Here’s the Information you’ll Need to Get a Business LoanBrian Jang ON August 4, 2018
Many businesses will at some point require a loan, whether to cover startup expenses, or some other financial need. Despite the fact that such loans are commonplace, far too many entrepreneurs are unaware of—and unprepared for—the type of requests for information that they will be faced with upon approaching a financial institution.
Your reason for seeking credit will be what determines the terms and security of your loan. We will use as an example a company that has developed a new product that will allow it to expand into a new market. In order to accomplish this, the company will need to finance working capital and equipment.
This business owner believes that his new product will cause his sales to triple over the course of the next three years. Until now, he has been financing his business through a combination of his own personal funds, and a small home equity loan. In order to expand, he will need $1,000,000 to finance working capital (receivables and inventory) and $500,000 for the purchase of new equipment.
Typically, he can expect to be asked for a minimum three-year history of his earnings and cash flow, with a current financial report and likely also a projection for business over the course of the next year or two. It is also quite likely that the lender will want to have a Chartered Professional Accounting firm review prior financial statements, or alternately offer a Notice to Reader Statement, which is when they will offer no assurance regarding the financial statements.
If your statements have been prepared internally over the past few years, it would be wise to speak to the CPA firm before meeting with the bank in order to determine the time and cost involved in having them issue a review-engagement report, or a Notice to Reader Statement on your previous financials.
To secure the loan, banks and financial institutions will need to assess any available collateral, the personal character and net worth of the owner, and personal and corporate tax returns and notices of assessment.
Your company’s and your personal credit will be reviewed as part of the lender’s due diligence. It may be wise to obtain a personal and corporate credit report in advance, which will allow you to correct any errors before submitting the loan application.
To secure the loan and reduce the lender’s risk when offering credit, collateral will always be required. In the example above, a request of $1,000,000 to cover working capital needs, the bank would seek security on the company’s accounts receivable and inventory. The standard is to lend up to 75% of the corporation’s receivable under 90 days, and normally no more than 50% of inventory.
To continue with the example from above, the corporation’s receivables are $750,000, of which $650,000 in under 90 days, and inventory of $950,000. These are adequate amounts for the size of the loan.
In order to keep the loan in good standing, the bank might insist upon a monthly aged accounts receivable listing, and an inventory listing one or more times per year. Your corporation should have a competent bookkeeper or accountant capable of generating the required information.
Generally, working capital loans are revolving and they can fluctuate on a daily basis, up to the maximum of the loan. They are usually interest only, due on demand. The interest rate is usually variable, tied to the bank’s lending rate plus from 1 to 5 percent, determined by the level of risk involved.
The loan to purchase equipment in our example would see the bank attaching security directly to the equipment. These loans are repayable on principal and interest, often over a period of 3 to 5 years.
Once the loan is in place, the lender will perform an annual year-end review. Normally, banks will require annual financial statements with either a review engagement report, or a notice to reader. These will need to be provided within 120 days of the year end.
The banking agreement will spell out all of the financial covenants that the corporation will need to have maintained by the end of the year. A CPA will be aware of these covenants and will help you avoid breaches and either correct or account for any breaches that could not be avoided.
Applying for a loan can be quite complicated, requiring the services of a corporate lawyer who can review all of the documentation from a legal standpoint in order to help you avoid any surprises. You can trust your CPA to review the terms and monitor the financial well-being of your corporation to help you avoid going into default.
For all your business loan questions, contact BCJ Group today!