A business is established on the premises of the owner seeing value in his/ her idea and expecting growth of the same. To ensure growth of the business, there is need for funds, which could come either from the owner’s pocket or from an external agency.
When funds come in from an external agency, there is a possibility that the owner will need to cede control of the business. If the owner wishes to avoid that, then the possible form of funds that has to be raised is debt, which could again take different forms like loans, debentures, etc.
Availing a loan from a bank is not an easy task considering the fact that lending to business can turn out risky for any lender. Therefore, lenders do a very thorough due diligence of all documents and the way the business is run before approving a debt. In addition, the loans may be approved only on the basis of a collateral, just for extra surety.
In such cases, we can imagine the distress it may cause to a small business owner.
Small businesses are often run by an individual or a small group of people who do not have the means to be able to produce the required documentation or even offer assets in support of their loan.
We, as your Credit Coach, would like to present some simple tips that can enable you to improve your chances of availing a Small Business Loan
Ensure Evaluation of Your Need For Credit
It is very important that you are well informed of your business’ need for credit. If you are not sure of why it needs credit and the quantum of credit that it needs, convincing the lender will turn into a difficult proposition.
Having a proper plan helps. A proper business plan that shows your operations and financials till date, future prospects, the funds needed to achieve your goal and the way the funds will be utilized is an absolute necessity. It not only provides clarity to the lender, the process of drawing up the case for credit will help the business evaluate its needs.
It is also important at this stage to decide which form of credit will work for your need, as there are different forms of business loans available.
For Ex: If your creditors are availing extra time for clearing their bills are you are facing the crunch, the ideal option for you may be Invoice Financing, whereas if you approach the bank for a long-term loan, not only will the purpose not match, you may end up with a higher cost of interest payments.
Additional Reading: 9 types of business loans you should be aware of
Keep Your Documents In Order
No matter how small or big the business is, documentation is a necessity for availing any loan. While certain lenders may demand extensive documentation in form of financials like Tax returns, bank statements, GST returns, etc., others may be satisfied with the basic financial documents.
Small businesses often are focused more on business development that they do not pay attention to documentation. However, it is only through your documents that a business can demonstrate their financial stability. A business may have sales, but if the documents doesn't show inflow of revenue, then the lenders are very likely to reject such a loan application.
Do not forget the basic mandatory registrations and returns like GST (if you fall under the bracket) or Income Tax, etc. A small business generally has smaller number of transactions, so if the entire accounting process sounds intimidating, then you can always outsource your accounting processes. But do not make it an excuse for not keeping proper records.
In addition to being important for availing credit, these documents are important even from the legal point of view, so it pays to pay attention to them.
Additional Reading: The Credit Mantri Guide to Business Loans
Apart from your documents, the lender generally relies on your credit history to base the lending decision. As with personal credit history, a business credit history is dependent on the previous credit behavior by the business.
For a business, there are various kinds of credit rating or scoring. Bigger businesses get their debt and businesses rated by Credit Rating Agencies like CRISIL, ICRA, etc. Smaller business can go in for SME Ratings service offered by these rating agencies. While the business rating by themselves are generally not available in public domain, rating for debt already issued by the company is in public domain.
But these are often useful for assessing bigger business, while a smaller business has none of these.
When a business is smaller in size, there is no demonstrable credit history, in general, making it difficult for the lenders to assess creditworthiness. Also, in many cases, small businesses are run by an individual or a group of people, so in the absence of business credit history, the personal credit history of the promoters assumes importance.
So if you are a small business looking for credit, make sure your credit histories i.e., personal and business (irrespective of how short it is) credit history show high standards of creditworthiness
As lending to a business is fraught with more risks than retail lending, a low credit score will close all chances of you getting a loan.
Additional Reading: Learn more on how your personal credit scores can affect your chances of availing a business loan?
Fine Financial Fundamentals
It is a well-known fact that no lender likes to lend to an individual who has no means to pay back the loan. Same is the case with business: any bank would like to lend to a business that has good cash flows and profits. You would need to demonstrate that your business is in a strong position to pay back the loan being borrowed.
In addition, all your financial statements have to be in sync with what you put on your business plan. For Ex: If you show a projection of 20% growth in sales over the next 2 years, the base for the same should be evident from strong cash flows at present.
A business is not run in isolation; the general economic conditions in the country or your specific market are also taken into effect. Similarly, the effect of the input cost into your manufacturing cost also plays a big role.
For Ex: If you are running a business which uses up a lot of fuel, then rise in Crude Oil prices or any unrest in the OPEC countries plays a role in deciding the cost of your product. Similarly, if you export your product to a country which doesn’t have a stable political environment, your revenues will be under question.
Explore Different Types Of Lender
In the current day scenario, many lenders have understood the extensive documents required from small businesses in obtaining credit from traditional sources like banks and other formal financial institutions. Hence, there are many other channels which have opened up and provide easy access to credit without having the businesses provide extensive documentation.
These new age lenders make decisions based on many other factors other than credit scores and age of businesses, which helps them make lending decisions easier and faster.
The rate of interest charged by these lenders may be a tad higher than the traditional lenders. So, the call on which lender to approach should be made after carefully evaluating the pros and cons of each lender.
If you have an immediate requirement, then going in for a fintech lender may prove worthwhile for you. Whatever be the need for credit, make sure that your financials are strong, and that you have shown responsible credit behavior in personal and business capacity.