In 2009, a chiropractor set up shop in Huntsville, Ala. He searched for a bank loan to cover start-up costs and four months of expenses.
When he finally found a lender, the bank didn’t approve the full amount he sought. But he figured he’d accept the smaller loan and hope for the best.
Within months, however, business slowed to a trickle. Squeezed for cash, he reluctantly cut all marketing and advertising. Fewer and fewer patients booked appointments.
“He had to move his wife and two kids into the back of the office,” says Joanne Randolph, president and chief executive of the Women’s Business Center of North Alabama. “The Titanic was sinking and there was no stopping it. He lost everything.”
Randolph recounts this story to illustrate the importance of knowing how much money you need to borrow—and why. By submitting detailed financial projections to justify your request, you help the bank understand your business and how you’ll use the funds. Don’t automatically settle for a lesser amount.
America’s small businesses have struggled to tap tightening credit markets in recent years. Despite increasing signs of a gradual recovery, the barriers for securing loans remain high for many entrepreneurs.
New government programs might help. The Small Business Lending Fund sets aside $30 billion for community banks to lend to smaller businesses, but it’s too soon to assess the initiative’s impact.
Another promising sign is many small businesses are reporting revenue gains. As they become creditworthy in the eyes of loan underwriters, they can access funds to raise inventory levels and invest in capital improvements.
But how much cash is enough? And what’s the best way to get it?
Know Your Numbers
A thorough business plan includes financial information showing how money flows in and out of your company. Not all banks require a business plan to issue a loan. But you can calculate your cash needs more precisely if you know your operation inside out and you maintain accurate financial statements.
About 25 percent of businesses with fewer than 500 employees keep financial statements, according to the Federal Reserve Board’s Survey of Small Business Finances. For the rest, owners need to crunch some numbers to arrive at the right loan amount.
“Say you’re a florist doing $1 million a year,” says Edward Rogoff, professor of entrepreneurship at Baruch College. “Before meeting with a bank, check how your business is doing compared to other florists. Banks will do that, so beat them to it by checking the RMA [Risk Management Association] database” that pools results by NAICS [North American Industry Classification System] codes.
Armed with this information, explain to a banker why a loan of a specific amount will either help your business catch up to industry peers or drive your already-superior numbers higher, adds Rogoff, author of “Bankable Business Plans.”
The next step in applying for a loan is developing a solid relationship with a bank that targets entrepreneurs. Even if it cannot issue a loan, its lending officers might connect you with angel investors, grant opportunities and funding programs sponsored by universities, private foundations and government.
“In our area, smaller community banks may be a better option,” says Randolph, who’s based in Huntsville, Ala. By contacting your local Small Business Administration or Women’s Business Center office, you can learn which banks in your region are actively lending to business.
Enlist Your Attorney and Accountant
Once you identify the best banks, build a file that paints a comprehensive picture of your company’s financial performance. Loan officers will scrutinize your documents, paying special attention to cash flow and expenses.
“You need to present credible projections,” says Todd Reppert, president and chief financial officer of Main Street Capital Corp. in Houston. “It’s important to show what you can reasonably support as reasonable growth versus hyper-growth that lenders won’t buy into.”
In their eagerness to impress banks, some business owners exaggerate their firm’s revenues and underestimate expenses. But loan underwriters inspect cash flow and other critical numbers on their own and follow strict rules that govern whether they’ll approve credit, so puffery won’t work.
A more conservative approach is to take each cost or expense projection and multiply by three—and underestimate revenues. Also prepare to invest at least 10 percent of your own money “to show you have skin in the game,” Randolph says.
In addition to presenting realistic financial figures, weigh the costs and benefits of hiring a certified public accountant to audit your firm’s books. While audits require considerable time and expense, they can convince bankers to issue attractively priced loans to firms that generate well over $1 million in annual revenues.
On average, audited businesses save nearly $7,000 a year on every $1 million in outstanding debt, according to a recent University of Chicago Booth School of Business study. That’s because they lock in lower interest rates than firms that lack CPA audits.
Once you do everything right and the bank wants your business, stop impressing and start negotiating. Scrutinize the final loan documents and question any red flags such as one-time or annual bank fees that seem excessive.
“Have a qualified, experienced attorney review the loan documents,” Reppert advises. “Don’t use a divorce attorney golfing buddy to negotiate and review your loan agreement.”