loan application package, including tax returns, P&L statements, a business plan, credit score and bank account records, if requested. Lenders want to make sure they are giving money to competent business people. Submitting an incomplete package signals a lack of attention to detail that could cause concern and might sink your chances of securing capital.
Mistake No. 2 – Too Many Overdrafts
Cash flow is the lifeblood of any business. Lenders want to be sure that businesses can pay back the money they borrow. That means having money in the bank at the end of the month. Funders will examine your business bank accounts to see if there are insufficient funds charges. Frequent negative balances will hurt your chances of securing a small business loan.
Entrepreneurs typically are ideas people or operations experts. However, they are not always financially savvy and may not have the skill set to oversee the company’s incoming revenue and outgoing expenses. If and when that is the case, be sure to hire a strong CFO (for larger operations) or an accountant who specializes in working with small businesses.
Mistake No. 3 – Lack of a Strong Business Plan
Preparing a well written business plan is of critical importance for companies seeking funding. The plan must provide a blueprint for the future and should detail the business concept (products and services offered), goals, primary target market, competitive landscape, differentiation from rivals in the industry, executive team bios, marketing plan, and projected revenues.
The business plan helps an entrepreneur figure out how much money he or she must borrow and provides a road map for success. It is also a tool that a business owner uses to convince funders to provide the capital required to launch or grow a company. Many underwriters will read only one portion of the business plan: the Executive Summary, a one-page document that briefly summarizes the business, target market, competition, differentiation, team experience, and financial projections.
Business owners who do not have the ability to write a business plan on their own can hire someone who does. Their fees can range from $ 40 per hour to $ 150 per hour, depending on their experience and success rate. A site such as UpWorks is a good place to start to look for a freelance business plan expert. Alternatively, an entrepreneur can purchase a software package, such as Business Plan Pro, which offers more than 500 business plan samples that can be used as guides.
The document must not be submitted to the bank and forgotten about. Rather, it should be constantly revisited and fine-tuned since things constantly evolve in the operation of any firm.
Mistake No. 4 – Not Borrowing Enough Money
Your business plan should provide an idea of how much cash will be required. However, unexpected costs will arise inevitably. Startups should ask for enough money to sustain the business for the first six months operation. You don’t want to have to go back to the bank a few months later and ask for more funding because you underestimated your costs.
Mistake No. 5 – Not Having “Skin in the Game”
Lenders want to see that borrowers have “skin in the game.” Simply put, why should they give you money for your venture when you are not willing to put up money of your own? Some types of business loans require collateral, which mitigates the lender’s risk. Collateral can be in the form of cash, real estate holdings, or equipment.
Mistake No. 6 – Neglecting to Check Your Credit Score
Check your credit score before applying for a small business loan. A free copy of your credit score is relatively easy to secure from one of the major credit bureaus: Equifax, Experian, and TransUnion.
Make sure there are no discrepancies and that past hits against your score (ex: tax liens that have been paid) are no longer appear as current. It is your job to see that information reported by the credit agencies is accurate.
The better your credit score, the more attractive interest rate you can secure. Borrowers with credit scores of 700 or above should have little trouble in securing capital. If your score is under 650, the task will become a bit more challenging. Fortunately, SBA loans can be obtained by borrowers whose credit scores are in the 650 range. Borrowers with scores under 600 may have to approach high interest alternative lenders (ex: cash advance companies that skim a monthly portion of credit card earnings) that are willing to take on riskier loans… in return for higher interest rates.
Borrowing money to start or grow a business is a major endeavor. Depending on the type of business, the amounts can be in the $ 50,000 range all the way up to the millions. Having a basic understanding of how small business finance works is valuable. Following the loan application process and avoiding common mistakes will go a long way towards securing the financing required to kick-start a business.
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.