Preparing ahead of time and having your documentation in order is the best way to maximise your chances of securing the right loan. But what if you're not looking for finance right now? Perhaps you're thinking: “I don't need capital right now - I'll come back to this in a couple of years.” The answer: it's always the right time to start getting organised, and the sooner you do it, the better off you'll be.
If you're looking to grow your business and take it to the next level in 3-5 years, you'll need to be thinking about employing capable talent, buying inventory and advertising to potential customers. Each of these activities requires a significant amount of time and capital, and can even become an ongoing cost that needs to be accounted for each year. For example, marketing can become quite expensive, as you'll need to be identifying and nurturing new customers for your business every month to keep sales high.
In the current lending climate, accessing capital to fund these activities can be challenging. Business owners battle stress and anxiety with day-to-day bills and cash flow timing mismatches. A cash flow 'mismatch' happens when your cash flow isn't constant and reliable: you might have a supplier invoice to pay while you're still waiting for your customers to pay you. It can be stressful and uncomfortable; if you pressure your customers, they might go elsewhere, but an unhappy supplier might jeopardise your ability to stay in business.
The most frustrating part of this dilemma is that you can be an incredibly skilled business owner and still face these challenges. It's a natural cycle that isn't always in the business owner's favour.
As a result, keeping your eye on the horizon is a smart move as a small business owner. Make sure you're keeping a check on your credit score, maintaining careful accounting records, collecting accurate data, and staying ahead of your industry by continually learning and building relationships.
By doing these things as part of your standard business practice, you're putting yourself in good stead should you need to apply for finance at short notice.
What business owners should know before applying for a business loan
Although every application is different, there are some common things that lenders tend to look for. This means that you can significantly increase your chances of securing finance by educating yourself on the things that factor into the lender's thought process and algorithm.
By being proactive, you increase your chances of having access to a wide range of funding options. The more choice you have, the more empowered you'll be to pick the loan that works for you (rather than the loan that works for the bank).
There's no silver bullet that can guarantee loan application success , but we've broken down the lending algorithm trends into three key components:
- Your business' credit profile;
- Your loan and repayment schedule; and
- Providing security for the loan.
These components are premised on which institutions you can seek finance from, so let's quickly run through what the lending landscape looks like today.
Business Lending Options
From a lending perspective, there are four sectors that offer formal business loans.
1. Banks and Financial Institutions The majority of lending dollars in Australia are processed by the banks. Banks offer a wide range of loan options and facilities, including overdrafts, lines of credit, and credit card facilities. Traditionally, banks have the most rigid criteria for assessing business loan qualification.
2. Online Lenders Typically, online lenders have different assessment criteria to the banks. Aiming to be more agile and accommodating than the banks and formal financial institutions, online lenders are often able to serve a wider range of customers (especially those customers that might be harder to fund).
3. Peer-to-Business lending With changes to the worldwide lending market, a range of non-traditional lenders have appeared and are offering services such as P2P (peer-to-peer) lending. P2P lending is the practice of lending money to individuals or businesses through online services that match lenders/investors directly with borrowers.
4. Online Marketplaces Services such as Valiant Finance allow business owners to compare and apply for loans across the entire spectrum of lenders including banks, online lenders, and the alternate lenders.
Calculating the real cost of a business loan can be difficult
Sometimes it is very difficult to understand the real or total cost of a business loan.
The advertised interest rate is often the lowest rate that they can offer, if you have a perfect credit score. The reality is that the actual rate you'll be offered is significantly higher than the advertised rate. This actual rate is calculated from the risk profile of the applying company, which is nearly always different to the risk profile used for the advertised rate. For business owners, the difference between the advertised rate and applied rate can be confusing.
Some lenders choose to have a low advertised rate which grows dependant on your risk profile, and some choose to advertise high but hope that the customer’s final loan rate will be lower. From the lender's perspective, both approaches are driven by the institution’s sales and marketing strategy, not what is easiest for the borrower!
Because there is often confusion between the advertised and the tailored loan rate, there is good reason for business owners to explore more than one loan opportunity at a time. Comparing real interest rates specific to your business could save you thousands of dollars in repayments.
In preparation for business loan applications, business owners should understand these three loan qualification areas:
Qualification Area 1: Your Business Profile
Lenders use your business profile as a basis to start calculating the risk of offering you a business loan.
1. Trading History This relates to how long your business has been in operation. Operation in this context relates to time spent trading with customers. Your trading history is important as there are a number of lenders who will not provide credit to organisations that have a short trading history.
2. Revenue Revenue relates to the amount of income that the organisation produces. Lenders typically favour companies that can show growing revenue throughout their trading history. Profitability is the calculation of how much money the organisation makes after expenses. As your business becomes more cash flow positive, a greater number of financing options will become available.
3. Assets Assets relates to the company’s ownership of property, vehicles, and inventory. Understanding the asset types and amount will help determine and offset the business loan risk. This is because, in the case of a default, the lender can take possession of the business' assets and sell them to help repay the loan. This acts as a safety net for the lender. The 'safer' the loan is, the lower the interest rate they can offer.
4. Debts If the organisation has other loans that need to be managed and repaid, these will be taken into consideration when assessing the company’s ability to repay the loan.
5. Company Credit Rating A credit rating is an evaluation of the credit risk of a business, predicting their ability to pay back debts, and a forecast of the likelihood of the business defaulting. Credit ratings are calculated and maintained by external agencies like Equifax, Dun & Bradstreet, and Experian. Savvy business owners check their credit file before applying for loans to limit any surprises.
Qualification Area 2: Your Loan and Repayment Request
When applying for a loan it is important to understand the minimum and maximum loan qualifier for each loan option.
1. Loan Purpose As the term “business loan” is broad, lenders will want to understand the purpose of the loan. By categorising loans into purpose groups, lenders can better calculate risk and propose interest rates. For example, the purpose might be to buy equipment, pay salaries, refinance debt or open a new shopfront.
2. Loan Amount Loan Amount relates to how much you need. As lenders offer different borrowing amounts, understanding how much you need is important. Try to avoid requesting a loan amount either higher or lower than published lender amounts. Remember that the loan amount may not be identical to the cost of the project; perhaps you have a bit of money already saved up, or you're relying on sales to fund part of it.
3. Loan Term The loan term relates to the time that you would like to repay the loan. This will need to be mutually agreed between you and the lender.
4. Time to Fund Some lenders are able to move quickly on the approval process, while some are not. By understanding the time frame of when you need the funds, you will be able to target the most appropriate lender.
Qualification Area 3: Your Loan Security
The third area to keep in mind relates to the overall security of the loan, and the checks and balances that the lender puts in place to ensure that the loan is repaid if your business is unable to repay the loan itself.
1. Director’s Guarantee Business owners could elect to provide a guarantee to the lender. This guarantee would state that if the business was unable to pay the loan, the owner will take personal responsibility for meeting the loan requirements. The Director’s Guarantee is one of the key risk areas that every lender will look at to mitigate lending risk.
2. Secured Loans A secured loan is a loan in which the borrower pledges some asset (e.g. a car, property, inventory or equipment) as collateral for the loan. The asset then becomes a the security owed to the lender upon default of a loan.
3. Unsecured Loans An unsecured loan is a loan that is issued and supported only by the borrower’s creditworthiness, rather than by a type of collateral. An unsecured loan is one that is obtained without the use of property as collateral for the loan. Borrowers generally need to have a high credit rating to be approved for an unsecured loan.
The security attached to the loan can play a huge role in determining your risk profile. As a rule of thumb, a secured loan with a director’s guarantee is much less risky than an unsecured loan without a director’s guarantee.
The riskier your business looks on paper, the harder it is to lock in a loan — and the higher the interest rate charged on any successful loan application.
Ultimately, understanding the risk associated with your loan will allow you to manage your options and the long-term cost of taking on a financial product. By being proactive and learning about these aspects of lending, you'll be able to identify preferable lending products and speed up the time it takes to get funded.
Want more information on business loans? Valiant works with 70+ lenders across the lending spectrum, and our team of experienced credit specialists can help you find the right product for your business.
Check it out here: https://valiant.finance/match/wizard/new
Jacob leads the Working Capital team at Valiant. He is the go to guru for assisting small business owners with their everyday business finance needs.