That bank loan you want for your company?Well, the bank is going to want a lot before they give it to you.
Do you find this daunting? Me too. I was really disappointed when I needed my company’s first commercial bank loan to finance receivables of more than $1 million—from well-known distributors no less—and we ended up having to sign a lien on our family home to get the loan.
We said, “Wait, we’re a corporation, why do we need personal guarantees?”
They said, “If you don’t believe in your business, then we don’t either.”
We said “Wait, these are good receivables, you already checked the credit ratings of these distributors, why aren’t they enough?”
They said, “If you don’t believe…(see above).” And at that point I realized the truth in the old cynical joke that says banks will lend you money only if you don’t need it.
One of the first things overly-optimistic entrepreneurs discover as they look for fundingis that banks don’t fund business plans. In their defense, it would be against banking law if they did. Banks are dealing with depositors’ money. Would you want your bank to invest your checking account balance in a startup? I wouldn’t. And neither would the U.S. banking regulators.
So here’s what to expect a bank to ask for when you apply for a commercial loan for your business. There will be occasional exceptions to every rule, of course, but here’s the general rule:
1. Collateral
As I explained above, banks do lend money to startups. One exception to the rule is that the federal Small Business Administration (SBA) has programs that guarantee some portion of startup costs for new businesses so banks can lend them money with the government, reducing the banks’ risk.
So your business has to have hard assets it can pledge to back up a business loan. Banks look very carefully at these assets to make sure they reduce the risk. For example, when you pledge Accounts Receivable to support a commercial loan, the bank will check the major receivables accounts to make sure those companies are solvent; and they will accept only a portion, often 50 or sometimes 75%, of receivables to back a loan. When you get an inventory loan, the bank will accept only a percentage of the inventory and they will kick a lot of tires first, to make sure it isn’t old and obsolete inventory.
The need for collateral also means that most small business owners have to pledge personal assets, usually house equity, to get a business loan.
2. Business plan
There are exceptions, but the vast majority of commercial loan applications require a business plan document. Nowadays it can be short—perhaps even a one-page business plan—but banks still want that standard summary of company, product, market, team, and financials.
3. All of your business’s financial details
That includes all current and past loans and debts incurred, all bank accounts, investment accounts, credit card accounts, and of course, supporting information including tax ID numbers, addresses, and complete contact information.
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4. Complete details on Accounts Receivable
That includes aging, account-by-account information (for checking their credit), and sales and payment history.
(And if you don’t know what your Accounts Receivable are, then count your blessings. If you had any, you’d know. Or, read our guide to find out.)
5. Complete details on Accounts Payable
That includes most of the same information as for Accounts Receivable and, in addition, they’ll want credit references, companies that sell to your business on account that can vouch for your payment behavior. If you need to know more about Accounts Payable, just read our guide that explains things simply.
6.Complete financial statements, preferably audited or reviewed
The balance sheet has to list all your business assets, liabilities and capital, and the latest balance sheet is the most important. Your Profit and Loss statements should normally go back at least three years, but exceptions can be made, occasionally, if you don’t have enough history, but you do have good credit and assets to pledge as collateral. You’ll also have to supply as much profit and loss history as you have, up to three years back.
Regarding audited statements, having “audited” statements means you’ve paid a few thousand dollars to have a CPA go over them and take some formal responsibility for their accuracy. CPAs get sued over bad audits. The bigger your business, the more likely you’ll have audited statements ready as part of the normal course of business for reasons related to ownership and reporting responsibilities.
Having statements reviewed is a lot cheaper, more like a thousand dollars, because the CPAs who review your statements have way less liability if you got it wrong. Banks won’t always require audited or even reviewed statements because they always require collateral, assets at risk, so they care more about the value of the assets you pledge.
7. All of your personal financial details
This includes social security numbers, net worth, details on assets and liabilities such as your home, vehicles, investment accounts, credit card accounts, auto loans, mortgages, the whole thing.
For businesses with multiple owners, or partnerships, the bank will want financial statements from all of the owners who have significant shares.
And yes, as I implied in the introduction to this article, that’s leading to the personal guarantee. Expect to sign a personal guarantee as part of the loan process.
8. Insurance information
Since it’s all about reducing the risks, banks will often ask newer businesses that depend on the key founders to take out insurance against the deaths of one or more of the founders. And the fine print can direct the payout on death to go to the bank first, to pay off the loan.
9. Copies of past returns
I think this is to prevent multiple sets of books—which I think would be fraud, by the way—but banks want to see the corporate tax returns.
10. Agreement on future ratios
Most commercial loan include what we call loan covenants, in which the company agrees to keep some key ratios—quick ratio, current ratio, debt to equity, for example—within certain defined limits. If your financials fall below those specific levels in the future, then you are technically in default of the loan.
