Do you have what it takes to ace a business loan application?
It is not as difficult as you might think. We go through the hurdles borrowers often fall flat on and give you our top tips on how to be a better applicant.
But first for some context, what is a business loan?
Business loans are a capital boost you can put to work for any business purpose. Whether you’re a cafe owner looking to expand or a law firm needing a quick cash flow injection, a business loan gives you the reins to control your finances and fund your next move.
Now onto the applications.
Let’s say you’re a 45 year old Marrickville local who owns a hip craft-brewery called Splinter’s. You man the operation with a small team that plays way too much Arctic Monkeys and were never really good with the details. Splinters is successful but the financial records are in shambles.
Nonetheless you stride into a meeting with your lender and pitch your case, thinking you’ve blown them away.
Then… radio silence.
The 3-5 business day response time comes and goes, and the tumbleweeds begin to blow over the financial savannah.
To add salt to the wound, they hit you with a “sorry, but we can’t help you” message. Ouch: this isn’t the first time and without a change, it won’t be the last.
How do you fix this?
Read on, for here is our guide to getting approved the first time.
The first thing a lender will want to know when you’re looking for finance is the reason you’ve entered the finance ring and your repayment capability.
Lenders don’t have a crystal ball. When you approach them looking for money they don’t know who you are, why you need money, or what your cash flow looks like. It is essential to have a clearly defined purpose in your business plan as this is one of the first questions a lender will ask. Bringing it back to Splinter’s, the lender will want to know if you are a reasonable business who won’t be going in over their head with the extra capital. Does this line up with the goals in your business plan? Do you really need the money? Would another fermentation tank be overkill?
The last thing a lender wants is to facilitate a risky purchase that jeopardises your loan repayment.
The second point is your repayment capability, AKA your business’ cash flow.
This is one of the most crucial parts of your application. You must have prepared a profit and loss or cash flow statement to show your lender that you have the funds to repay them. Think of your initial discussion with your lender as a first meeting with the in-laws. Except these in-laws have a credit license and need to meet ASIC’s responsible lending rules. Yikes. They want to see that you have a stable income, act with integrity, and stay on top of your affairs.
Lenders acting in good faith will only write loans that their borrowers can service comfortably.
This is where bulletproof financial statements can go a long way. In particular, you want a watertight profit and loss and cash flow statement. There are two pitfalls to avoid here: miscategorising and misreporting.
Categorising things wrongly in your statements is like putting clean clothes in the dirty laundry basket. It is unforgivable and would bring an accountant to tears. It signals to your lender that you don’t know what you are doing or that you don’t manage your finances well. Reporting things wrongly on the other hand is like putting dirty laundry in the wardrobe. Pure chaos. If a lender sees this they will lose confidence in your ability to sustainably repay a loan.
But even if the reporting is done right, you’re still not out of the woods.
This brings us onto the holy trinity of approval ratios and the Five C’s of credit. The holy trinity includes debt to EBITDA, debt to assets, and DSCR.
A business’ debt to EBITDA ratio tells the lender how long a company would need to operate at its current capacity to pay off all its debts. It is a powerful indicator on whether a company is likely to default on debt, making it a lender’s best friend for risk management. If it is abnormally high for your industry, a lender won’t touch you with a ten foot pole.
Debt to assets highlights how much of a business is owned by creditors versus by shareholders. This shows a lender the capital structure of the business and flags any risky levels of debt funding. An unusual debt to assets ratio is like an amber light warning lenders to be cautious.
Finally, the DSCR measures how much cash flow a business has available to pay its current debt obligations. Though there is no industry standard, a DSCR of at least 2 is considered very strong. It signals to your lender that you have enough operating income to service your debt – so either you are earning very strongly or your debts are proportional.
As you can see lenders will not just take your word that your cash flow is sufficient.
They call the shots themselves.
If there are holes in the accounting, your ratios don’t stack up, or there are unusual sums of money floating around without explanation, they won’t approve you. So keep credible, timely, and accurate records that would make an accountant blush – and apply for funds when you’re in a stable financial position.
Thirdly, understand your lender’s loan requirements well.
Even if your business is in good stead, things still might not stack up for your lender. They tend to have strict requirements for the property security they want which you must meet.
So what kind of security are lenders looking for?
Lenders prefer property assets with a measurable market value that can be converted to cash, have an active buyer base, can be utilised for business use and have transferable ownership. Bonus points if the property is located in a metropolitan or regional area.
Some lenders will only take residential and commercial property as security, so that is something to keep in mind. Of course, there are exceptions, but as a general rule of thumb, a well-located investment or commercial property will be picture perfect security.
Once you have suitable property security or a suitable asset to use as security, your lender will determine how much you can borrow using an LVR. Typically LVRs sit between 50 to 70 per cent. This means that your loan amount will sit between 50 to 70 per cent of the total value of the asset at the time of the loan being written.
The final step is to nail the specifics and documentation.
Before they approve you, lenders need to know the specifics: the amount you want to borrow, when you’re planning to commence repayments and the term of the loan. Knowing these things beforehand will save you time and make taking out a loan much smoother.
The lender will also need you to agree on exit fees, ongoing fees, early repayment fees, and valuation fees among others. You must understand your obligations and be prepared to pay them as they come due.
We’ve got a list of all the documents you’ll need in our Sparrow Loans white paper. But some of the key ones are financial statements, 100 points of ID, and a personal statement of financial position.
Let’s take it back to our first example, the Marrickville brewery that failed with their business loan application. They had been denied many times before, but with the help of this guide, things will be different. Splinters’ were careful in their application and included everything the lender asked.
They provided a robust business plan. They had bulletproof financial statements. They had suitable property security. They had been through all the paperwork. They were ready to stride into that meeting and get approved.
This is the switched on and capable borrower that a lender will want at the table. So take these tips and run with them the next time you are looking for funding.