It takes money to make money, or so the old adage goes. Many entrepreneurs launch businesses with their personal savings, by running up their personal credit cards, or by borrowing funds from friends and family. If you want to avoid these means of raising capital, you may choose instead to go to a bank. Lately, however, banks have been exercising much tighter restrictions on lending. In this environment, then, the loan application – usually a standard form supplied by your prospective lender – is something you simply do not want to botch.
The process of applying for a loan typically takes two to three months, from the time you begin applying to the time the bank approves or rejects your loan application. When approaching a lender, it pays to be meticulous when you fill out your forms, and to provide ample documentation and back-up. You should also plan on answering a series of questions both about your business and about your personal financial situation. Here's what you need to know.
Filling Out a Loan Application: Before You Get Started
Chances are, you'll fill out several loan applications in a bid to get money. At the outset, you'll want to consider whether to target large national institutions with whom you might do other banking, or small, community-based organizations that might be kinder to local entrepreneurs in this economic climate.
In either case, before beginning the application process, make sure you personally have good credit. What prior debts, if any – including both business and personal – do you have? Will they affect your ability to maintain a consistent payment schedule? "How you manage your personal finances is very reflective of how you might be able to manage business finances," says John E. Clarkin, a professor of entrepreneurship at the College of Charleston, South Carolina. "That includes your personal credit."
One area where many would-be entrepreneurs are tripped up: Having too much personal credit. If you carry several credit cards in your wallet, each with a high level of available credit, a bank may worry that you are a threat to run into more debt by using that extra credit if the business runs into trouble.
After you make certain that your personal financial situation will not be a barrier to borrowing money, it's time to make a plan for how you will position yourself and your business idea. Ask yourself these questions: Precisely why do you need a loan in order to start or to expand your company? How will you spend the money? If you intend to buy inventory or equipment, from whom will you buyt it? Who at your company will manage the loan, if not you? Having a game plan to tackle these questions will make the process of filling out a loan application easier.
Filling Out a Loan Application: The Basics of the Form
Most loan applications start with the basics: Asking your business name and phone and fax numbers, as well as the legal structure for your business (LLC or S-Corporation, for example), and the date of incorporation. If you are just starting a company, you should meet with an accountant to determine your method of incorporation ideally before you go to the bank.
The next few questions on the loan application will inquire as to the "type of business" you run. For starters, you'll need to know just how your business is covered under the North American Industry Classification System, commonly referred to as the NAICS code. (To learn more, go to the Census Bureau's website, http://www.census.gov.) Then, under "description of products and services," you should include a pithy explanation of what your business does. There's no need to be long-winded, but it makes sense to explain exactly how you make money—your sources of revenue, a phrase describing products, the sorts of customers you have, and what your typical deal or sale looks like.
For the next section, on finances, you'll enter your current bank account information, including your account number and recent deposit information. For gross annual income, list your business's income for the year. And remember to stick to your current numbers: You should enter the income earned in the past year, not your expected income in the future. The same goes for the number of employees, cash balance, debt payments, etc. You'll want to check with your accountant or financial advisor before listing your fiscal assets and deciding on a fiscal year-end, since that can vary depending on what type of company you are.
The next question on an application is often: Are you in good standing with your secretary of state? Basically, the bank wants to know whether you have paid your business taxes for the past three years. If yours is a new entity, check with your secretary of state to make sure you are properly registered and in good standing before checking this box.
These days, lenders tend to ask small businesses owners for collateral or a personal guarantee – or to put up personal money should your business not be able to repay its loan. So when you are asked whether you wish to pledge as collateral your accounts receivables, inventory, or equipment, you should weigh your options carefully. Pledging collateral, just as in making a personal guarantee, can improve the chance of approval. But keep in mind that it also increases your exposure. "If you're going to start a business, you've got to be willing to lose some money, but don't lose your entire future, your house and your children's college education by pledging too much," says Dan Short, a professor of accounting at the Neeley School of Business at Texas Christian University.
The loan application's next section will also remind you that the obligation you hope to take on could have serious personal financial consequences. Most applications will ask for additional personal information, including everything from a breakdown of the business's ownership (do you own 100 percent of the company, or share equity with other principals?) to your personal cell phone number.
It will also inquire as to whether you are married and are filing the loan application jointly with your spouse. If your spouce will play an integral role in the company, especially if you will both work from home, this is something to consider, because you both have a stake in the business's success. But if it is a venture you are embarking upon with non family-members, bringing your spouce and his or her financial interest into the venture has the potential to cause complication down the road. You'd be wise to consider first consulting both of your financial and legal advisors before putting in a joint loan application.
Finally, most loan applications will conclude with a section of financial questions that can vary from state to state and from institution to institution. Most commonly, this section includes a question or two about whether your business complies with state law, such as whether one customer will take up a large share of your sales.
Additionally, you may be asked to provide personal tax information, which you can attach or provide in separate documentation. Information on whether you or others will provide a personal guarantee is often requested at this point. If your business partners or investors are able and willing to not only pledge some startup funding but put up backing in case the business cannot repay its loan, the bank will want to know how much of a guarantee each co-signer intends to make. Making a personal guarantee not only shows the bank you have financial stability, but also have faith in your project.
"The personal guarantee is something that just about every young business is going to have to offer," says John E. Clarkin, a professor of entrepreneurship at the College of Charleston, South Carolina. "You're making personal decisions, such as how much money to take out of the business, so the bank needs to make sure you're prevented from running all your expenses through your business."
Filling Out a Loan Application: Additional Tips
• Typically at the end of your application there will be an agreement concerning the fees associated with the loan, and a section of notes applicable just to your borrowing situation. These can and should be discussed one-on-one with your lender.
• Be sure to double- and triple-check that you've filled in every question and check box necessary on the application. If anything is missing when the application gets to the bank's loan underwriter, your application will likely be delayed for an additional two to three weeks.
• When you meet with a banker to go over a loan application, bring along plenty of documentation including a resumé, a credit report, and past tax returns, as well as your business plan and balance sheets.
• Err on the side of too much information. "It already seems like they ask for everything from your firstborn to your kitchen sink, but our policy has always been do more than what they ask for," said Anne Barr, vice president of Dallas-based Venture Opportunities, which advises entrepreneurs on financing business purchases. "Add a sheet if you need to, because the more they know, the more they can be sure they're willing to take the risk on your business."
