How to Prepare Your Business for a Loan

Almost every business owner who sits across from me assumes a business loan works like a car loan. It doesn't, and that one misunderstanding costs people months.

With a personal loan, you show the bank your income, point at the car you want, and walk out with the money. A business loan is a completely different conversation. As a commercial banker, I'm not just asking whether you can afford a payment. I'm asking whether this business will generate enough cash to cover its expenses, pay the debt, and still make a profit. I'm asking how much of your own money you're putting in. And I'm asking what the bank can take and sell to get its money back if things go wrong.

There's a saying in banking that sums this up: banks are 3-to-1 cash flow lenders that look for a second way out. If you understand that sentence, you understand how to prepare your business for a loan. The rest of this post breaks it down, with real examples from my desk.

Rule 1: Bring Your Own Money to the Table

The "3-to-1" part starts here. For every $3 the bank lends, it expects you to put in $1. That works out to a down payment of roughly 25% of the project. Depending on the deal, it could be as low as 10% or as high as 50%.

Banks call this a cash injection. It's money sitting in a bank account that you can put in immediately, before the bank advances a single dollar. It isn't money you hope to raise. It's cash you have today. Money you've already spent on deposits may not count, so ask your banker before you spend it.

This is where a large share of applicants fail, especially startups. They don't realize the down payment is required up front, and they walk in without it.

What Happens When You Skip This Step

I once worked with an owner getting ready to open a new business. Before we ever talked numbers, they had spent most of their savings on deposits, which left nothing in the bank for a down payment.

They spent the next several months trying to fill that gap by bringing in other people. Each new arrangement fixed one problem and created another, and none of them met what the bank needed.

The down payment requirement was explained at our very first meeting, but it wasn't heard. The result was months of rework, a lot of wasted time for both of us, and plenty of frustration.

(Details have been changed to protect client privacy.)

The lesson is simple. Before you spend a dollar on deposits, leases, or equipment, set aside your cash injection and don't touch it.

Rule 2: Prove Your Business Cash Flows

A bank lends against cash flow first. Your financial statements need to show that there is enough money moving through the business to do three things:

• Cover all of your operating expenses
• Make the payments on all of its debt, including the new loan
• Still leave a profit after the debt is paid

A small profit isn't enough. If the loan payments would wipe out what the business earns, the answer will be no. Bankers measure this with the debt service coverage ratio (DSCR), which compares the cash your business generates to the debt payments it has to make.

Starting a new business? You won't have year-end statements yet, so you'll show cash flow with projections: a realistic forecast of revenue, expenses, and loan payments. Expect the bank to test every assumption, and be ready to explain where each number comes from.

Understand Your Own Numbers

This is the part most loan advice leaves out. It's not enough to have financial statements. You need to understand them.

Many owners either build their financials themselves online or have an accountant prepare them, then slide the paperwork across my desk without really knowing what it says. I regularly see owners apply for a loan when their year-end statements show the business lost money. That application isn't going to work, and the owner could have known that before ever booking the meeting.

Your accountant can produce the numbers. Only you can explain them, defend them, and fix the problems before a banker sees them.

Rule 3: Give the Bank a Second Way Out

Cash flow is the first way a bank expects to be repaid. The second way out answers the uncomfortable question every lender has to ask: what if the business fails?

The bank wants assets it can take and sell easily to recover its money. That means collateral, and it means net worth, both personal and business.

The ideal borrower has about $3 of net worth for every $1 they borrow. That isn't a requirement, and plenty of loans get approved with less. But the closer you are to it, the stronger your second way out and the easier the conversation.

This is also why personal guarantees come up so often. In a small business, and especially a new one, the owner's own assets are a big part of the second way out. If you or your partners aren't willing to stand behind the loan, the bank usually won't either.

Your Personal Credit Is Your Business Credit

A lot of owners expect the bank to run a credit check on the business. With startups and young companies, there's usually no business credit history to check. So we pull the owner's personal credit, even when the business is incorporated.

The reasoning is straightforward. If you haven't managed credit well for yourself, you're unlikely to manage it well for your business. The reverse is also true. Owners who handle their personal credit responsibly tend to handle business credit the same way.

If you're planning to borrow, start cleaning up your personal credit now:

• Pay down revolving balances like credit cards and lines of credit
• Make every payment on time
• Check your credit report and correct any errors. Equifax and TransUnion both let you check yours for free.

Your Business Plan Should Be Shorter Than You Think

Business plans matter, but owners often put their effort into the wrong places. I've received plans that were, with no exaggeration, the size of a magazine.

Bankers work an eight-hour day like everyone else. Nobody is reading a hundred pages word for word. What I actually want to know is:

• What the business is and what it does
• Who the owners are and what experience they bring
• Who the key people in the business are
• How many employees you'll have
• Who you see as your competition
• How you'll operate the business day to day (your customers, your main suppliers, and your revenue streams)

Make those answers easy to find in a few clear pages. A tight plan tells me you understand your business. A bloated one tells me I'll be digging for answers.

The Paperwork Difference: 3 Weeks vs. 3 Months

I tell clients it often takes three months or more before they see money. Most of that time isn't spent on analysis. It's the back-and-forth of chasing missing documents.

A commercial banker typically won't start the application until all of the documents are in. Even if your banker doesn't read every page, someone at the bank will. Every missing item adds another round of delays.

The Client Who Made It Easy

Before my first meeting with a recent client, I sent over the list of documents they would need. They came to that meeting with everything:

• Accountant-prepared financial statements
• A personal statement of affairs listing their personal assets and liabilities
• Bank statements that matched what they had listed on their statement of affairs
• Property tax documents showing what they pay
• A current value for their home and major assets
• A tight business plan
• A list of what they need financed, with the amounts including tax (many banks won't finance the tax, so plan to cover it in cash)

I entered the information into our system, analyzed it, and moved the loan forward quickly. They had their financing in about three weeks. Most clients take around three months, and I've seen some take as long as a year.

Notice that the bank statements matched the statement of affairs. Make sure you have the most recent statements. Consistency across your documents builds trust. Gaps and mismatches create questions, and every question adds time.

Applying in Six Months? Start Here

The plan is simple to state and hard to execute. Whether your bank meeting is six months away or next week, focus on the same three conditions: be ready for a 3-to-1 cash flow lender that's looking for a second way out.

Sit down now and map out how you'll meet each one.

Your Cash Injection

• How much do you need for a 25% down payment, or more if your deal requires it?
• Where will that money come from?
• Is it already sitting in a bank account, untouched?

Your Cash Flow

• Do your financials show a profit after all expenses and all loan payments, including the new one?
• Do you understand those numbers well enough to explain them yourself?
• If the numbers don't work today, what has to change in the next six months?

Your Second Way Out

• What is your personal net worth, plus what the business owns?
• How does your net worth compare to the loan? (About $3 for every $1 borrowed is ideal, not required.)
• What collateral can you offer, and are you prepared to sign a personal guarantee?

Once you have those answers, gather your documents, clean up your personal credit, and trim your business plan down to what a banker actually reads.

If you can satisfy these conditions before you walk in, you'll have a very strong chance at your next bank meeting. And you'll likely be the client whose loan closes in weeks instead of months.