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.
Without 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.