Obtaining a Loan to Expand Your Business
Banks routinely provide loans to small businesses to purchase equipment, relocate, or otherwise expand their businesses by providing working capital for purchasing inventory and hiring more staff. The requirements for these loans are similar to any small business loan. At a minimum the borrower must demonstrate or provide the following:
- Good credit history
- Financial statements/projections and business plan that clearly demonstrate how the loan obtained would increase the profitability of the business
- Collateral to secure the loan
The borrower would also need to fill out a loan application and submit recent tax returns. These documents will demonstrate the ability to repay the loan even if the expansion plans did not turn out to be as profitable as was expected.
Obtaining Funds to Purchase an Existing Business
Banks generally view a purchase of an existing business with somewhat of a mixed feeling. On the one hand, the existing business is a known entity, on the other the new potential owner is not a known entity. In this case, how favorably the banks look upon the purchase proposal depends on many factors. The following is a list of criteria that banks ideally hope to see:
- Borrower should have good credit history free from any recent bankruptcies, tax liens, or seriously delinquent financial obligations.
- Borrower should contribute at least 15% of the purchase price required.
- Borrower should have strong familiarity with the business to be purchased.
- Borrower should have a business plan and financial projections.
Banks would also prefer to see the following on the part of the seller and the business to be sold:
- Seller would take back at least 10% of the purchase price over a period of one to three years, or would in some way remain engaged with the business for a year or so.
- Existing cash flow from the business is enough to easily service the new debt acquired; i.e. the business generates enough cash flow to meet the new monthly payments in addition to its existing expenses.
- The business should either be profitable or demonstrate the potential to be profitable if run well.
- The borrower must obtain latest three years of business tax returns from the seller that can verify the financial history of the business.
In addition to the above, the borrower will be required to fill out a loan application and a personal financial statement.
Need Help Evaluating the Deal
To determining what the maximum amount you should pay for the business you are considering buying. You should review the following:
- What is the expected annual after-tax cash flow of the business (what is the after-tax amount of money retained after all business expenses have been paid for)?
- What is your desired payoff period (in how many years do you want the business to pay back the money you spent acquiring it)?
- What do you realistically believe the selling price for the business to be at that time (if your payoff period is two years, what will the resell value of the business be then)?
If the payoff period expected is two years, for example, then what you pay for the business today must not exceed the amount of net after-tax cash the business generates during that time plus the net value of the business if sold at the time minus what you owe your creditors. Borrower must have a good credit history, with no bankruptcies, tax liens, or seriously delinquent financial obligations.
Obtaining a Business Start-Up Loan from a Bank
Since new businesses are the most risky of all types of businesses, banks generally are more cautious about lending start-up capital. Still most banks, in collaboration with the Small Business Administration, do lend to small businesses provided the borrower meets the following minimum criteria:
- Borrower must have good credit history, with no bankruptcies, tax liens, or seriously delinquent financial obligations.
- Borrower must inject 33% of the total funds required. This means that if you need a total of $100,000 to start your small business, you must bring in about $33,000 from your own sources. This demonstrates to the bank your conviction regarding your business idea.
- Borrower must demonstrate strong background and experience in handling tasks required by the business; specifically, the borrower must demonstrate adequate skills in selling, managing, and negotiating.
- Borrower should provide collateral, preferably in the form of cash equivalents (savings, bonds, CD's, etc.) or equity in real property. In some cases, banks may accept business collateral such as equipment or inventory as collateral.
- Borrower should preferably have a secondary source of income, separate from income expected from the new business.
- Borrower should provide a business plan that clearly demonstrates how the borrower proposes to make money from the business.
- Borrower must provide a minimum of two years of financial projections--profit and loss statements and cash flow statements--that clearly demonstrate how the business will make the monthly payments on the loan in addition to the rest of the business expenses.
- Borrower should provide the most recent three years of tax returns.
- Borrower must fill out a personal financial statement and a loan application.