We've written a bit before on the best options for small business financing sources. This time we're going to focus on clearing that first hurdle for a small business loan.
At some point your business financing needs will outgrow the most common sources, namely cash. Whether that's coming from personal savings, friends, or family - that well will run dry.
Let's Review A Bit, Equity vs. Debt
Equity financing is a great option for a growth focused company, especially those with valuable intellectual property or favorable market dynamics. You can get the capital you need and avoid the overhead that comes with servicing debt.
Globally, venture capital activity for the Americas exceeded $72 billion in 2016, according to KPMG. The average deal was in excess of $8 million...one more time, the average deal was in excess of $8 million.
Obviously there's a lot of money floating around on the equity side of things, but the average deal size is also a really good indicator of the types of businesses that win these deals. That is, growth companies.
For the most part, your small business is not going to be competitive when it comes to equity financing.
On the other hand, debt financiers absolutely love working with cash flow (aka "lifestyle") businesses.
Your local credit union, or a specialized business lender, is going to care much less about your ability to generate a 100x return when you sell the company and much more about the reliability of your cash flow.
All of that makes debt financing a very common source of small business capital for entrepreneurs. In 2016 alone, the Small Business Administration funded more than $17 billion in small business loans.
The average deal was worth a bit over $370,000, a figure likely to gel with the needs of most SMB owners looking for capital.
Interestingly, over $6 billion of those 2016 SBA loans went to new businesses, which is especially impressive. The average deal there was just under $330,000. Again, a much more likely scenario for the typical small business entrepreneur.
The true beauty of debt financing is that it's a mature and liquid market. Honestly, how many VC's do you know? What about angel investors?
Now think about how many banks are in your neighborhood.
The First Test Is The Most Important
With that maturity comes a lot of volume, the SBA alone did nearly 6x more deals than all VC activity in the Americas. As you'll learn, there's a very defined process for securing a business loan.
Nearly all business lenders will follow a similar process, and the first step of that is commonly referred to as "Lender Compliance".
This tends to be automated by the lender's pre-qualification system. It's basically an algorithm programmed to score your business' risk using a pre-determined set of parameters.
If it sounds a lot like a test, it is. It's just not one that you would study for, but rather one that you have to complete before applying for a loan.
The vast majority of rejections happen at this very early stage, during the compliance process.
There are twenty common lender compliance items to prepare for, we'll focus on eight in this post that are all about legitimizing your business identity - the others will be covered in an upcoming post.
Most lenders will check some of them, but there's no way to know in advance which items they'll look at, so you need to cover all of them before you start.
Legitimize Your Business
1. A real, registered business entity with the state
That means you don't operate as a Sole Proprietorship, but are registered with the Secretary of State as some sort of Corporation, LLC, or the like.
This is a super easy thing to do. You can get it done online in under an hour for most cases, and the cost is generally a few hundred dollars.
There are plenty of providers out there happy to help you, including LegalZoom, USLegal, IncFile, and Incorporate.com just to name a few.
If you don't have this done, you will be automatically rejected.
2. An EIN, or Employer Identification Number
This is basically the tax ID for your business. When a business is registered as some sort of corporation, you assign tax obligations to the business rather then a personal social security number.
You can complete this directly with the IRS, there's no charge.
If you don't have this done, you will be automatically rejected.
3. A bank account
You can't use a personal one, and you'll need to take care of 1. and 2. in order to set this up. The lender wants to see that you're treating this as a real business, keeping the finances separate, and that the bank has cleared you for an account.
The longer your bank account is open, the better. Balance and transactions aside, account age is an important factor. The day you open the account is the day lenders will consider your business started.
For the most part this step is free, although you might need a minimum balance to avoid fees.
4. Business licenses
Everything that is required by the Federal government, state, county, and city will be required for your loan approval. The lender will ask you to detail what you have, along with the address your business is registered to.
Common Federal compliance requirements are liquor and firearms licenses, if you deal with either of those.
For state and local compliance you may have occupational licenses (e.g. financial services), agricultural licenses, pollution permits, weights and measures certifications, and the list goes on.
The SBA website is a great resource for additional information by state. Some of these will cost money, or require approval from an oversight body.
Lenders will confirm with each records-keeping body that all of the licenses and permits are active, and in good standing. If you're missing any, you will be automatically rejected.
5. A real business physical address
The lender will check with the USPS on the type of address your business is registered to. It must come back as a "commercial" delivery point.
80% of business lenders will outright reject an application that is tied to a residential address.
Home based businesses are statistically more likely to fail, and they're much less likely to have the right cash flow for debt servicing.
That also means no PO boxes, and no mailbox store addresses. Earth Class Mail street addresses will work for these purposes.
6. A unique phone number
A phone number that is not registered to your home address, personal SSN, or personal bank account will be required here.
There are plenty of inexpensive solutions for this, you can cheaply lease a toll-free or local number from services like Grasshopper. Register it under your business name, use your EIN, and setup billing to your business bank account.
It's not guaranteed that this will be a factor, but it's any easy item to check off the list.
7. Directory listing with 411
Yes, it's still a thing. Lenders move slowly when it comes to changing their requirements for qualification, even though the world long ago moved on from calling into directories.
It's a lot easier than it used to be though, VOIP numbers and cell phones will work for directory listing. So in this case, take care of 6. and then get your number listed for your business - make sure the listing matches your entity name or DBA.
There's a free service for this, but you can also go directly through Whitepages or some carriers like Verizon.
8. A real website and business email domain
That's right, businesses without websites and those that can't be found easily via search engines are more likely to fail. Lenders will look at whether you have a website, and if your business email address is custom or branded.
Unfortunately, [email protected] is not going to fly. You need something business appropriate, like <first name>@<your website> to pass this check.
There are plenty of inexpensive solutions here. You can easily buy a domain for $10 per year, GoDaddy is a good place to start and there's Google Domains as well, among thousands of other options. Setting up an email on your new domain just takes a few minutes.
On To The Next One
Consider 1-8 table stakes for getting consideration from a business lender. There's really no way around them, you need to throw in some chips just to play.
Fortunately, it's not all that expensive to fill in any gaps you may have.
In the next post we'll dive into the remaining items, all focused on establishing and building your business credit. Stay tuned!