Let’s Work Together

Obtaining Financing

Apr 29th, 2014

When discussing the topic of financing, it brings to mind a multitude of possibilities. In addition to traditional bank lending, ‘financing’ can take the form of a grant, a private investor, assistance from family and/or friends, and it can involve any number of innovative new solutions like KickStarter, Kiva Zip, etc.

For the purposes of this entry, we’ll limit comments to the process involved in obtaining a conventional loan through a commercial bank while emphasizing that preparations will almost always take the same path.

So, an individual, partners, or group formulates an idea that ultimately leads to the conclusion that starting a business appears to be a viable undertaking. Assuming they have conducted sufficient research to determine that the product or service will be welcomed by the public and there is a level of demand and not too much competition, what are the next steps?

Every lender will do its due diligence to determine the feasibility of an enterprise. So, before approaching a lending institution, borrowers should spend as much time and effort as is necessary to prepare a package (business plan) that concisely communicates several key messages. Those are:

  • What are you proposing to do? (executive summary)
  • General business description? (name, address, product, pricing, etc.)
  • What sets you apart from competitors? (mission statement)
  • Financial projections

The plan should be laid out in an organized format making sure to list strengths as well as weaknesses. It’s best to acknowledge your weaknesses – and address how you plan to overcome them – so lenders know you are aware and not just overlooking any shortcomings. If prospective business owners do their job thoroughly, they will conclude after preparing a business plan that they have eliminated most doubt or come to the realization that their plan is flawed and should go back to the drawing board

Once a written narrative is completed, financial projections are the next and most critical element. Even if it seems that wannabe owners have prepared an air-tight plan of action, it’s all for naught if the numbers don’t add up. At this juncture, it is imperative that projected sales and costs be based on strong assumptions, market research, and realistic economic factors rather than pie-in-the-sky hopes.

In a previous blog in this space contributed by Gary Brownlee, he noted several leading causes of business failure. Among those were: taking an emotional approach to pricing, no knowledge of pricing patterns, no experience in record-keeping, and no knowledge of financing requirements and conventions. We might add to that list other elements such as a failure to understand ALL costs, as well as the correlation between costs and sales volume.

Assuming the client has crossed that hurdle, the next step is to present the completed package to a lender. Prospective borrowers should understand that commercial banks are averse to risk. In other words they are not interested in making loans if the loan purpose appears risky in any way.

You may say, “that’s what banks do…they make loans!” However, it must be noted that they are interested in making loans that will be paid back. They must answer to shareholders and to bank examiners who will question every loaned dollar. Not only that, but the borrower must also have ‘skin in the game’ or be a stakeholder in the risk. That comes in the form of a down payment, which is most often the biggest hurdle for borrowers.

Small Business Administration (SBA) guaranteed loans offer some assistance in that regard. The SBA guaranty assumes some of the risk the bank might otherwise have to bear, and it allows the borrower to possibly obtain the loan with a lesser percentage down payment. Most banks welcome the assistance that an SBA loan provides.

ISBDC advisors are prepared to assist their clients with an abundance of industry research information, demographics data, and other tools to assist with preparing a business plan and financial projections. They are also adept at navigating the landscape of lenders and providing help to prospective business owners as they reach that juncture in the process. Most importantly, they can be an unbiased sounding board for their clients who seek to move their plans from the idea stage to implementation. Become a client to take advantage of our one-on-one business consulting.