One of the most common methods of funding for any small business is to take loans from banks. But, banks don’t hand out loans easily. They require a lot of things done in a detailed manner before they can release the loans. Even within loans, there are some categories that they will be willing to give out more readily than others. With the economy poised to revive soon, governments across the world are offering stimulus packages. As part of that, restarting a business is an important part of that venture(1).
Compared to a home loan or an auto loan, a business loan can be easier to obtain. But, if you need funds for your business, there are options. Each bank that offers you a loan looks at some criteria before releasing the funds. They are
Even the strongest business can fall victim to unforeseen circumstances inhibiting its ability to repay a loan. Knowing this, the bank requires collateral to protect its interests. The type of collateral that you can offer can differ depending on the type of loan you are taking. Some banks require a personal guarantee on all the loans that you are taking while others require a lien or a mortgage on any existing assets. The purpose of any security is to reduce the credit risk inherent in any loaning process. The value of any security that a bank asks is usually higher than the value of the loan that they are offering you. This is an important part of bank loan requirements for the business.
If you want a loan without offering any collateral, you must prove that you can repay it on time. If the loan is structured so you have to make payments for a short period, you must be able to prove your financial soundness. Established businesses don’t have any trouble doing this, but offering to startups can be risky. Many banks might hesitate to take on such responsibility and mandate collateral be offered.
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When you’re starting a business, you won’t have any proof of your creditworthiness or, for that matter, your credibility. Banks have no validation that you will repay your loans on time. One of the most important criteria that banks use for giving credit is a credit score. Usually, when giving loans to businesses, banks look at their credit history. However, since that won’t exist for new businesses, banks will check individual credit scores to determine your creditworthiness.
Personal credit scores are also used when banks don’t have sufficient information about your business’s creditworthiness. In that case, credit is offered based on personal information. That is why this is one of the most important factors banks consider before granting a business loan. If there are multiple partners in a business, then the credit score of everyone is important in granting a business loan.
What do banks look for when applying for a business loan? They look for proof that you have a business that can take off. Business loans are not personal, housing, or auto loans. The rates of interest on business loans also differ depending on the type of business and the value that banks see in it. So, one important consideration is your business plan. When you’re applying for a business loan, banks need you to submit a business plan for verification against the feasibility of granting you a loan. The idea is that you should have complete knowledge of what you’ll be using those funds for. You need to provide the bank with some plan of utilizing the funds and where the loan money will go. Banks need assurance that the financial resources will be used for purposes that further the business needs.
Every business has a risk appetite, and so do banks. Banks might be willing to offer loans but only to a certain extent. Risk is inherent in every business, and banks know what amount of risk to shoulder. So, even if you have a sound business policy, banks might not grant you loans because of the industry that you operate in. If your business is in an industry with high risk, you might not get a favorable outcome from the banks in terms of the loan you asked for.
Of course, the risk in any industry also depends on the economic climate. The global financial outlook changes can determine which industries become safe and which ones become risky enterprises. Based on the long term forecasts and perspectives, banks might offer you a loan for your business. This does not mean that banks consider your business as bad or instantly classify your loan as a bad debt. It is just that the banks predict that the industry you are in can experience a sudden downturn, or there could be drastic fluctuations in the industry. These changes can negatively impact the loan that banks will give you.
Much of the economic climate scenario is something that you can’t control. It depends on how the economy is performing at that given moment. However, given the situations, you need to convince your bank that you are strong in all areas. If, and that’s huge if, the loan falls within the bank’s acceptable risk appetite, then you could get a loan.
Getting a loan from a bank can be cumbersome. But if you’re getting funding from other sources as well, drafting agreements to solidify the relationship and getting terms that are favorable to you can be difficult. That is why our bundle of agreement templates will be useful for you.