Whether you are starting a new business from scratch or expanding an existing one, many entrepreneurs reach a time when they look into securing a business loan.
If you’re new to the world of business lending, it can feel intimidating. How do you start? Can you just walk into a bank and ask for money? Well, sometimes! But before you do that, it’s a good idea to understand what lenders are looking for, and what programs you might be eligible for.
In this blog post, I will go over some key considerations to think about so you can take this important step with more confidence.
Not all lenders are created equal
Let’s start by going over the different types of business lenders. At a high level, there are three different categories of lenders, and lenders within each category generally take a similar approach to make lending decisions.
1. Banks and Other Financial Institutions
This includes Canada’s ‘big’ Schedule I Institutions (RBC, CIBC, and the like), as well as credit unions. These lenders are usually formula lenders which means they will look at the hard numbers of your business and personal finances to make their decision; However, some have special programs for equity-seeking groups that are more flexible. These lenders can offer fixed-length term loans or more flexible products like lines of credit.
2. Private Lenders
This category includes a diverse array of private companies (sometimes called alternative lenders) that lend to businesses. They often focus on specific financing products (for example, inventory financing, receivables factoring, emergency short-term loans, or debt consolidation),. Like banks, private lenders are formula lenders. They generally can’t lend as much as a bank, but can usually get you a decision quickly and may have a streamlined application process. If you’re thinking of applying with a private lender it is very important to understand their terms and conditions, as some lenders have extremely high interest rates and fees, and may have strict lending terms.
3. Developmental Lenders
These are lenders that have been set up by governments to drive economic development and support businesses that have trouble accessing traditional lending from banks. In British Columbia, developmental lenders include WeBC, Community Futures, Business Development Bank of Canada (BDC), Futurpreneur, and Aboriginal Financial Institutions. Developmental lenders usually have a holistic approach to lending, and do not make their decisions based solely on a formula. While developmental lenders are set up to help entrepreneurs, they do have eligibility criteria they must follow, and they may need more time and documentation to make lending decisions.
All lenders will have slightly different lending criteria, but here are some questions to ask yourself to understand how you will match up with common eligibility considerations.
1. Financial Considerations
- Have you invested in your own business? All lenders want to see that you have (or will be able to) contribute some of your own money to the business. This will usually be called owner’s equity, and maybe looked at relative to your total debt (including the new debt you wish to take on), by calculating a debt-to-equity ratio. WeBC usually looks for a debt-to-equity ratio of no more than 4:1, but other lenders may require more or less. If you are starting a new business and do not have any money of your own to invest, it may be challenging to get a loan. It may also be difficult if you are an existing business and have many years of negative earnings resulting in negative equity on your balance sheet.
- Do you have any security (collateral) to offer? Some lenders, such as WeBC and WEOC, offer smaller unsecured loans to borrowers with good credit history and a strong business plan, but other lenders will need you to offer some collateral that they can recover in case you are unable to repay the debt. Cars and property are common security, but you might also be able to use business assets like equipment or inventory. Each lender will have their own policies so make sure you ask. Before you talk to a lender, you should have an estimate ready of what your collateral is worth.
- Will your business create enough income to pay your debts? To understand this, lenders may look at your Debt Service Ratio, which measures your total debt payments against your net earnings. If you are an existing business and you have not been profitable in the past, or if you are a new business that is projecting low income, it may be more difficult to get a loan, because your lender needs to know you will have enough money to make your payments. Developmental lenders can take a more holistic view, but other lenders may have strict requirements.
2. Personal Considerations
- What are your personal net worth and personal income and expenses? Many loan applications will ask for a statement of personal affairs, where you provide information about your personal assets and liabilities, and about your current earnings and personal expenses. This information will help them understand if you’re in a good position to repay the debt should something bad happen in your business. If you have a positive net worth and other sources of income, that is more favourable than if you have significant debt and no other income outside of your business.
- What is your Credit History? When you apply for a loan your lender will pull your credit report, which allows them to see how you have handled other debts in the past. Many lenders have credit score cut-offs, and if your score is lower than the cut-off, you will be declined. WeBC does not have a credit score cut-off for its secured loans, but for an unsecured loan, we generally require a score of at least 650. It is always a good idea to check your credit report before you apply for a loan to make sure there are no mistakes.
- What is your citizenship status and where is your business located? WeBC requires applicants to have Canadian Citizenship or Permanent Residency, and to reside in BC. Other developmental lenders may have similar requirements.
- Are you a member of our target group? Lenders may have a mandate to serve specific groups of people and will ask about your business ownership to make sure you meet their criteria. For example, WeBC requires that businesses be at least 51% women-owned (with exceptions for businesses owned jointly with a spouse), and Aboriginal Financial Institutions require 51% Indigenous ownership. Community Futures requires you to live in a rural area, and Futurpreneur requires the owner to be under the age of 40.
4. Other Considerations
- How long have you been operating? Some lenders have a mandate to work only with start-ups (such as Futurpreneur), while others can only work with businesses that have been operating for at least a year or two (such as BDC). Similarly, many banks will be looking for you to have a minimum number of years of operation before they can consider lending to you.
- Are there any social concerns related to your business? Developmental lenders sometimes have other criteria that limit them from lending to businesses that have social acceptability risks. For example, there can be limitations to lending to bars, cannabis shops, adult entertainment shops, or gambling businesses, among others.
- Is your business earning revenues yet? Many lenders have limitations when it comes to lending to ‘tech’ businesses that are still in the start-up phase, or businesses that are focused on a product that is still in the research and development phase. Your lender may ask you if your product has been fully launched yet, and/or if you have any paying customers. If you are still in the pre-revenue phase, it may be difficult to access a loan.
- Do you have a strong plan? Lastly, all lenders will want to know that you have a strong plan in place for your business, and many will ask for a business plan and cash flow projection so they can understand the risks of lending to you. For this reason, it’s a good idea to prepare a business plan and cash flow projection before you start contacting lenders. This will also make you more confident about how much you need to borrow.
Approaching a lender for a business loan can be intimidating, but if you can understand the above eligibility criteria, it will help you have a better conversation with potential lenders, and if they aren’t able to approve a loan, you will have a better idea of what you need to work on to be ready for a loan. If you would like to learn more about WeBC’s lending program, be sure to register for our Business Loans Information Session, which is the first step to determining your eligibility.