Interest rates are skyrocketing and banks are circling the wagon. But even in these challenging financing times getting a loan isn’t as hard as you think. But you need to be prepared. And you need to understand what a banker is looking for. So before approaching a traditional bank for a loan, make sure you can answer these 3 questions.
What is the loan for?
“Dad, can you give me 50 bucks?” says your teenage daughter to you. You say “Sure! How about a hundred? Two hundred?” No, you don’t. What’s the first thing you ask? You ask “What for?” This is a natural human response from anyone being asked to give up anything. You want to know the reason. So why should a bank be any different?
Before a bank lends a customer money, a good banker always wants to know what the money is going to be used for. Is it being spent on something worthwhile? Is it an investment in an asset that will provide a return—like a piece of equipment or property? Is it something that’s risky or not appropriate? This is the first thing disclosed for any company looking for money in the public markets: their “use of proceeds”. A bank wants its customers to succeed and is happy to finance the right customers who are investing in the right things. So before you step inside the loan advisor’s office, make sure you have a very specific reason why you’re asking for the money and what you’re going to do with it.
Can you pay it back?
Banks are businesses just like your business is a business. They are entitled to earn a profit just like you are. Bankers are very, very interested in debt service. They want to make sure that your cash flow is well in excess (at least more than 20 percent in excess) of what would be required to make their loan payments. They are not interested in forecasts or predictions that either can’t be justified or that use unreasonable assumptions. They want to be sure that, barring any surprises, you will be able to pay your loan back, with interest. Before meeting with your loan advisor, pay close attention to the bank’s loan applications and make sure you are including every amount possible that impacts your cash flow. Make sure that your debt service is adequate, reasonable and attainable. This will make your conversations much easier.
Are you willing to take a risk?
Banks often ask for personal guarantees. Of course, the main reason is to cover their exposure and provide for some type of recourse if things go bad. But there’s a much more important reason why this is asked. It’s about skin in the game. If a bank is going to risk its capital on your business, it’s not an unreasonable to question to ask what you’re going to be risking. No one wants to be in a position where you’re being asked to pony up assets due to a bad loan. But there’s a concern by any investor or lender when a business owner isn’t willing to risk his or her own assets. Most entrepreneurs do this. Why should you be any different? Make sure you’re comfortable with this before moving forward. A banker’s going to ask you. And you should be prepared to step up.
Cash flow isn’t just about cash. It’s about the availability of cash. It’s knowing that you can tap into a credit line or a working capital loan when you need the cash. That’s why knowing these 3 things will better position you to have the capital you need.
