The Big Picture: Small-Business Loans In Today’s Economy

Tips for Getting Your Loan Approved

Contributor: Catherine Corley, Vice President of Member Strategy for Sam’s Club

THE ECONOMIC IMPACT ON SMALL-BUSINESS LOANS
Even with the economy being the number one factor facing small businesses in 2009, small-business loans are still expected to increase this year. With job losses high and traditional employment options limited, many people will turn to self-employment and small business, says the Small Business Labs 2009 Top 10 Small Business Trends article—from the website dedicated to tracking and forecasting the trends impacting the future of small business.

As proof, the previous three recessions have seen an increase in the number of small businesses being formed, and now it’s easier and cheaper than ever to invest in a start-up. While failure rates will also increase, these failures won’t be great enough to offset the number of new small and personal businesses.

Additionally, baby boomers will have to extend their working years, and small businesses will be their best, and sometimes only, option. And on the flip side, “Generation Y” will continue to be more entrepreneurial than youth in recent generations. Small businesses are appearing more attractive to this generation due to limited opportunities with big businesses and the low costs and risks of starting their own companies.

HOW TO OBTAIN AND USE SMALL-BUSINESS LOANS
Things to consider before requesting a loan
It’s a good idea to ask yourself these questions before applying for any type of small-business loan:

“Do I need more capital or can I manage existing cash flow more effectively?”
“How do I define my need? Do I need money to expand or use as a cushion against risk?”
“How urgent is my need?” You can obtain the best terms when you anticipate your needs, rather than looking for money under pressure.
“How great are my risks?” All businesses carry risks, and the degree of risk will affect cost and available financing alternatives.
“In what state of development is my business?” Needs are most critical during transitional stages.
“For what purposes will the capital be used?” Any lender will require that capital be requested for very specific needs.
“What is the state of my industry?” Depressed, stable, or growth conditions require different approaches to money needs and sources. Businesses that prosper while other similar ones are in decline will often receive better funding terms.
“Is my business seasonal or cyclical?” Seasonal needs for financing generally are short term. Loans advanced for cyclical industries such as construction are designed to support a business through depressed periods.
“How strong is my management team?” Management is one of the most important elements assessed by money sources.
Perhaps most important, “How does my need for financing mesh with my business plan?” If you don't have a business plan, you should make writing one your first priority. All capital sources will want to see your business plan for the start-up and growth of your business.

Basics for applying for a loan
Once you have gone through the questions above and decide you still need a loan, here are the steps to get you started:

Determine what loan is right for you—do your homework, research the different types of loans and seek the advice of an expert.
Prepare a written loan proposal, including—
a) Description of Business: Provide a written description of your business, including the type of organization, location, product or service, brief history, proposed future operation, competition, customers and suppliers.
b) Management Experience: Resumes of each owner and key management members.
c) Personal Financial Statements: The SBA requires financial statements for all principal owners (20 percent or more) and guarantors. Financial statements should not be older than 90 days. Make certain that you attach a copy of last year's federal income tax return to the financial statement.
d) Loan Repayment: Provide a brief written statement indicating how the loan will be repaid, including repayment sources and time requirements. Cash-flow schedules, budgets, and other appropriate information should support this statement.
e) Existing Business: Provide financial statements for at least the last three years, plus a current dated statement (no older than 90 days), including balance sheets, profit and loss statements, and a reconciliation of net worth. Aging of accounts payable and accounts receivable should be included, as well as a schedule of term debt. Other balance sheet items of significant value contained in the most recent statement should be explained.
f) Proposed Business: Provide a pro-forma balance sheet reflecting sources and uses both of equity and borrowed funds.
g) Projections: Provide a projection of future operations for at least one year or until positive cash flow can be shown. Include earnings, expenses, and reasoning for these estimates. The projections should be in profit and loss format. Explain assumptions used if different from trend or industry standards and support your projected figures with clear, documentable explanations.
h) Other Items As They Apply: Provide items such as lease (copies of proposal), franchise agreement, purchase agreement, articles of incorporation, plans and specifications, copies of licenses, letters of reference, letters of intent, contracts and partnership agreements.
i) Collateral: List real property and other assets to be held as collateral. Few financial institutions will provide non collateral-based loans. All loans should have at least two identifiable sources of repayment. The first source is ordinarily cash flow generated from profitable operations of the business. The second source is usually collateral pledged to secure the loan.

Be prepared to answer the following questions from your lender

Can the business repay the loan? (Is cash flow greater than debt service?)
Can you repay the loan if the business fails? (Is collateral sufficient to repay the loan?)
Does the business collect its bills?
Does the business control its inventory?
Does the business pay its bills, and on time?
Are the officers committed to the business?
Does the business have a profitable operating history?
Does the business match its sources and uses of funds?
Are sales growing?
Does the business control expenses?
Are profits increasing as a percentage of sales?
Is there any discretionary cash flow?
What is the future of the industry?
Who is your competition and what are their strengths and weaknesses?

EXPERT OUTLOOKS ON OBTAINING SMALL-BUSINESS LOANS
Economic downturn has harmed the ability of small businesses to secure loans and lines of credit; however the severity of the effects on entrepreneurs is still being debated by the experts.

Overall, the majority of experts believe that the lending outlook looks bleak—suggesting that it is not a good time to borrow money. “I think the appetite for lenders, in general, is very dried up. Lending for small businesses, which has always been difficult, will just get more difficult in this environment,” said Dennis Ceru, professor of entrepreneurship at Babson College. Martha Doron, associate professor for the School of Accountancy at the San Diego State University mirrors Ceru’s sentiment: “It has always been the case that banks are not willing to offer money when one needs it the most. New companies looking for cash still have to look at alternative methods—banks do not want take the risk.

Even when economic growth returns, however, experts don’t see banks planning to resume normal lending too soon. The Federal Reserve’s most recent survey of senior loan officers found that most expect to maintain higher lending standards throughout the second half of 2010. And for riskier borrowers—including many small businesses—credit “will remain tighter than average for the foreseeable future,” according to the survey. Credit-card lending, once an easy source of unsecured funds, has also been curbed:

58 million cardholders had their limits reduced between April 2008 and April 2009, according to the Fair Isaac Corp. (FICO). Source: Entrepreneurs Turn to Alternative Finance, Sept. 1, 2009 Business Week

But there’s reason to believe it’s “less dire for smaller businesses” than the numbers show, according to Holly Wade, policy analyst at the National Federation of Independent Business. Small businesses traditionally have a variety of capital sources—they tend to cut back on borrowing when sales decline and/or borrow from smaller banks that have sidestepped the toxic-loan issues. And the federal Small Business Administration is offering some stimulus-package relief, reducing bank fees and increasing the percentage of each loan that the government will guarantee. In fact, in the last two fiscal years, $3.3 billion of completely authorized funds were left on the table unspent for SBA504 loans. Next year, this amount is expected to increase to $4-4.5 billion, according to Business Week and Fox Business. All these factors appear to be helping—the banks are at least saying they are open for business. As long as a borrower doesn’t expect “pre-2008” terms, “we have money to lend and a strong desire to do so,” said Robert McGannon, chief lending officer at the Kansas City, Mo.–based Country Club Bank. Source: For Small Businesses, Borrowing Is Not So Dire, Sept. 2, 2009, The Wall Street Journal

While it may take a little more effort to secure their loan these days, small business owners have never been shy to hard work. So the experts agree that the best place to start when securing a small business loan is through smaller bank branches and credit unions. “Small community banks are the way to go. These smaller lending agents provide the largest opportunity for you to secure your loan,” said Bill Dunkelberg, chief economist, National Federation of Independent Business, in Washington. “We let the big banks get so big that they are too big to manage and that means, too big to fail.”

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