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2013

Bizloans_Body.jpgby Iris Dorbian.

 

It's a question that besets many small business owners when applying for business loans: how much should I ask for? More so than deciding on which lender to approach, not having a sound estimate of how much capital you need to borrow could lead to cash flow problems—which could lead to your business shutting down.

 

How then can small business owners determine how much financing they need when approaching lenders? What factors should they take into account when calculating the ideal sum of their business loan?

 

Be clear on the reason for the loan

Are you launching a startup? Or do you need the loan as additional working capital to make improvements in your business? Answering yes to either question is critical when deciding on how much you need.

 

Denise Beeson, a small business-funding consultant who previously lent her services to a local SBA-administered Small Business Development Center, a provider of mostly free resources and training to small business entrepreneurs, in Santa Rosa, California, always asks her small business clients the previous questions whenever they come to her about wanting to apply for loans. For those with startups, she does issue a caveat: "If this is a start-up, I remind them that an SBA preferred lender does not fund startups," says Beeson "We then discuss where they may find funding, such as peer-to-peer lending options, tapping into their personal resources, or asking family and friends."

 

If the small business owner is seeking to buy a business from another, Beeson notes that the seller may fund the loan.

 

Also, if the small business owner is seeking working capital for myriad reasons, which might include increasing the marketing budget, making renovations, or paying off debt, Beeson says she will ask clients if they can produce documentation verifying that the debt was accrued as a result of the business.

 

Bizloans_PQ.jpgWithout providing the necessary paper trail needed to accompany a loan application, small business owners could hurt their chances of getting financing from a lender, insists Beeson. To prove her point, she offers the following anecdote:

 

"Recently a restaurant client was interested in an SBA loan to consolidate debt based on improvements to the premises," she recalls. "They had almost $100,000 in debt including credit card debt that was claimed as accumulated to the business during the recession. However, when we looked at the statements, the entries were not clear when and what had been done. In addition they could not produce any paid invoices from contractors or suppliers linked to the credit card statements. Unfortunately, we could not move forward because the borrower could not provide the needed documentation to the preferred SBA lender."

 

Consult trusted financial professionals

If you are unsure or confused about how much you should ask for when applying for a business loan, it might behoove you to visit a financial expert such as a reliable bookkeeper or a CPA that regularly deals with small business clients. By reviewing your financials, he or she can then approximate how much financing you will need, taking into account existing debt obligations and operating revenue. And a word of caution: don’t be lax or lazy when it comes to understanding your financials. Sloppy bookkeeping or a lack of knowledge about your books or tax returns will prevent you from acquiring a loan.

 

Take into account your other non-related business expenses

To determine how much you’ll be able to repay and the length of the loan’s duration, small business owners need to do a cash flow analysis of all their expenses, including mortgage payments or auto loan payments. By doing so, a business owner will be able to develop a more viable estimate of how much they’ll need to borrow from a lender.

 

Rohit Arora, CEO of the six-year-old Biz2Credit.com, feels this is an imperative step for all small business owners to take when deciding on how much of a loan they should apply for.

 

“A lot of business owners don’t take [their miscellaneous non-business expenses into account when deciding how much money they should borrow,” he says. “Everything boils down to your repayment capacity. So if you feel that you can borrow some money and there’s some good opportunity that will help you make money off it, that’s good. But that calculation is not a certainty.”

 

Carefully consider payment terms

After you analyze your financial situation, both on a personal and business level, you will also need to decide on how long you want to pay off your loan. By following this best practice, you will be able to produce a rational figure as opposed to an amount that you will never be able to discharge in light of your finances and debts.

 

Arora agrees, offering a hypothetical scenario: “Let’s say a business owner is borrowing $100,000 and they have to pay back everything in one year,” he explains. “Then the amount of repayment they have to make in terms of speed is pretty steep. Typically for small businesses, the cash flow is their bloodline.”

 

Similarly, Arora says small business owners need to exercise extreme caution, particularly if they’re planning on borrowing from alternative lenders. “A lot of times they want their money back pretty quickly,” he warns.

 

Know the lender

When figuring out how much money you need to borrow, it’s vital that you research your lending options. Which banks or lenders are amenable to small business owners in your sector? Just conjuring up a random number for a loan will not help you if the lender is not open to your industry, says Beeson, who advises business owners to also explore nontraditional lending options.

 

If you need to figure out how much of a business loan you should ask for, you will need to know offhand all of your business and non-business expenses. Not only is this information essential for maintaining good credit—a prerequisite for getting a loan—but it will help you come up with a realistic number that will allow you to comfortably fulfill repayment terms and not disrupt your cash flow.

 

Disclaimer: Since the details of your situation are unique, you should always seek the services of a qualified professional for advice specific to your business.


QAstephentaylor_Body.jpgby Iris Dorbian.

With over 30 years of experience as a chief financial officer/controller, Stephen Taylor prides himself on having the expertise and knowledge to help businesses identify problem areas and then craft solutions to address them. In his current role as partner at B2B CFO Partners, a 26-year-old business advisory firm comprised of former CFOs, Taylor says the bulk of his practice is helping small to medium-sized business owners devise a sound plan on how to sell or exit their business. Recently, Taylor spoke to business writer Iris Dorbian about why he feels it’s imperative that business owners should plot their end scenario right when they launch their business instead of right before retirement.

ID: How do you advise small business owners who want to exit their business? What's the first thing you do?

ST: I start with all my clients asking questions. In the case of an exit, I ask them, "What is it you want to accomplish?" Then the questions go toward assessing their financial and mental readiness to exit. Depending on where they’re at, one exit option might be better suited to their circumstances than another.

ID: When do you think it’s the right time for a small business owner to exit? And conversely, when should they stay?

ST: That’s really up to the business owner. In some cases, the business owner is nearing retirement age but there are other instances where younger entrepreneurs—we call them serial entrepreneurs—build a business and then want to sell it to build another business.

I worked recently with a business owner, close to retirement, about 64 years old, who had a third generation family-owned business. He was just tired and wanted to exit. One thing that all of my partners do when we start working with a client is a "discovery analysis." It's a seller’s due diligence. This gives you a quick snapshot of where the business is. In this case, the client had a manufacturing business but he had some other activities, which included real estate and some rental properties that he owned. By the time I finished my discovery analysis, I concluded that for the five quarters of good data I was able to get, he had very minimal earnings before interest, taxes, depreciation and amortization [also known as EBITDA]. He would not be able to get the price for the business he needed to retire. I helped him get more liquidity into the business. But he will have to spend the next three to five years trying to get some revenue back into the business and some profit. So he was ready to retire, but it just couldn’t happen.

ID: That’s unfortunate.

ST: It is. Typically these business owners have an unrealistic expectation of what their business is worth. I mean, people tell them things about how to value their business and they tend to listen only to the things that assign the maximum value in their mind for it. We’re able to look at it more objectively and give them a realistic gauge. That’s why it’s best to start this process early. It can take three to five years of planning to do it right.

QAstephentaylor_PQ.jpgID: What was the size of his business?

ST: His business was $7 million to $10 million in revenue. [The staff size was] probably 25 to 30 and probably half of those people were in the office doing various support functions.

ID: How often do you work with small businesses in this situation?

ST: I talk about exit strategies even when the business owner doesn’t bring it up. One of the things that happens a lot in a small business is that for the business owner, it becomes a job and not a business. And when he’s ready to retire, there’s really nothing there of value. If the business owner wants to build something of value, build a company—that’s one thing. But if he’s just in it for a job, he’s not going to have anything of value when he wants to exit.

ID: Based on your experience and insight, what would be your tips to small businesses owners seeking an exit strategy? What should they do and what should they not do?

ST: First of all, it takes a lot of planning obviously. One thing that a lot of small business owners do is run their businesses for tax efficiency and they take advantage of charging whatever they can for the business to save on their income taxes. It’s perfectly fine and legal to do that, but it creates a problem. Buyers will typically look back at the three years of EBITDA. It is important for a business owner to do everything possible to maximize EBITDA at least three years prior to an exit.  Some business owners continue to run their business for tax efficiency but that diminishes EBITDA and the perceived value of the company. If you know you’re going to exit the business in three years, you should start managing to maximize profits and not minimize taxes.

ID: Do you have another example with a small business client that you can share that illustrates one of your tips?

ST: Another one that I was indirectly involved with was when I helped a partner. In this case, the owner wanted to retire but was willing to stay on temporarily. We were able to engineer a plan whereby the manager, chief operating officer, and a group of senior managers were able to buy the business out over time with the seller taking a [promissory] note. That can be done when the business owner has done a good job of building his management team. If you have a strong senior management team, they’re always good candidates to acquire the business.

Disclaimer: Since the details of your situation are unique, you should always seek the services of a qualified professional for advice specific to your business.


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