Insights
6 Expert Tips for a Successful Business Loan Application
By Ellen Chang
Timing and preparation are key to successfully applying for a business loan.
For growing businesses, a loan provides the necessary funding to expand locations, purchase real estate or remain competitive. That’s why it is crucial for companies to prepare for the application process well ahead of time, so that the capital will be available when needed.
Instead of using credit cards or other high-interest debt, a conventional or Small Business Administration (SBA) loan from a bank will offer more flexibility in loan terms, liquidity and interest rates.
“The survival and growth of small businesses depends on access to credit,” states the Federal Deposit Insurance Corporation (FDIC) in a recent report that surveyed 1,200 U.S. banks.
Business owners who are prepared on what information and data is needed for a business loan can help expedite the process, says Mark Koshnick, senior vice president and head of central Texas commercial lending at East West Bank.
Loans are one way for companies to take advantage of market opportunities, emerging markets and weaker competition by acquiring them or seeking opportunities for vertical integration, he says.
“Some business owners are so debt-adverse that they are losing chances to grow,” Koshnick says.
A banker can show an owner how the company can improve its cash flow and lower its costs, such as by purchasing a building instead of paying rent or owning assets, which can be tax advantageous, he added.
Here are six tips for owners before they apply for an SBA or bank loan.
1. Prepare early
Start by preparing three months to a year before you need to apply for a loan, depending on the purpose.
Entrepreneurs who need to purchase new or used equipment to expand their current business should start three to six months beforehand, says Koshnick. An owner who is planning to purchase a building or other real estate should begin preparing 12 months ahead.
Planning ahead gives owners an opportunity to clean up their balance sheet, pay overdue vendors and other loans. Existing debt from banks or alternative lenders can easily take 12-24 months before they are paid off or at a lower level.
“Banks like to see companies with a healthy balance sheet that shows equity because all the profits were not distributed,” he adds. “Minor mistakes can add up quickly.”
2. Understand different types of loans
Some business owners are wary of taking on debt because they have misconceptions about the repayment obligations, shares Koshnick. Understanding the ins-and-outs of the terms of the loans and their interest rates can help mitigate the underlying fear.
When companies are profitable, they should start planning ahead…Waiting until there is a dip in revenue or losing a large customer is not a good game plan to obtain a loan.
Loans with longer terms, such as real estate ones with repayment periods of 20-30 years, or refinancing current loans allow a “little cushion” for business cycles, he says.
While a line of credit requires repayment within one to three years, an equipment loan is often 3-10 years.
“A banker can help an owner model financing scenarios and do a break-even analysis to see which type of loan fits their business the best,” Koshnick says.
3. Consider SBA loans
SBA loans are backed by the federal government, which means that the down payments are lower and typically in the 10-15 percent range. This is attractive to owners, says Alex Chang, a vice president and Houston-area manager at East West Bank.
While some people mistakenly believe that getting approval for an SBA loan is a lengthy process, many of them take the same amount of time as a standard conventional bank loan, he says.
Receiving approval for an SBA loan also means that any real estate appraisals or environmental surveys only need to be conducted once before the loan is approved, unlike a conventional loan which could require appraisals each time they are approved or as often as every 3-5 years. Both appraisals and surveys are time-consuming and costly. Real estate appraisals and environmental surveys can easily cost $5,000-7,000 each time they are conducted.
“With SBA loans, you do the appraisals and surveys once, and almost any for-profit industry can qualify, although there are a few exclusions,” Chang says. “If you’re a mom-and-pop business trying to get off the ground, the maturities for SBA loans are 25 years instead of 3-5 years.”
While the closing costs are higher than a bank loan, the advantage is that the federal government guarantees the loan, encouraging more banks to offer them and absorb the risk.
Another benefit is that if your business is profitable after the first five years, SBA loans do not have a prepayment penalty, he says.
The amount of an SBA loan can range from $100,000 to $20 million, depending on the structure of the loan. “SBA loans are very good for smaller businesses and owners who rely on them for their livelihood,” Chang says.
Owners only qualify for SBA loans if the property they are purchasing is 51 percent occupied by the owner, which means it cannot be an investment property.
4. Learn the benefits of traditional bank loans
One factor that business owners may not be aware of is that conventional bank loans require larger down payments, depending on the industry. The typical down payment is 20-50 percent.
Loans to purchase hotels and other volatile assets, such as commercial or multiple buildings in a shopping center, for example, typically require a 40-50 percent down payment. This amount may be more than some owners and investors can afford, who may not be prepared for those figures when they are seeking a loan. “I had one small business owner who wanted to buy an apartment, and he didn’t know about the down payment requirement for a commercial property,” Chang says. “Other owners are not aware that they need enough cash flow and a large, steady number of paying tenants whose contracts are not expiring soon.”
5. Document your cash flow
While many entrepreneurs have adequate financial statements prepared by certified public accountants, some attempts to lower their tax rate can affect their chances of getting approved for a loan, Chang shares.
“I have seen many prospective clients get very creative with their financial statements to save some money on paying taxes,” he says.
When owners fail to report all their cash flow and revenue on their financial and tax statements, the probability of receiving approval for a loan declines, Chang says. Banks typically want to see a company’s revenue cover expenses by a ratio of 1.2.
“When the company has a ratio under 1.2 because their CPAs deducted too many expenses, it’s too high of a risk for a bank,” he says. “It can be kosher for the IRS, but not kosher enough for a loan.”
Expect that a bank will require three years of tax returns to ensure that a company’s revenue meets the minimum threshold.
Another factor that bankers examine are the accounts receivable. If one vendor comprises 20 percent or more of what they sell, then a large decline in revenue is a probability, Chang says.
“Banks like companies who have a good blend of customers, including national brands,” he says.
6. Find the right timing
When companies are profitable, they should start planning ahead, and examine their current business plan and strategies to expand and increase their revenue. Waiting until there is a dip in revenue or losing a large customer is not a good game plan to obtain a loan.
“When businesses are in a good period, management should start preparing for a decline in cash flow and obtain a line of credit,” Chang says. “When your company’s cash flow is good, be prepared for when things turn sideways. Don’t let your pride get in the way and believe that you can make it through the downturn, because when the cash flow is no longer there, banks cannot approve a loan.”