by Doug Howard, president of the Entrepreneur Factory
May 2005

The Truth About Small Business Financing

howardDoug300The myths. All I need is a good idea and I can get funding. There are Federal and State loan programs that make it easy to get small business financing. Funding is easier to get if I am a woman or a minority. If I am incorporated, I can get a loan without a personal guarantee. I can get a business loan without pledging personal assets. Sure, there are some exceptions, but by and large these are myths. There is no easy money out there and even the best of ideas are held up to the same loan scrutiny as other business ideas.

There are two truths about small business lending. First, it is really based on credit and collateral. Second, it is very difficult to separate business financing from you personally.

Start with credit and collateral. If you do not have good credit, it will be very difficult to get a small business loan whether it is for a new business or an existing one. The bank will check your credit, review your tax returns and look at your personal financial statement and this will largely determine your credit worthiness. Even if you have been in business for years, your personal credit will be the most important factor and the first hurdle. Once that is cleared, the next issue is collateral.

If you want to borrow $80,000 to start or expand a business, financial institutions will want $100,000 in real assets to secure the loan so that they have an 80% loan-to-value (LTV). The most desirable asset is equity in real estate. If real estate is used for collateral, an appraisal will likely be required. Most other assets will be largely discounted when they are considered for collateral. Equipment and leasehold improvements are not given much, if any, value. Inventory is also not given value. The whole purpose of collateral is to cover the bank in the event of default and most of those assets will either be gone by the time a default occurs or would be difficult to convert to cash. So collateral is a huge issue. In many cases, it will take the pledge of personal assets, often home equity, to secure financing.

Now, assume that you have good credit and you the collateral to get the loan done, but the reason you incorporated was to keep you and the business separate. Can the deal be done without your personal guarantee? You can ask, but in most cases, NO! In fact, if you get a loan with an SBA guarantee, which can help get a difficult deal done, SBA will want liens on all available assets including those from other businesses you may own even if the assets are far in excess of the amount needed to secure the loan. In other words, regardless of your corporate structure, you’re on the hook!

Now, I don’t want to give you the wrong impression. There are ways to get loans done. Here are some suggestions. First, have good credit. Pay your bills on time and keep your personal debt, especially credit card debt, as low as possible. Second, it’s great to own a home, especially if you have equity. Third, assemble a complete financing package for the bank. Fourth, present your plan to several financial institutions and see who works for your business. Lastly, seek other creative ways to supplement financing such as vendors, landlords, family/friends, business seller (if you’re buying) and other means.

Providing a complete financing package can really make a difference. It shows the banker that you are organized and have thought through your request. It also helps because the person you meet with will not be the ultimate decision maker so an attractive, organized package can help them present your case. The package should indicate how much you want to borrow, what you will use it for, projections for the business, three years of personal and business tax returns and a personal financial statement. You can even dress it up with pictures of the business, sample ads and other colorful ways of showing that you will be successful and will pay back your loan.

Prepare for a frustrating process. The first loan meeting is usually very positive and likely to conclude with “I don’t see any problem in doing this deal”. Then, the package gets submitted, the process slows down and the fun really begins. You will be scrutinized, the deal will likely come with new conditions and the whole things will all take longer than you can imagine. Meanwhile, you must focus on running your business. Many banks leave this story out of those small business friendly ads they run.

I wish I could tell you where to stand in line for the “I’m a Woman”, “I’m a Minority” or the “I have a Great Idea” loan. It would be great if small business grants funded start-ups that were good for the local community or if state and federal agencies backed loans for good business ideas with no collateral. I promise, if the situation changes and I will write again. I’ll draw a map and show you exactly where to stand on line for your share. Until then, prepare your plan and prepare to be frustrated. And remember, the call this the American Dream!

Doug Howard is president of the Entrepreneur Factory, and founder of Start-Up Carroll, a group helping small businesses in Carroll County get started.

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