Need financing? Plan ahead before going to the bank
Read time: 3 minutes
Let’s say you’re an entrepreneur in need of a business loan. Your business is growing, and you’d like some extra money for an expansion project. Sales are going up, and you’re making a nice profit. Should be an easy sell to a bank, right?
Not necessarily, especially if you don’t do your homework, says Pat Latour, Senior Vice President, Growth and Transition Capital at BDC Capital.
"If you’re going to expand, you’ve got to have a plan. If you don’t, you can jeopardize the rest of the business that is doing well,” he says.
Need to know the numbers
Many entrepreneurs walk into a bank without the right planning—and then they’re surprised when their small business loan request is turned down. "Knowing the numbers is key,” Latour says. “How will the expansion affect your profitability?”
"Growing businesses need more working capital because they’re often supporting additional inventory and more staff. And it often takes a while for the expansion to increase profitability,” he says.
"On the other hand, an expansion can also lead to unexpectedly rapid revenue growth. Entrepreneurs should also plan for that scenario and be ready to use the extra revenue to aim even higher.”
How do you prepare?
How do you get your ducks in a row for a successful business loan request? First, take time to work out your anticipated return on the investment, including how your business operations will change as you grow.
Second, it’s vital to get the timing right when you apply for a loan. Latour says businesses often wait too long before reaching out to their banker. Instead, they use cash flow to finance major expansions and wait until they’re facing a cash crunch before visiting the bank.
"One of the biggest reasons businesses fail or an expansion doesn’t succeed is a lack of working capital. It’s always easier to get financing beforehand than when you have a time sensitive crunch,” he says.
Latour advises fast-growing businesses to meet their banker every year to get a pre-approved loan for capital expenditures. They can then draw on the pre-approved loan instead of tapping working capital. Such a credit facility also lets a business react more quickly to opportunities, since it doesn’t need to apply for a new loan each time it needs funds.
Change to grow
Sean Darrah learned some of these lessons at his fast-growing food services business, Pace Processing. Starting from a 1,500-square-foot space, it expanded into a 10,000-square-foot location in six years. But even that space was maxed out, and Darrah wanted to expand into a new, bigger building. He had always used working capital to finance his growth, but he now realized he needed a loan for the costly expansion.
He was in for a surprise when he approached a bank and was initially turned down. Despite sales growth of 25% to 30% per year, he had been spending all his operating cash and writing off equipment every year. "It looked like we didn’t have many assets,” Darrah says.
After Darrah hired an accounting firm to help him demonstrate his company’s true value, the bank took another look and agreed to the loan, which allowed Pace to move into its own new 25,000-square-foot building.
Now on a much better financial footing, Darrah also got a line of credit for future capital spending. "What prevented us from taking the next step was always spending all our cash. It was really clear we needed to change to grow.”