Raising startup money, especially if you want someone to lend it to you, is about the toughest task facing anyone trying to start a small business.
Gwen Fayne knows. Last year she decided to buy a closed grocery store-laundromat in her small community and add a beauty salon.
She put together a business plan and applied for loan guarantees from the U.S. Small Business Administration. The SBA agreed to guarantee $60,000 in loans, but she had to put up $6,000 in cash of her own.
Even with that guaranty, one bank turned down her application because of concerns over environmental problems having to do with underground gasoline tanks that once had been located on the same site where Fayne wanted to open her business, she says.
So she dished out another $1,000 for a soil assessment, then got her loan from another bank. She reopened the store by mid-May, and the laundromat and beauty shop followed in late July and early August.
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“It took me about a year working on this thing,” says Fayne, who keeps a part-time job at the Tennessee Department of Employment Security.
Fayne and other small business owners succeed in getting financing because they follow the right steps, starting with the business plan, say advisers and lenders.
A good business plan should start with customer and market research, says Tom Bowie, consultant for the Tennessee Small Business Development Center in Memphis.
“Most people quit a job, take their life savings and start a business without knowing who is going to buy their product, where and at what price,” he says.
Bowie says good business plans also should include an overview (perhaps the most important element, he adds, because most people, if they read nothing else, will read the overview), an organizational plan and a financial plan, which should contain a three-year forecast of sales, profits and losses.
“The No. 1 reason businesses fail is lack of financial planning,” said Mickey Ison, a certified public accountant.
About 20 percent of new businesses fail in the first year, Dun & Bradstreet figures show. About half are gone within seven years. Those facts are not lost on lenders.
“From the time you walk in the door, I’m nervous,” says Greg Hadaway, small business commercial lender at one national bank. “I lend the bank’s money like it’s mine, because it’s my neck on the line.”
But then, all lenders are skeptics. “We’re going to be looking for all the reasons an individual can’t pay us back,” says Art Sandridge, small business lender with a competing bank.
The bottom line is that you will get a loan if you convince your banker you can repay it.
“When I make a loan, all I want is to be repaid,” Hadaway says. “I want to be repaid in accordance with the terms we agreed on. If you do that, I can be your absolute best friend. If you don’t, I can be your worst enemy.”
Building that friendship begins with a business plan.
“Lenders won’t even talk to people who don’t have a business plan,” says Victor Lattan, counselor with the Tennessee Small Business Development Center in Memphis. Bankers believe if you won’t put forth enough effort to write out a plan, you don’t need to be in business for yourself, he says.
You should include what the loan money will be used for, the type of business, the people involved, the market you’re in and why you think your business will succeed.
Be complete and be honest, advisers say. Bankers generally will uncover any hidden facts and, when they do, they’ll torpedo the loan application.
Bank officers also look at a number of other factors in deciding whether to loan you money.
– Character. That means a solid reputation and a good credit rating. If your credit is bad, tell the lender up front and explain the reason. While banks don’t like to lend money to people with bankruptcy in their background, they may make exceptions for people who paid creditors after they emerged from bankruptcy.
– Capital. Many people want banks to provide them with all the money they need to start a business. That won’t happen; bankers usually won’t make a loan if you don’t have your own money in the business. Generally, the bank likes to see the owner put up at least 20 to 33 percent of what he or she needs to get started. In Fayne’s situation, with an SBA loan, she was required personally to put up only 10 percent of the loan amount.
– Capacity to pay. You have to give the bank enough financial information in your business plan to show where the money will come from to pay back the loan and to assure that it will be enough. Banks will look for indications that from the day you open the doors you will have enough cash coming in to pay all bills until you expect the business to turn a profit.
– Collateral. “We’re willing to look at a new business and take a credit risk, but we can’t rely solely on the profitable operations of a new business (for money to repay a loan) because it hasn’t been tested yet,” Sandridge says.
So you have to have assets of value to back the loan-equipment, real estate, machinery-so the bank will have something to fall back on if you can’t pay. Often the bank will ask you to provide a personal guaranty that you personally will repay the loan if the cash from your business and the value of the collateral falls short.
– Economic and market conditions. Although your company has no control over the state of the economy or the market, this is still a factor. Bankers also want to know what the market is for your product or service, who needs it, how strong your suppliers are, who your competitors are and what sets you apart from them.
– Background. Before granting you a loan, bankers want to see-by your education, work experience and knowledge of the kind of business you plan to start-that you know something about the business. You must also show your banker you have management ability-that you can run a company, solve problems, manage people and work under pressure.
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– Commitment. Bankers want to be convinced that you will continue in business as long as financially possible, even under bad conditions.
Not only do you need to to find someone to loan you money, but you also must feel comfortable with your lender.