November 25, 2013

The 6 Things Lenders Look For

small business financialsWhether you’re starting a food business from scratch and need money to help you get it up and running or if you’re at the point where you need additional capital to grow your existing business, you need to know what lenders are looking for before you approach them for a loan.
While most people automatically think of banks when they think of lending, the fact is that even if you’re approaching your friends and family for a loan they are, technically, lenders. Though the later may not be as rigorous when evaluating you for a loan, it’s good to know in advance what lenders are looking for so that you can try to put yourself in the best position for success.

The 6 Things Lenders Look For:

  1. Do you have skin in the game? Lenders don’t want to be the only ones to put their money at risk with your business venture. They need to know that you believe so fervently in your idea or your business that you’re willing to contribute money towards your goal as well. Typically, lenders are look to see that you are willing to put in at least 20-30% in order for them to feel comfortable that you too are incentivized to make the most of this opportunity.
  2. What’s your background and experience? Lenders want to see that you, or someone on your management or advisory committee, has relevant business experience. This doesn’t have to be previous entrepreneurship experience, even working as an employee for a related business or industry can help show that you understand what you’re getting into and have the knowledge and expertise to grow the business wisely with this loan.
  3. What’s your credit history? I realize this might be a painful topic for a lot of people coming out of the recession, but credit history is still a closely scrutinized aspect of lending as lenders want to feel as though you are a safe loan risk. According to the Small Business Administration, lending institutions are, on average, currently looking for a credit score of 700 or better. If you’ve owned prior businesses, your prior business credit history might also be taken into account.
  4. What sort of collateral do you have backing up this loan? In the lenders mind, the worst case scenario is that you default on the loan and they want to do everything they can to protect against that. One way they do this is by taking a look at what collateral you have in your possession that would help the lending institution make its money back. For example, the any equipment your business owns could be used as collateral or even your own personal home or car. Keep in mind that collateral, from a bank’s perspective, is discounted so that if you bought a new piece of equipment for $100, they will see it as having collateral value of $50 when they’re calculating what your collateral is worth.
  5. What do your cash flow projections look like? You should be prepared to show 1-2 years of cash flow projections that include realistic assumptions about how your business is going to perform going forward. Be prepared to explain to lenders why you made the assumptions you did. For example, for a start-up company this might be looking up common percentages for your category (such as, what percentage of gross revenue is spent on marketing). For existing companies, these assumptions should be based on past performance and account for growth and efficiencies you’ve gained such as taking the past 3 years’ annual percentage of gross revenue that you spent on marketing and using that figure as your assumption in your cash flow projections.
  6. What’s your business plan? How do you plan to use this money you’re asking for? Is your business model a sustainable one that can grow? A detailed business plan helps lenders understand the scope and purpose of your business, your business goals, and get a better handle on the financials of the business.

Without a doubt, the lending market is still incredibly hard for small food businesses, be they start-ups or existing businesses, but taking the time to get these 6 things in order before talking to lenders is critical if you’re serious about finding a lender to work with.

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2 comments on “The 6 Things Lenders Look For

    • smallfoodbiz on said:

      That’s where things like crowdsourcing might be helpful. I’ve done some articles on it in the past that you can search for. Also, in 2014 I’m going to try to put more energy I into writing additional posts about financing for small businesses because you’re correct, it’s often hard to have all six and even then lenders are still very leery of small food businesses.