Small Business Borrowing: dealing with the bank and other sources of funding

What do bank's look for in a business loan application?

For many small business owners, the relationship they are able to build with their bank can become an important one. It can sometimes make the difference between whether a business is able to launch or perhaps in future, to grow and expand.

Your business funding options

That’s not to say that a bank is the only source of financing for your small business. You can seek to borrow money through loans from directors or shareholders, personal contacts, crowd-sourced funding (eg. check out KickStarter), so-called "angel investors" and venture capital companies for example.

In Australia, if you were to join a business incubator network for example, often when making connections with other small business owners and entrepreneurs in your local community who are working at growing their business, you can learn more about the funding choices that are available to you.

In particular, if you were looking for investors to help fund the launch of your business then you need to understand the types of formula that can be used to arrive at a realistic valuation of your business, based upon your forward revenue and profit projections. Very often when negotiating with potential investors, it is the valuation of the business that can prove the thorniest issue to resolve.

When might your small business need to borrow money?

When you’re new, you may require funds to furnish your office, or to buy stock, lease equipment or vehicles, or to pay employee salaries. It is a common mistake for entrepreneurs to seriously under-estimate the capital or funds required to launch a new business

Or there may be times when cash flow becomes tight. Perhaps a big customer has delayed payment on a big order. Cash flow problems can be one of the biggest stressors for small business owners. However as your business matures, by leaving some profit in your business as “retained earnings” (saving for a rainy day) then you will be more capable of adjusting to the ebb and flow of cash flow

Perhaps you might seek to expand your business. Whether this is to increase your production capabilities, or to set up an operation interstate, or even to fund an acquisition. Sometimes you will simply need extra funds so that you can “seize the opportunity” that has arisen …. You will do your sums, and assess that what you stand to gain will sufficiently exceed the costs of borrowing.

When you’re looking to borrow from the bank, they will usually seek some type of security over the debt. This may be guarantees from the directors of the business if it’s a company, with security over some type of property or company asset.

By gaining a clear understanding of what the bank looks for when determining whether to approve a business loan application, the more likely you will be to succeed with your application.

Anote of caution - avoid over-capitalising in your business

Never lose sight of this principle – the only reason you borrow money is because you’re confident that you will generate profits greater than the cost of borrowing.

Now admittedly, this may take some time to come to fruition …. What’s the old adage “You’ve got to be willing to spend money to make money”

So then, what are the ways in which some business owners can end up over-capitalising in their business?

Whether it’s a retail store owner or a café proprietor or a hairdressing salon owner who invests heavily for example in a major new refurbishment or shop fit-out …… They may fail to consider what they will likely recoup when they seek to sell the business in the future. Or they may be unrealistic when they do their sums and attempt to project the impact of the refurbishment upon the likely increase in sales. It's all too common that new business owners make decisions from the heart rather than the head ....... By all means be passionate and optimistic about the prospects of your business generating a healthy return on your investment - but you cannot allow emotion to drive your decisions at the expense of reasoned assessment.

So to avoid the perils of over-capitalising in your business, seek advice from your accountant to help you perform a realistic and impartial evaluation of costs versus likely profit.

What does a bank require?

But if you decide to borrow funds from your bank, what are some of the things that they would be wanting to look at?

I asked Rebekah Haig, who is Head of SME Banking with the Bank of Melbourne, to share some of her insights on this topic.

She referred to a recent survey conducted by Business Connectors that revealed more than half of the small to medium enterprises that apply for funding do so without having a business plan and more than two out of three of them do not have a cash flow forecast.

For most small business owners, applying for funding is not something they will likely be doing more than once or twice in the life of their business. Hence for many, it is not a skill that is in any way regularly practiced.

Rebekah referred to some simple steps that a business owner could take to help improve their chances of being successful with their funding application .......

Develop an up-to-date business plan that includes cash-flow projections which actually match your funding request
Prepare a cash flow forecast that incorporates the requested funds - and which shows how this loan will be repaid and over what period of time the loan will be repaid
Have all your paperwork handy - such as tax returns, bank statements, and any other statements that verify any assets you own (including super). The quality of your preparation will provide some reassurance to the funding body that you are an organised person
When you are meeting with a potential investor, as already mentioned, be very well prepared. Show that you have a strong grasp of your business and the market within which it competes. Present yourself as confident and capable - because they are investing as much in you as they are in the business itself. Yes, they will want to take a careful look at the numbers - but they will also be assessing your motivation, your attitude, your clarity of vision. The success of any business plan will rely as much on the ability of the person executing it as it does on the quality of the research and analysis that might be behind it.

Lessons from "Shark Tank"

For anyone here in Australia who may have watched a weekly TV show called "The Shark Tank", you would probably have seen exactly the dynamic we have been discussing. Those entrepreneurs who are able to demonstrate a strong grasp of the financial side of their business when they are being questioned by "the sharks" project a much more confident and capable image. They are generally the ones that gain greater interest from these savvy investors because they seem so well prepared. And the business owners who are more capable of factually justifying the cause of their optimism regarding the growth prospects of their business are usually the ones who succeed in enticing an investment offer from one of the sharks.

So if you're looking for funding to jump-start your business, start with developing your business plan. Hope this has helped. Cheers

About the author
Brian Carroll is the founder of Performance Development, a corporate training business in Melbourne, Australia. He is an experienced management coach and a qualified psychologist, with a passion for helping people achieve their goals in life and business. You can find out more about Brian at his Google + profile