If you are a Canadian small business owner, the possibility of taking out a loan to fuel your business growth may have come up on the horizon. Even if you are bootstrapping and don’t intend to take on business debt, it’s always a good idea to stay informed (and prepared) in case you eventually need to. Getting a business loan can be straightforward if you have your financial ducks in a row. If you are not where you want to be when it comes to your business finances, this blog will show you how to set yourself up for success.
There are usually two trigger events in your business that may require a business loan. When you are just starting out and when you are looking to grow. For entrepreneurs who are just starting out, unfortunately the options tend to be more limited. You are leaning on your personal credit history and a strong business plan. These types of loans are harder to come by. There is no way for lenders to de-risk the loan based on business revenue if you are pre-revenue. Makes sense. If you are under the age of 39, and have been in operation for less than a year, Futurpreneur Canada is a great resource to check out.
If you have been running your business for two years or more, traditional (conventional) lenders will generally ask for a minimum of 2 years worth of financial records. This includes:
In addition to gathering information to get a sense of the financial track record of your business, lenders are also very likely to take a look at your personal financial situation.
Why is this? Even if you are incorporated, conventional lenders will likely require a personal guarantee of the lending facility, even if it’s in the corporation’s name. What does this mean? It means that should the corporation default on payment, the lender then can come to you personally to request payment because you have been required to offer a personal guarantee. This is very standard practice amongst most lenders for owner-operated corporations. So regardless of whether or not you operate as a sole prop or a corporation where you are the sole shareholder, the lender is going to also take your personal finances into consideration in a big way. Because not only will they consider if the business operations provide adequate cash flow to support repayment of the loan, they will also consider your personal debt load and whether or not you would have the capacity personally to repay the debt should the business fail.
Sometimes lenders will ask you for information that you may feel is not applicable to the whole process. It can be difficult to share private information. But it’s in your best interest, because the more information they have, the less they have to guess about certain aspects of your financial situation, and the more likely they are to be able to approve the credit application. If they don’t know the whole story, how can they make an informed decision?
So find someone you can trust to work with, and pour your heart out. The feeling of mutual trust will work in your favour.
Prepare to have your business and personal finances under close scrutiny. Unlike us entrepreneurs, banks don’t like to take on risk. They are very conservative and need a lot of reassurance (read proof) that you can pay back the money you borrowed. Before you even start engaging in the application process, you need to take a good close look at your own financial situation. This can be uncomfortable, but a very necessary step. Here are a few questions to ask yourself that will help you get a pulse of your eligibility.
How good is my credit?
Even though you are borrowing money for your business, the bank will still want to take a look at your personal repayment history. There is no magic credit score number that will guarantee loan approval. According to Equifax Canada, a 'good' score is anything above 660.
Is my bookkeeping up to date and cleaned up?
Keeping good financial records is key to a successful loan application (and a successful business for that matter). If you don’t know what your money is doing every month, you won’t be able to answer many of the questions the banks will ask you. Nor will you be able to determine what you need the money for. Start by cleaning up your books and getting a good financial picture of your business.
Do I have a strategic plan for my business?
Most lenders will ask you for a business plan as part of your application. Don’t worry if you’ve never prepared a business plan before. It doesn't have to be super-complicated and there are great tools out there to make it easy for you. The idea behind a business plan is to show that you have spent some time considering your business' future, particularly your plans to manage risk and create sustainable profitability over time. Think of your business plan as your business roadmap - an opportunity to show that you have a solid plan for navigating through the ups and downs of your planned business journey. Creating a business plan is a great business exercise whether you are applying for a loan or not.
Am I in a solid cash flow position?
Cash flow - the lifeblood of your business. Cash-flow is just as it sounds - the flow of cash through your business - and in order to stay afloat in the long run, it should be net positive. Meaning, do I have enough money at the end of each month to pay all my obligations and still have some money left in the bank? This is probably the most scrutinized marker for lenders. Because it is the quickest indication as to whether or not your business can afford the monthly debt repayment.
As a rule of thumb, business loans should be used strictly for business expenses that have a strategic, positive impact on your business. Loans are typically used for hiring extra help, purchasing equipment, purchasing additional inventory, and training programs.
In some cases, loans can also be used for facility improvements, commercial leases, or building purchases. It can be tempting to spend that money on less than legitimate business expenses. It is important to have a specific plan for the loan money. Things like, trips, office furnishings and decor are not a great use of loan money.
It’s important to remember that this is not free money and to be as purposeful as possible with the allocation of those funds. Ask yourself whether the investment you are making will net you a return? If not, really consider why you are thinking of making that purchase and stay disciplined.
Business loans can be an extremely useful tool to help grow your business or resolve temporary cash-flow problems. Applying for them takes work and a well-organized financial house. This is just another reason why it’s crucial to keep your books organized and in good shape, whether or not you ever intend to take out a loan. You never know when a business opportunity will arise.
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Wishing you success in your business,
- Martina + Ashli
Date published: July 15, 2022
Disclaimer - The information provided in this blog is general in nature and solely for educational purposes. Readers use and implementation of the information comes at their own risk and is their own responsibility.