10 Questions a Lender Will Ask Before Funding Your Small Business
According to research, over 50% of small businesses fail within the first year, while 95% go under by the fifth year. Now, that’s not an encouraging statement to kick off this post. But it makes sense because running out of cash is one of the top causes for business failure.
Financing is essential for any business, small or big. Actually, a steady source of funds is to a business as fuel is to an engine. Giants such as Amazon, Microsoft, Coca-Cola, Google, KFC, Nike, Alibaba, you name it, all started small. But years of strategizing, growing their market reach, and of course, external financing to fund their ideas have seen them grow into the industry leaders they are today.
Fortunately, your business has the same potential. As long as you have researched your market well, including doing a thorough SWOT analysis and assembling the right team, you can survive well past the dreaded fifth year. But just like the mentioned businesses, this is only possible if you have a reliable flow of funding to fuel your operations and expand your market reach whenever the business calls for it.
Usually, an entrepreneur starting out may fail to appreciate the importance of external funding until their business kicks off and the funds run out when they need them most. However, as you get more experienced, you realize how essential having a go-to funding solution is for both short-term and long-term cash needs.
For instance, sometimes debtors may delay payments, or business slows down when you need to settle accounts, or it could be a huge opportunity has come up, and you’re cash strapped. Getting financing in such moments is the deciding factor between drifting into a financial crisis and avoiding business interruption.
However, as you already know, securing funding is not a walk in the park. Small businesses seeking external financing get turned down quite often. Below is a list of questions your lender is likely to ask you to assess the viability of your business. We’ll briefly discuss each of them to help you understand how you need to prepare before submitting a funding request.
How Much Money Do You Need?
This is mainly one of the first questions a lender will ask you. It helps them test your preparedness to take up the facility. If you give a very high figure and further questions reveal the business cannot service the loan, or your intended expenditure is too low, chances of being denied increase. In such a case, we often assume you’ve not made your financial projections well and may consider your business too risky to fund.
Essentially, you need to assess your financial needs first and calculate the maximum monthly installment you can afford, given your current profitability. In a nutshell, as much as it’s okay to have ambitious growth plans, it all boils down to your business’s current capability.
How Much Is Your Annual Revenue?
Lenders will want to know how much your business makes in a year, as this helps determine your ability to pay the loan. Here, you’ll need to provide actual past results and not just forecasts. If you have expansion plans, you can include the financial projections in the business plan summary. Generally, as a rule of thumb, we fund about 10% of the annual revenue.
How Soon Do You Need the Money?
Do you need the money to settle an overdue account, pay oncoming end-month bills, or purchase an asset? Giving information on how soon you need the cash helps lenders recommend the most appropriate facility as different loans have varying lending timelines. Again, financiers usually have unique lending policies. Some offer instant loans, while others have lengthy evaluation processes. For instance, we can fund you the same day we receive your offer if you provide all the necessary documents.
How Long Have You Been in Business?
The market has a range of start-up loans, which investors provide based on your business idea’s viability, more so, the market potential. But in most cases, financiers will try to minimize their risks as much as possible by funding businesses with some track record. If your company has been operational for at least a year, generating consistent revenue, it’s viable for most financing options in the market.
How Will You Use the Funds?
Essentially, business loans are meant to help entities generate more income. As such, the purpose for which you’re applying the loan should be directly related to the business operations. For instance, if you intend to acquire a vehicle, be ready to demonstrate how it will contribute to more revenue. That way, the financiers have an assurance that the business will keep generating enough income to meet the obligations.
Do You Have Any Other Loans or Current Funding From Other Lenders?
Usually, most businesses operate with more than one loan. But before advancing an additional facility, lenders will always seek details of the existing loans. This helps calculate a business’s ability to meet obligations without plunging into a crisis. In the event our calculations indicate the loan requested is too high, we often advise on the maximum additional credit that your business can manage.
How Is Your Credit Profile?
Your credit history is another major consideration lenders make before deciding on your creditworthiness. Generally, you should expect them to pull your business and personal credit reports – oftentimes, just a soft pull – so it’s good to answer the question honestly.
Do You Have Any Outstanding Accounts Receivable?
A business requires to provide bank statements, which gives lenders insight into their cash flows. However, sometimes you may have a low bank balance because there are significant outstanding accounts receivables (AR). For this reason, financiers will seek to know if you’re expecting any payment from debtors and how much.
Note that sometimes we may require you to provide detailed accounts to assess the risk factor in the pending invoices. This is especially crucial where you’re offering the accounts receivables as collateral. A significant AR report with credible customers can also qualify you for invoice factoring, in which you can receive up to 90% of the value of their outstanding AR within a couple of business days.
What’s Your Collateral?
Usually, lenders will advance credit on the condition that you provide collateral sufficient to cover the loan should you fail to service it. Even where your financials look healthy, collateral is essential as business risks are always present. Sudden economic downturns can shake up even the most stable businesses, and lenders always want to have a guaranteed means of recovering their money.
What’s Your Business Plan?
A financier will want to look at your business plan. Among other things, it should summarize your company objectives, products and services, financial projections, market potential, employees, business model, etc. Essentially, the plan should highlight your strengths and position in the market against competition and apparent risks.
What Insurance Do You Have?
A lender will always try to minimize their risks as much as possible. As such, they will seek to know what insurance covers you have, both business and personal policies. Moreover, they may want to reach an agreement on payout priority to cover your outstanding dues should anything happen to your business or you.
How Do Your Books Look?
Finally, the lender will want a summary of your books to determine your net worth. This may include your cash flow statement, income statement, and balance sheet. The cash flow statement should summarize the movement of cash in your investing, financing, and operating activities. On the other hand, an income statement should highlight your gross income, net, and taxable income. They will especially be interested in your tax information to establish whether your business has been compliant. The balance sheet will also be a primary area of interest, as it details the available assets for collateral.
In addition to the main financial statements, they may also ask for accounts payables alongside the receivables to determine your solvency. If you have been in business for some time, prepare to provide details about three years back.
Generally, lenders are usually very conservative with lending. They have a duty to safeguard their funds by performing due diligence in their lending activities. This means they typically place much more emphasis on repayment ability, although business goals and credit are also considered. That said, the fact is that lending is not usually an automatic process. You need to demonstrate your business’ ability to handle the additional obligation. As such, it’s essential to prepare your business and have the necessary documents ready before approaching a lender. But above all, you should be ready to tackle common loan interview questions satisfactorily. While financing requirements vary from one lender to another, the above-discussed questions can give you a head start to a successful loan approval process.
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