Need to borrow to start your business? Here's some tips.
Written on the 8 December 2021
Starting up or buying a business often involves a large capital outlay. If you have insufficient funds or personal worth to meet the initial costs, you may need to consider borrowing.
Applying for a loan can be daunting, especially when you are not experienced in the area. Whether you are applying to a bank, finance company, venture capitalist or other source, the lender's basic requirements will be similar. The following is a broad overview of the finance application process.
Generally, a lender will consider three key elements when determining whether to approve a finance application:
the character of the applicant;
the applicant's projected cash flow;
the available collateral or security for the loan.
Character
Your finance provider will want to know that you have the commitment and aptitude to be a successful business owner. Provide them with:
your resume or other documents showing relevant work experience (credible references may be useful too);
a detailed, well-thought-out business plan, displaying your understanding of the business and what is involved in running it;
your credit history;
full disclosure of other relevant information when requested;
open and honest responses to any queries.
Cash Flow
The finance provider needs to be reassured that proceeds from your business will be sufficient to cover any loan repayments. Show them:
cash flow projections, based on reasonable assumptions and attainable benchmarks (you may need an accountant to assist with this);
justifications for your estimates and assumptions (how do you intend to sustain a particular level of sales, rent, wages etc) and provide any documents you may have which assist in supporting your rationale (eg: current expenditures for the business, staff rosters to demonstrate wage expenses);
current balance sheets and profit and loss statements of the business to show your anticipated figures are attainable.
Collateral
If you have equity in an asset, you can borrow against the asset which then becomes security for the loan. Generally, borrowers use their home or investment property for collateral. If you are buying a franchise, some financial institutions will lend against the franchise system itself if it is accredited by the finance provider. You will need:
an accurate and realistic market price for your house or other security (the lender will often require an independent valuation after indicative approval so you must be sure your valuation is credible);
a certificate of title or other evidence that you own the property;
information about any existing mortgage that may be on your property.
Be careful when using an asset as security as you are risking your ownership of this asset if you default on loan repayments.
Other Information
In addition to information relating specifically to the three criteria above, a lender may request further information about your personal finances and about the business.
These include:
personal income and/or tax returns;
personal debts/liabilities including any other loans;
details about the business structure, including details of any companies, trusts, shareholders, beneficiaries etc;
details relating to the business premises and lease (if relevant);
details of the franchise system and the franchise agreement (if the business is a franchise);
details regarding key personnel.
Be prepared to provide personal guarantees as this is a standard requirement for most finance providers.
What can I expect from my loan?
Before applying, and during the application process, be sure you know exactly what you can expect from any approved finance application. Important elements to consider include:
Amount - as a rough guide, financiers will lend between 50-80% of the set-up or purchase cost, depending on the lender, your history and the perceived risk.
Term of Loan - in general, lenders will not agree to loan terms longer than the term of the lease or the franchise agreement (where applicable). Terms can be up to 10 years where they are secured against the business assets.
Guarantees - lenders will usually require personal guarantees from any directors or shareholders.
Insurance - often lenders will require you to have sufficient life insurance, including cover for death and total or permanent disability.
Interest rate - it is crucial to understand how much effective interest you will be paying. As a general indicator, you can expect to pay between 8% and 10.5% on loans secured against the business.
Other fees/charges - often extra fees go unnoticed or may seem insignificant, but they add up quickly and you need to be aware of the real cost of the loan. Additional fees can include establishment fees (around 1% of the loan amount), stamp duty and legal fees.
The application process, from initial application to settlement, can be lengthy and complex. Be organised and start planning well in advance to avoid the stress of last-minute delays!
