If you’re planning to borrow money for your business, here are four common mistakes to avoid:
1) Your tax return shows the business isn’t making any money.
2) Your balance sheet doesn’t make sense.
3) You can’t explain how the borrowed money will improve your bottom line.
4) You’re talking to the wrong lender.
Your tax return shows the business isn’t making any money.
Tax returns are the gold standard for financial information to small business lenders, because the business owner has to sign off on the accuracy of the numbers, “under penalty of perjury”. Plus, the incentives cause most people who “fudge” to understate rather than overstate income. So if there’s any doubt about other information, a lender will fall back on the tax returns.
Lending officers know the ins and outs of business tax returns far better than most business owners. They recognize legitimate reductions in taxable income, like accelerated depreciation and business tax credits, and they automatically add them back when figuring how much debt you can support. What they aren’t going to recognize is revenue that didn’t make it to the tax return, or expenses that you’ve “fluffed” or “stretched” in pursuit of lower taxes. Most lenders require 2 or 3 years of tax returns—so if you really want a loan, you might need to look at ways to show some taxable income.
Your balance sheet doesn’t make sense.
It’s called a Balance sheet because it’s supposed to balance. If the math doesn’t work, a lender isn’t likely to look further.
Assets – Liabilities = Equity
Assets are the things your business owns or has rights to. Land, buildings, & trucks should be obvious. But some people don’t realize horses owned by a horse farm business are assets. So are tack and stable equipment. One bucket is no big deal, but two buckets and a tub per stall multiplied by 300 stalls in a training center yields an asset worth taking note of.
Liabilities are the things your business owes. The mortgage, and truck & equipment loans belong here. So does “trade payables”, which is the accounting term for what you run up on the house tab at the tack or feed store during the month. Missing assets hurts your chances of getting a loan, but missing liabilities is a guaranteed deal killer.
Equity is the accumulated value of the business—what the owner put in, and what it earned over its lifetime, reduced by anything the owner took out. Another way to look at equity is that it’s the owner’s “skin in the game”. You really want equity to be a positive number—if it’s not, there’s a problem, and you need to reevaluate the whole business—getting a loan without fixing the underlying problems is like putting the hose in the stock tank without closing the drain hole.
You can’t explain how the borrowed money will improve your bottom line.
This is what some lenders call “making a business case” for your loan. The best example I’ve seen of doing this right was a riding school looking to finance a larger trailer. They outlined how many students wanted to show with them, and how much they could charge for shipping and coaching fees. With one show a month the trailer would bring in enough additional revenue (above their current smaller one) to make the loan payment.
You can also make a business case by showing how the asset you plan to purchase is likely to appreciate in value over time. Real estate is the prime candidate for this approach, but I’ve also seen it done with a fancy young horse for resale.
You’re talking to the wrong lender.
Different lenders have different areas of interest and expertise. Look for the ones who know and understand your business. If you’re buying or building a farm, your local Farm Credit affiliate is a good place to start. Community banks and credit unions in agricultural areas are often also receptive. Big national banks….not so much.
Another factor to consider is your “banking relationships”. Many banks give priority in lending to those who are already customers—with a checking or savings account, for example. It pays to shop around—you may find that moving your business bank account to a bank that’s friendly to your type of business has multiple payoffs—better service and a better chance of getting the business loan you want.