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When you're an untested business owner, borrowing money can be daunting. Here's how one savvy pro discovered that preparation is the best weapon in such battles.
After working in corporate finance for six years, I'm no stranger to borrowing money. But working with banks while representing a large corporation is vastly different from asking a local bank branch for a six-figure loan to fund a personal business venture. What I learned along the way was that negotiating for a small-business loan is a multistep process that begins well before the application is submitted. And it never really ends.
First, the cold reality. Oft-reported studies suggest that three out of five small businesses fail within the first year. Banks know these studies well.
This was on my mind as I prepared for the intense scrutiny that's part of the loan-approval process. I wrote a business plan to justify the loan. It included a brief description of my business, a summary of the requested loan (how the funds would be used and repayment terms), management resumes, a personal financial statement, and a projected income statement for the first year. I demonstrated that there's a market for my service and that I had sufficient skills to start and manage the business. My forecasts also showed the business would have sufficient cash flow to repay the loan.
I asked friends and associates to review the document. This was my baby, and I wanted to be an entrepreneur so badly, I knew my heart could play tricks with my mind. I often get so wrapped up in a great idea that I fall in love with it regardless of its practicality. But a reality check is best done before entering into a venture, not after.
I practiced my presentation skills, trying to anticipate the questions the bankers might ask me: "That's a great question. Efficiencies will be seen by month three because I'll implement a computerized point-of-service system the previous owner didn't have. This will allow real-time access to inventory levels as well as sales trends for products. This will help turn inventory faster because I'll order only the product I need."
At various times, I would break into this song and dance as potential questions popped into my head. This often happened when I was driving, piquing the curiosity of folks in cars around me as they watched me mouth my answers.
After countless hours reviewing my business plan to make sure it made financial sense, I developed a comfort level. I started calling banks and asking to speak to their business bankers. This is usually someone called a "relationship manager" who's the "front man" for the bank. He doesn't make loan-approval decisions, but he's the initial gatekeeper for loan applicants. If he thinks you're a legitimate prospect, he'll pass your paperwork to "corporate" for a decision.
My initial conversations with relationship managers would go something like this: "My name is John Canter, and I recently relocated to Louisville. I'm interested in establishing a working relationship with [insert bank name] because I'm in the market to buy a business. Let me tell you a little bit about myself and my background as well as the business I'm interested in purchasing."
While the banks were interviewing me, I was interviewing their relationship managers. Their experience in different businesses can be valuable sounding boards to new entrepreneurs like me as business grows.
Reactions to me were as different as the banks themselves. Once I walked in to a relationship manager's office and immediately saw surprise on his face. When I asked if I'd caught him at a bad time, he responded that I looked too young to run my own business. I didn't get off to a good start with that bank.
I visited five banks and quickly narrowed my list to two. My choice came down to the relationship manager. Most banks offer the same service at the same price, so I based my decision on my comfort level with this person and his level of experience.
When discussing my business plan, I came armed with two weapons. The first was a list of industry benchmarks I found in the 2002-2003 "Annual Statement Studies " (Risk Management Associates), which I found at the library. This book covers common financial ratios and statements from national surveys of commercial-loan accounts for hundreds of industries. Reciting these benchmarks not only showed that I'd thoroughly researched my industry but also laid to rest concerns about whether my business could meet these metrics.
My second weapon was a hefty portfolio of other banking needs. I knew from working with banks at my previous employer that the margins on loans are so low that banks make very little on them. What they're interested in is the fee-based services that complement the loan, such as checking, payroll and credit-card processing accounts.
Anticipating the specifics of the loan is where you can start losing sleep at night. These specifics boil down to the equity and collateral a bank wants. Equity is generally the money that you put into the business yourself. Banks rarely lend 100% of the funds a new business requires. By investing your own equity, you demonstrate that you're willing to risk your own money in the venture.
Collateral is the assets you pledge as security on the loan. These assets may be a part of the business, or they may be personal (i.e., your house).
I walked away putting down 30% in cash and financing the rest. My wife has been supportive through this entire process, but nothing tests a marriage as much as approaching your loved one to ask if you can put your home down as collateral (though I'm sure its tougher to tell your spouse you just lost the house because your business failed).
I hope I never have that conversation.
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