BBBTipsTM on Business Credit

10/20/2004

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WHEN You Need a Business Loan

Are you getting ready to establish your own business? Or is your business at the point where you need to upgrade equipment, hire more personnel or expand to new markets? Chances are you're going to need to borrow some money, a basic activity for most businesses. Basic doesn't always mean routine, however. The credit process can be a challenging one, particularly for new entrepreneurs.

If you take the time to become informed about available sources of credit and how to put together an effective loan proposal, the borrowing process will go more smoothly and you'll increase your chances of securing funding for your small business.

There are many sources of money that can assist with starting or expanding a small business. You should consider several available options before making a borrowing decision, including:

Personal savings: Savings and other personal resources provide a primary source of capital for many business owners. Before ringing up high-cost debt or risking your retirement savings, however, you may want to look at other options, including small business loans.

Friends or relatives: Friends and family may be willing to provide financial assistance to you for your business, maybe through an interest-free or low interest loan. Formalizing in writing any such arrangements will help to protect your business and their investments. Detail the terms of the loan and an agreed-upon payback schedule in a written contract, signed by both parties.

Banks and credit unions: Perhaps the most common source of fundingWHERE to Find the Money You Need for those who can present a sound business proposal, banks and credit unions offer a variety of credit programs to build your business, including lines of credit, term loans, owner-occupied business mortgages, business credit cards and SBA-guaranteed business loans.

Other financial service institutions: These include savings and loan associations, insurance companies, finance companies and mortgage companies.

Government Financing Sources: Many regional or state economic development offices, as well as the U.S. Small Business Administration (SBA) offer financing options for small businesses. To view in-depth information on SBA-guaranteed business loans, lines of credit, mortgages, equipment financing and more, visit the financing area of www.sba.gov/financing/.

Private Foundations: Your regional or state economic development offices can direct you to legitimate foundation grant programs for which you might qualify. Or visit your public library to local reference books describing foundations and the criteria they use in awarding grants.

BEFORE You Shop for a Loan or Line of Credit

The key factor to successfully securing a loan is preparation. If you are borrowing small amounts of money, you may not need rigorous documentation. However, if you are seeking a substantial loan or line of credit, you will hinder your chances if you are disorganized or vague on information about your business plan.

Your goal is to convince your lender that he or she will be putting their money to good use when they grant your business credit. To do so, you will need to work up a sound business loan proposal, one that illustrates how reliable you are, demonstrates that your business has the potential for success, and clearly details how much money you need, why you need it and how you will pay it back.

Following is a checklist of items that you'll want to review for inclusion in your loan proposal. (A few of the items pertain only to those seeking financing for an already established business, rather than for a start-up venture).

Management/ownership: names, addresses and Social Security numbers of you and other principal owners, partners or officers, as well as information on your backgrounds, qualifications, experiences and accomplishments.

Business description: business name and address; history and nature of the business; number of employees; annual sales; listing of assets.

Market profile: descriptions of your business's products or services, markets, competitors, and customers and their needs.

Financial information: financial statements, balance sheets and income statements (that reveal your business profits or losses) for the past three years and current interim financial statements; personal financial statements on you and your business partners that list all personal assets, liabilities and monthly payments; your personal tax returns for the past three years; and collateral you're willing to pledge as security for the loan (this might include equity in the business, borrowed funds and available cash).

Loan request details: state the purpose for the loan request, the amount you are requesting and the type of loan; specify how the loan funds will be used; include cash flow projections indicating how much cash you expect to generate to repay the loan and other payment plan details.

WHAT Types of Loans are Available?

Short-term loans are the most common type of business loan and generally have a maturity of up to one year. They are intended to provide interim working capital, and are typically repaid in a lump sum when inventory or accounts receivable are converted into cash. Types of short-term loans include working capital loans and accounts/receivable loans.

Intermediate-term loans have maturity dates that range from one to three years. Such loans are often used to start a business or to meet large, one-time needs like purchasing new equipment or for expansion plans.

Long-term loans have maturities greater than three years and up to seven years and are based in part on the life of the asset that is financed. Such loans are used for major business expenses, such as real estate and facilities, construction, durable equipment, furniture and fixtures, vehicles, etc. Repayment typically is made in monthly or quarterly installments.

A line of credit permits you to borrow money as you need it, up to your credit limit, without having to reapply each time you need more funds. This type of credit can be customized to fit the needs of your business. Businesses that experience seasonal fluctuations or that want to have funds readily available to take advantage of unexpected opportunities may find lines of credit to be particularly useful.

WHY are Credit Factors Important?

In evaluating whether to grant your loan request, your lender will review and evaluate a number of credit factors. Potential borrowers should familiarize themselves with these factors and make certain to take them into consideration when putting together their loan proposal.

Equity investment is used to assess whether a company's level of debt is appropriate in relation to the amount that the business loan applicant has invested in his or her business. Weak equity investment can be viewed as a signal that management is not committed to the success of the business. Sufficient equity is particularly important for a new business. To check this, lenders will look at the debt-to-worth ratio of your application, which compares how much money the lender is being asked to lend (the debt) to how much you, the owner, has invested (the worth).

Earnings requirements are important measures because a business cannot continue to operate if it spends more money than it takes in. Proper cash management ensures that the right amount of cash is available when the need arises. Loan applicants should be able to demonstrate their ability to repay the loan from the business operations. For a new business, it's particularly important that you detail the assumptions underlying how you intend to generate revenues to meet the repayment schedule.

Working capital is defined as current assets minus current liabilities. Also referred to as net current assets, working capital measures what is available to pay a company's current debts. It represents a cushion of protection for the creditor.

Collateral is security that you pledge for repayment of the loan. Typically, collateral must be adequate to secure the loan and can consist of both business and personal assets. Certain types of loans have personal guarantees requirement for owners, as well as individuals who hold key management positions.

Resource management, otherwise defined as "character," is a prime consideration when determining whether to grant a loan. The ability of you and other owners/partners to manage the resources of the business is dependent upon your education, experience and motivation. Key ratios that most lenders will look at as an indication of resource management include debt to worth, working capital, the rate at which income is received after it is earned, the rate at which debt is paid after becoming due, and the rate at which the service or product moves from the business to the customer.

CONGRATS - Your Loan has been Approved!

Once your loan is approved, the real work begins. You'll want to make certain that your business adheres to sound financial and resource management in making use of the loan funds; strictly abides by the terms of the loan; adheres to its payment schedule, and proves to be a worthy credit risk. Remember, chances are you will need additional working capital as your business expands. Establishing a good credit record will prove instrumental in obtaining additional credit when the need arises.

IF Your Loan is NOT Approved…

If you loan is not approved, don't give up. There are other sources of available funding, described above, that you may want to pursue. If you're a first-time borrower, you might want to seek the advice of an experienced professional, like an accountant or financial advisor, to review your loan proposal and offer helpful feedback. Various business support groups have members who could also counsel you on how to improve your loan package. The Service Corps of Retired Executives (SCORE), which is sponsored by the U.S. Small Business Administration, may be another resource to draw upon.

  • Credit cannot be denied on the basis of sex, marital status, race, age, national origin, or religion. This applies to you and to the people you deal with.

  • If your application for business credit is rejected, you can find out why by sending a written request to the lender within 30 days after you have been denied credit. The lender must give you the specific reasons in writing within 30 days after you ask. If you disagree with the reasons, discuss your concerns with the lender. Complaints can usually be resolved at this level.

  • If your business is small (less than $1 million in gross revenues), the lender must keep records of your credit application for at least a year after telling you of the credit decision. If your business is larger, the lender is required to keep your credit application for only 60 days after a credit denial. If you do not request reasons for denial within 60 days, the lender may destroy your records unless you request that records be kept longer, or ask for a written statement of the reasons for denial.

If you believe your rights have been violated, you may wish to seek legal advice on how to sue a lender who violates the ECOA. Or you may wish to contact the Federal Trade Commission through its Web site at www.ftc.gov or by calling toll-free 1.877.FTC.HELP.

BEWARE of funding scams!

The one thing you do NOT want to do if you've been denied credit, is succumb to a financing deal that sounds "too good to be true." It's a sad fact that Better Business Bureaus hear from people each day who have lost money trying to secure funds to launch or operate their businesses. Two pitches in particular seem to appeal to unsuspecting business owners: advance fee loans and advertisements for "free grant" money.

Advance fee loans. The scenario goes something like this. An advertisement appears in the community newspaper, on the Internet or in an e-mail suggesting "Money to lend, debt consolidation, personal car and small business loans for people who have good/bad credit and past bankruptcies. Call Toll-Free Now!" Once you call the phone number, you are sent forms asking you to submit personal information, including copies of your driver's licenses, employment records, Social Security number, bank account information and credit card numbers. A few hours or days later a friendly telephone caller responds with the good news. Your business loan has been approved, but an "insurance fee," "processing fee" or three months' advance payment is needed before the loan is released and the check delivered. You'll be asked to pay the fee immediately through electronic transfer of the money. The money is picked up by the "loan" broker, but the promised loan never arrives and the up-front fee paid by the victim (which can total several thousand dollars) is lost forever.

The BBB advises business owners and operators who are in need of extra cash to thoroughly investigate all advertised offers of "easy credit" or "easy loans" from unfamiliar loan brokers, particularly those originating out-of-state or out-of-country. BBB experience indicates that the following are signs of advance fee loan fraud:

  • Pressure to act immediately. Advance fee loan schemers will try to get you to send money or give out personal information (credit card number, bank account information and Social Security number) before you get any paperwork. Insist on receiving the necessary paperwork before deciding whether to apply for credit.

  • Will not provide location information. If the loan broker hesitates to tell you their physical location, beware that this is a common ploy to avoid law enforcement detection. Refuse to do business with the broker until you have their physical address or location and can check them out with the BBB.

  • Claims that a loan is "guaranteed." Legitimate lenders do not "guarantee" you will be granted a loan before you even apply, especially if you have bad credit, no credit or a history of bankruptcy.

  • Request for immediate payment of an advance fee, while refusing to provide any details in writing. If you do not have the offer in hand - or confirmed in writing - and you are asked to pay, do not do it. It is fraud and it is against the law.

If you think you have been a victim of an advance fee loan, contact your Better Business Bureau (www.bbb.org), your local consumer protection agency (www.nacaa.org) or state Attorney General (www.naag.org)

Free grants. You've probably seen the ads or read the spam: "Free Money! Never Repay Cash Grants for Personal Needs, Medical Bills, Education, Business, Debt Consolidation and more." These solicitations can sound mighty attractive to a business owner looking for capital. The ads typically claim that "foundations can be a better source for finance than banks" and "anyone can get an interest free cash grant." Interested applicants are asked to send an application fee of $20 to $50, with the promise that their financial needs and requirements will be matched with the most suitable private foundations. Or, they may promise to provide a list of available grants. These promises rarely, if ever, pan out.

Generally, obtaining a grant is a complicated process, requiring documentation and research. The vast majority of grant-making foundations require that applicants for funds meet very specific guidelines established by the foundation and that the funds be used for specific projects supported by the foundation.

For More Information on Business Credit

Federal Citizen Information Center (www.pueblo.gsa.gov) offers publications to assist small businesses with credit, preparing a business plan, obtaining financing and other activities.

Federal Reserve Board (www.federalreserve.gov) offers "A Guide to Business Credit for Women, Minorities, and Small Businesses."

Federal Trade Commission (www.ftc.gov) has information on the Equal Credit Opportunity Act, which protects you against discrimination when you shop for credit.

Internal Revenue Service (www.irs.gov) has prepared a Small Business Resource Guide with tips on preparing a business plan, financing your business and more.

U.S. Small Business Administration (www.sba.gov) was created specifically to assist and counsel small businesses. Its Web site offers information on the various SBA financing options for small businesses and other helpful resources.

ABOUT BBBTips™

BBBTips™ is a trademark of the Council of Better Business Bureaus, Inc. (CBBB) used for information provided to assist consumers and businesses in making informed and intelligent decisions. BBBTips™ are developed in partnership with the Better Business Bureau Consumer Education Foundation, Inc. and made possible, in part, through the generous financial and technical support provided by corporate sponsors that are members of the CBBB and of the Better Business Bureau where the sponsor is headquartered. As a matter of policy, the CBBB and Better Business Bureaus do not endorse any product, service or company.

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