The difficulty experienced by new business owners is that many lenders want to see extensive business history, a strong bottom line, and a solid business credit track record, before they will consider making a business loan. But where does that leave new businesses?
Unfortunately, many of them end up using personal credit to finance their businesses. While this tends to be a common practice, it also has several important drawbacks. Business owners may not see any other options, especially if they are in desperate need of capital. However, taking out a business loan isn’t impossible if one is properly prepared.
The qualification process used by financial institutions to determine whether or not they are willing to extend credit to a business is only in place to protect their investment. It’s not all bad for business owners either. In fact, it likely prevents plenty of hopeful entrepreneurs from getting in over their heads.
Personal Financial History
When deciding whether or not to extend credit to a business, lenders will examine the credit history of the business owners. They assume that business debts will be managed in the same way the business owner handles personal debt, which is probably a reasonable and safe assumption.
Financial institutions are likely to require owners of new businesses to sign as personal guarantors, in order to secure their investments. However, if the business owner’s credit is not up to par, then guaranteeing the loan is not likely to carry much weight with the lender.
Thus, it is doubly important to manage and monitor one’s personal credit history, especially if one is interested in qualifying for business loans in the future.
Ability to Repay
Lenders will also look at a business’s potential to repay the loan. This means they will want to know about the assets the business possesses, and especially in the case of a new business, which assets the owner is willing to put up as collateral. Of course, it is in the applicant’s best interest to put up as little collateral as possible, but this may not always be an option.
In the case of more established businesses, potential financiers will also want to peruse the balance sheet, to see what capacity the business has to repay the loan. For new businesses, banks will want to see a business plan that includes realistic earnings projections, so they can properly evaluate the business’s potential to repay the business loan.
Putting together a solid business plan is an absolute necessity for new businesses hoping to acquire financing. Prospective lenders want to see that an enterprise has been thoroughly thought out, before they are willing extend credit.
The business plan should address several key factors. In addition to the earnings projections mentioned above, the business plan should realistically assess the business’s position in the marketplace, its competitive advantages, its brand image, and marketing strategy. It should also detail the business model, and the qualifications of those who will be overseeing key business operations.
The best time to start building business credit is before it’s actually needed. This won’t help businesses with an immediate need for an influx of cash flow, but it will help those with the time and foresight to prepare for future needs. Businesses can start out with equipment leases and vendor accounts, and use them to build credit gradually. That way, when a business loan is needed, the credit rating necessary to qualify will already be in place.
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