Virtually all businesses, at some point, need to borrow money. The question is, how do you convince someone to lend it to you? Although most new ventures are financed by the resources of family and friends, at some point it will be necessary to approach a commercial lender.
What does a lender look for? What criteria do they use? In the past, you would hear about the mysterious “Three Cs of Credit” (sometimes there are even five). That is:
- Character: Do you have a well-established reputation?
- Conditions: What is the purpose of the loan? Do you have established credit with businesses, banks, and credit card companies? Are there external/industry factors that will affect your business?
- Capacity: Do you have adequate financial resources to invest in your business? Will the business generate the necessary cash flow to repay the loan?
Although the aforementioned criteria are certainly still considered, small business lending has become significantly sophisticated since the explosion in the numbers of small businesses over the past three decades. That has led to dramatically increased demand for commercial credit.
Although there is no formula to make a loan proposal successful, experts agree that most of the loans that get approved have several common characteristics. Here are a few of the most important ones:
- Purpose: What is it exactly that your business intends to do and to whom? How does it intend to do it? When and where?
I have reviewed scores of ostensibly sophisticated financing proposals that have “failed” based on their inability to explain in a clear and concise fashion exactly what their business does and how they intend to use the borrowed funds. Often this section of the proposal will contain a lot of jargon and/or assume that the reader has a lot of knowledge about this particular type of business. Because the purpose statement comes at the beginning of the proposal, if it is not well written, you may lose the interest of the lender from the get-go and have a difficult time rekindling their interest.
- Management: Arguably the most important part of a financing proposal deals with the management of your venture. Therein lies the conundrum. Most small business owners have a limited scope of management experience. In fact, most start-ups are managed and/or owned by those who have a specific expertise, such as computer consulting or cooking, with virtually no experience in marketing, finance, or operations.
One of the best ways to remedy this situation is to develop an advisory board with individuals who possess the skills and experience you may be missing. Most likely you will be able to find people who will readily join your team and find it an honor to do so. Your proposal should highlight these individuals and their specific areas of expertise.
- Sales Forecasts: Its very easy to correct a shortfall in revenue with an electronic spreadsheet. In fact, one can create all kinds of impressive, professional-looking financial statements with this technology. The problem with most unsuccessful proposals is that the projections on these fancy statements are not tied directly to such information as market and market-share data, competitive analysis, and breakeven calculations.
You need to be able to show the lender how you arrived at your forecast in a clear, well documented, and unambiguous fashion. You should document or footnote every line item that appears in your cash-flow analysis (income vs. expenses on a monthly basis), which is usually the most important statement in your proposal.
Borrowing money is a necessary evil for most successful businesses. You can significantly increase your chances of success by focusing on the areas we have discussed. Remember also that many once small businesses, such as FedEx, used many creative approaches to financing to stay afloat (or maybe in the air)! In the case of FedEx, some of their pilots had to charge aviation fuel on their personal credit cards to get to the next stop!