How to Prepare for a Business Loan: What Lenders Want to See

Does your business need an infusion of capital to pursue growth opportunities? Securing a business loan can be a smart move, but you must be well-prepared. In today's tight lending environment, banks are increasingly selective, and your businesses must present a compelling case to get approved. Learning to think like a lender can help you put your best foot forward.

Evaluating Borrowing Decisions

Bank financing can provide an infusion of capital for various business purposes. For example, you might need additional funds to bridge short-term cash shortfalls because of seasonal operations or the cash conversion cycle (the time it takes to convert dollars spent on inventory and operations into cash received from customers). Alternatively, you might need financing to buy new equipment or expand your existing facilities and operations.

Before you reach out to your lender, address the following key questions:

• How do you plan to use the loan proceeds?
• How much money do you need?
• When do you need the funds?
• How soon can you repay the loan?

Banks generally offer two types of financing:

1. ‍Lines of credit. A line of credit is primarily used to meet working capital fluctuations. It's generally considered short-term, and banks may expect repayment within the next year. In practice, however, most businesses keep their revolving credit lines open for many years, occasionally drawing and repaying funds based on operating cash flow.‍
2. Asset-based loans. These loans are for specific items, such as equipment purchases or plant expansions. With asset-based loans, the loan's length is usually tied to the life of the asset that's being financed — and that asset is usually pledged as collateral for the loan. Banks generally don't allow business owners to finance 100% of an asset purchase. Instead, you'll probably be expected to contribute a reasonable down payment.

Understanding the Lender's Mindset

First and foremost, a lender will want to understand your business and how it's been financed to date. This includes your personal cash infusions, forgone salaries and sweat equity, as well as any equity contributions from friends, family members and outside investors.

Banks want to lower their risk. So, before approving a loan request or deciding on the loan terms, your lender will assess the three C's:

1. ‍Character. The strength of the management team — its skills, reputation, training and experience — is a key indicator of whether a business loan will be repaid. Banks also look at the company's track record with creditors. This includes business credit reports and trade references from key suppliers. The latter tend to be submitted by businesses without established credit histories and those who deal with smaller suppliers that don't report to credit agencies.‍
2. Capacity. Underwriters want to know how you'll use the loan proceeds to increase cash flow enough to make loan payments by the maturity date. To determine your ability to repay the loan, lenders will evaluate past and projected financial statements, as well as your business plan.‍
3. Collateral. Lenders typically require borrowers to pledge assets as collateral in case they don't generate enough incremental cash flow to repay their loans. Common examples include real estate, savings, stock, inventory and equipment.

Additionally, an owner's personal credit will be factored into the lending decision, and the bank will likely require a personal guarantee from the owners. So, expect to share personal financial details and put your personal assets on the line to secure the debt — even if your business is incorporated.

Preparing Your Loan Package

Before meeting with your lender, you should put together a comprehensive loan package that includes:

• A narrative "statement of purpose,"
• Three years of business financial statements (including balance sheets, income statements and statements of cash flow), if available,
• Three years of business tax returns, if available,
• Personal financial statements and tax returns for all owners,
• Appraisals for assets pledged as collateral,
• Prospective financial statements, and
• A three- to five-year business plan. (See "Preparing a Formal Business Plan" below.)

If the lender thinks you'll make a viable borrower, your application will go to the bank's underwriting committee. Underwriters will have greater confidence in your historical and prospective financial statements if they're prepared by a CPA and conform to U.S. Generally Accepted Accounting Principles.

Also, remember that this list is just a starting point. Lenders may ask for additional information, such as interim financial statements, lease agreements and marketing brochures.

Improving the Odds

Getting a loan isn't just about filling out forms. When lenders see thoughtful planning, realistic projections, and a solid grasp of your business's strengths and risks, they're far more likely to say yes.

Before applying for a loan, consult your CPA or financial advisor to help prepare detailed financials, craft a compelling business plan and present your loan package with confidence. Making this upfront investment can improve your odds of approval, lead to better loan terms and build strong long-term banking relationships.

Preparing a Formal Business Plan

Lenders want serious borrowers who are invested in their businesses and aware of their financial condition and performance. Here are five suggestions to consider when drafting a formal business plan to submit with your loan application:

1. Take your time writing narratives and projecting future growth.
2. Ask someone else to proofread your writing to ensure it's clear, concise, objective and accurate.
3. Always review your math when calculating ratios and building financial projections.
4. Be realistic about your strengths and market opportunities.
5. Be honest about your weaknesses and potential threats to your growth.

Lenders have seen all kinds of business plans and financial projections — and they know how to critically evaluate the underlying assumptions. Where possible, support your assumptions with market data and research.