Startup entrepreneurs will often try to avoid going to angel or venture capital investors as long as possible to avoid giving up equity by first investing their own money into the company, and then seeking out loans from banks if needed, after and getting a startup loan though requires a lot of checkmarks on a long checklist before banks will part with their money due to the high risk that most startups have.
There are a few things that you, as an entrepreneur, need to know about before even considering walking into a bank for a commercial loan for your business. We outline a few of these common things below – keep in mind that not all of them may be needed, but perhaps there are others that pop up once you start taking meetings with bankers.
A Good Amount of Collateral Will Be Needed
Banks lend money to startups all the time, but one exception is that the federal Small Business Administration (SBA) has created programs that guarantee some portion of early company costs so banks can reduce their risk and provide some capital together with backing from the government. These programs certainly offer startups some leverage when going into loan meetings with banks.
Hard assets are needed from startups to back up a business loan, and banks go through these assets with a fine-tooth comb to ensure that their risk taken is as low as possible. To outline an example – if accounts receivable are used to secure a business loan, banks will take a close look at the major companies on the list to check that they are solvent, and will discount the total amount to be received by 25% to 50%.
The vast majority of startups don’t have enough collateral for the banks liking, so key team members also need to put personal assets at risk as well to secure a loan – banks typically want home equity as it’s usually the highest investment that entrepreneurs have, and at the lowest risk of depreciating. Banks are well aware that, on average, 90% of startups fail and they do everything possible to lower their risk when lending money to early-stage companies.
Your Startup’s Financial Profile Will Be Closely Examined
Banks want to know everything and anything financially related to startups before they part with their money. Credit card accounts, active and past loans and debts incurred, all open bank accounts, investments, tax ID numbers, addresses, and all the contact information. A deep analysis is done by banks on startup’s financial situations, and if anything smells or looks fishy, it signals to banks that the potential risks aren’t worth the potential interest money that can be earned.
Complete Financial Statements, Ideally Reviewed or Audited
A startup’s balance sheet needs to list all company assets, capital, and liabilities, and the most recent balance sheet is most important for banks to look at. Banks like young companies with as much financial history as possible, profit and loss statements which date back at least three years are preferred by banks, but if that length of history hasn’t been established yet, then good credit and assets to pledge as collateral can go a long way in the eyes of banks.
Audited statements are well regarded by banks because it means a certified public accountant (CPA) has been paid by the startup to go over and audit financial statements, and formal responsibility has been established for their accuracy. As companies grow in size, audited financial statements become more significant to have ready for ownership and reporting responsibilities.
While banks do value reviewed and audited financial statements, they care more about collateral value committed as it gives them assets to claim should a company get into a bad financial situation, and become unable to pay back the loan money provided.
All Accounts Receivable Details
Sales and payment history, aging, and an account by account breakdown for analyzing a company’s credit all matters to banks. Be sure to have a thorough understanding of accounts receivable so they can all be clearly laid out in a format that banks can easily make sense of and then assess their total value.
All Accounts Payable Details
Most of the same type of information as for accounts receivable, plus banks want credit references – meaning companies which sell products to your startup on an account can speak about their experiences of payment behavior by your startup.
All Personal Financial Details
Banks want to deal with startups who have teams of people that are personally in good financial situations. Important elements include total net worth, social security numbers, asset and liability details, vehicles, auto loans, credit card accounts, investment accounts, mortgages, and any other financial information available.
Startups typically have more than one single owner, and as a result, banks typically require financial details from every owner – especially ones who hold a significant amount of shares and equity. Every owner can expect to sign a personal guarantee as a key part of the loan process.
Business Plans Still Matter To Banks
Many commercial loan applications need to be supported by a business plan document. Most banks don’t need a 30-page business plan anymore, shorter or lean business plans can be submitted just as long as the company’s summary, product(s), target market(s), industry, financials, and team are well outlined.
Banks do everything in their power to reduce risks, and as such, newer startups which heavily rely on their founders and owners may need to purchase life insurance should deaths occur and compromise company success. Banks may also request that upon death, life insurance money will first go to them to pay off the loan. Things such as life insurance can mean the difference between securing a bank loan and getting rejected, and not every entrepreneur will be on board with this arrangement and seek out alternative capital instead.
Past Tax Returns
Some startups will do anything to succeed, and a small percentage create multiple versions of books to be used for various reasons – when used wrong this is fraudulent activity, so please don’t do it. Banks want to see corporate tax returns to see what the government has on record for a business.
Future Ratio Agreement
Startups need to agree to keep some key ratios in good standing, including quick ratio, current ratio, debt to equity, and others. Financials should always be above specific levels going forward. Otherwise, a startup is technically in default of the loan.