Are you finding this intimidating? I do too. I was disappointed that my first commercial bank loan for my company to finance receivables exceeding $1 million from well-respected distributors proved insufficient. We signed a lien on our family house to obtain the loan.
We replied, “Wait! We’re a corporation. Why do we need personal guarantees?”
They stated, “If your belief in your business is not strong, we won’t be able to believe in it.”
We replied, “Wait! These are good receivables. You already checked the credit ratings for these distributors. Why aren’t these enough?”
They said, “If …(believes below,” and I could see the truth in the old joke about banks lending money only if they don’t need it.
Overly optimistic entrepreneurs find out the hard way that banks won’t finance business plans when searching for funding. It would be against banking law, they claim. Banks deal with depositors’ money. Would you like your bank to invest your checking balance in a startup? I wouldn’t. The U.S. bank regulators would agree.
1. Collateral
As I have already explained, banks lend money to startups. The federal Small Business Administration (SBA), which guarantees a portion of the startup costs for new businesses, has one exception. This allows banks to lend money to the government and reduces their risk.
Your business must have tangible assets that can be pledged to back up a loan. Banks carefully review these assets to reduce risk. When you pledge Accounts Receivable for a commercial loan, the bank will inspect the major receivable accounts and make sure they are solvent. They will only accept a small percentage to finance a loan, usually 50 to 75%. The bank will only accept a portion of your inventory when you apply for an inventory loan. They will also check many vehicles first to ensure that it isn’t obsolete or old inventory.
To obtain a loan, small business owners must also provide collateral, usually a house or other personal asset.
2. A business plan
Although there are exceptions to this rule, most commercial loan applications require a written business plan. Although it is possible to be concise or even lean, banks still require a standard summary of company and product details, market information, team members, financials, and financial statements.
3. All financial information about your business
This includes all past and current loans and debts, bank accounts, investment accounts, credit card accounts, supporting information such as addresses, tax ID numbers, and complete contact information.
4. Complete details on Accounts Receivable
This includes account-by-account information, aging, sales history, and payment history.
(And if your Accounts Receivable don’t exist, count your blessings. You would know if you had any. You can also read our guide to learn more.
5. Full details about Accounts Payable
This includes the same information as Accounts Receivable. Still, they will also need credit references from companies that sell to your company on accounts that can vouch for your payment behavior. You can read our guide to Accounts Payable for more information.
6. Audited or reviewed complete financial statements
The balance sheet lists all your assets, liabilities, and capital and must be the most recent. Your Profit and Loss statements should be at least three years old. However, exceptions may be made if you have sufficient history but have good credit or assets that can be pledged as collateral. Also, at least three years ago, you will need to provide as much history of profit and loss as possible.
Audited statements are statements that have been audited. This means that you have paid a few thousand dollars for a CPA to review them and take responsibility for their accuracy. CPAs are often sued for bad audits. For reporting and ownership responsibilities, the bigger your business, the more audited statements available.
A review of statements is much cheaper than paying a thousand dollars because the CPAs who review them have far less liability if they are wrong. Banks don’t require statements to be audited or reviewed every time. They always require collateral and assets at risk. Therefore, they are more concerned about the asset value.
7. All your financial details
This includes your social security numbers, net worth, details of assets and liabilities like your home, vehicles (investment accounts, credit card accounts, auto loans, mortgages), and information about your financial history.
Banks will require financial statements from all owners of significant shares in businesses with multiple owners or partnerships.
Yes, as I said in the introduction, it leads to a personal guarantee. You will need to sign a personal warranty as part of the loan process.
8. Information about insurance
Banks often request that newer businesses that rely on key founders take out insurance to cover the death of one or more founders. The fine print may direct that the death payout is paid to the bank first to repay the loan.
9. Copies of returns from the past
This is my opinion to prevent multiple books, which I believe would be a fraud. However, banks want to see corporate tax returns.
10. Future ratios to be agreed upon
Commercial loans usually include loan covenants. This is where the company agrees that it will keep certain key ratios (quick ratio, current rate, debt to equity) within defined limits. Technically, you will default on the loan if your financials fall below these levels in the future.
