As a Small Business Consultant, I often connect with other entrepreneurs who need to raise capital. In my experience, entrepreneurs who know nothing about financing have unrealistic expectations of what they can get from banks. Many entrepreneurs believe that just because they have an idea that they believe to be great, banks will automatically want to invest. That is simply not the case.
The Truth is in the Proof
When attempting to start a new business (or grow an existing one) with the help of funds raised from a bank, you will need to show them proof that you have a viable business. All to often I meet entrepreneurs who believe they have the next great business idea and that banks should lend to them based on the “potential” of the business. Unfortunately banks usually don’t lend strictly on potential.
What’s Needed: Good Credit or Existing Revenues
In my experience banks lend to two types of entrepreneurs — those with good, established credit or those with a proven business that’s already generating revenues. Banks look for security when lending to entrepreneurs. Therefore lending strictly based on an “unproven” business idea or to someone who has bad credit or no credit, doesn’t make sense for their bottom line.
Prepare Yourself to Get Approved
The best way to borrow money to start or grow your business is to prepare yourself to get approved. If you’re an aspiring entrepreneur, the best way to prepare yourself is to focus on building and maintaining a good credit history. When you can’t show lenders that you have an established business with a certain number of customers and revenues, they will want to verify that you can pay back whatever you borrow in other ways.
They will typically focus on your personal income (from a job or other avenues), assets, and your creditability. This is why it’s extremely important to maintain a steady income (for at least 6 months) when starting out. Banks have nothing to go on but your ability to service your debts and usually the only way they can do that when you are first starting out is to check your credit history and verify your income.
If you are an existing business owner, it’s best for your business to be profitable (and your debt to income ratio to be low) before your apply for bank funding. Banks will want to see that you have a steady stream of clients or customers and revenue before they grant your any funding. In addition, they will want to be sure you aren’t taking on more debt that you can handle by verifying that your debt is no more than 28% to 36% of your total income. Your debt to income ratio helps a lender determine what you can afford to pay back.
An Alternative Funding Source
If you lack the credit or revenues needed to get a loan for your small business, there is another alternative. The SBA microloan program typically caters to entrepreneurs and small businesses that lack good credit and have little to no revenues. Depending on the lender you can get as much as $50,000 for your startup or existing business. However, the average microloan is $13,000 to $20,000. If you’re interested in applying for alternative small business funding (because you lack credit or revenues), I suggest finding a SBA microloan lender in your area. The SBA provides a list of microloan lenders (based on location) on their website here.