How to get money from a bank to finance your small business

You often hear how difficult it is to get a small business loan from a bank. Here are several proven approaches to get a bank to part with their money.

Purchase an existing business.
Bankers are much more likely to finance a business that has a reviewable financial history. Lenders will want to see at least three years (if available) of financial statements with corresponding tax returns — and so should you. Ideally, current cash flow from the business would be able to support the expenses under new ownership along with the proposed loan payments. This option, however, requires the new owner to have skin in the game. Typically, owner injection requirements are 20-30 percent of the purchase price, but the more the better!

dollar bill folded like business suitAnother benefit to purchasing an existing business is that existing owners are sometimes willing to finance a portion of the purchase price. This amount can contribute to the equity requirement for the overall purchase amount. However, the existing owner will be in a succeeding position to the bank for collateral and may not be able to collect any payments until the bank loan is paid in full. This may allow the business to sell for a higher price and to sell to a buyer with less financial strength.

Purchasing an existing business with a U.S. Small Business Administration-backed loan of more than $250,000 also triggers an independent valuation, an estimation of the business’s worth carried out by a professional appraiser. And a sale to a closely held individual such as a relative, employee or partner can be expected to prompt a compulsory appraisal. While the right price of a business is ultimately what a knowledgeable buyer is willing to pay, the price structure must also fit the bank’s loan requirements.

Buy a franchise.
Buying a franchise is similar to buying an existing business: There is a track record, even when in a different city or state. Essentially, you are buying a proven business process and product line. That allows a bank to skim over the business concept and focus on your ability to run the business and your proposed location.

While easier to finance, franchises can be more costly to operate over time. Most franchises also require monthly fees between 5-6 percent of gross sales, plus additional marketing fees.

Furthermore, franchises are not intended for independent-minded entrepreneurs. Strict adherence to systems and processes and observance of company rules and regulations are mandatory. Lastly, to be financially successful, franchise owners usually need to own several locations. Therefore it is common for expansion requirements to be part of the franchise agreement.

Starting from scratch? Have a complete business plan.
It’s a good idea to understand your banker and specifically what your banker is looking for to loan you money. The lenders I know are great people and logical thinkers. Their number one criteria is how you plan to pay them back. That is why understanding the numbers in your business plan is critical when asking for money. You need to be able to explain how you are going to make money, and have a credible projection of future sales and expenses with an emphasis on cash flow. Also important is knowing competitors’ strengths and weaknesses, who your customers are, how you are going to reach them so they will buy your product or service and why they should buy from you instead of someone else.

Rayanna Anderson, Missouri State University

Rayanna Anderson, Missouri State University

Ultimately, bankers look at who is requesting the loan as their first priority. This is why bankers continue to assess your character or willingness to pay back the loan and capital (your stake in the business) as essential links to becoming an approved business loan applicant.

– Contributed by Rayanna Anderson, entrepreneurship coordinator and community liaison for MSU’s College of Business and former director of the MSU SBTDC. Anderson writes about issues she regularly sees consulting with small businesses in Springfield and in the state of Missouri.
This article first appeared in the Springfield News-Leader and Used with permission.