Every small business owner needs operating capital to ensure that their business is running at an ideal level. And as we all know, lack of capital is stated as the number one reason that businesses fail.
So why didn’t they secure some capital when they needed it? Why did these failing companies not secure a loan? A Line of Credit? Heck, why didn’t they use a personal credit card for Pete’s sake? What prevented them from taking action? As a former small business owner, I understand the need for operating capital, yet, having been on the flip side in banking now for some time I can see the pitfalls that prevent so many business owners from securing working capital.
Below are the major reasons, that I have witnessed as a Business Banker, that prevent business owners from obtaining working capital, and possible suggestions that may allow you to avoid these pitfalls.
No Tax Returns
I personally have witnessed dozens upon dozens of small business owners want to apply for a loan or line of credit yet when it came time to collect their financial information, they hadn’t done their taxes for some time. In one case it had been nearly 4 years since the business owner had done their taxes! When a bank is looking to loan funds, they have an obligation to ensure that they are minimizing their risk, and if you can’t prove that your company is sound and secure, then you’ll get denied. And frankly, if you haven’t done taxes for a few years you’re only proving that you are irresponsible.
Would you loan money to someone who proves that they are financially irresponsible? Doubtful. Banks, just like you, are in business to make money not lose it. So, stop getting angry if you are not completing the basic responsibilities of a business owner. Like the old commercial said: “just do it”.
- Do your taxes on time, every year
- Have a six-month financial statement prepared if you apply mid-year or before year’s end
- Bear in mind when you increase write-offs, you may potentially decrease your profits
- Find a good “business” accountant (not someone who does 1040’s all day)
- Extra idea: open a business savings account and put 20% of revenue aside for year-end taxes. This avoids using next year’s profits to pay for last year’s tax debt.
No Collateral
Often I’ll speak with a business owner who wants a very large line of credit, let’s say one million, but only generates two or three million in revenue each year. For any institution that lends money, this can be difficult math to get past. So, an institution will frequently ask the owner to put up some type of collateral that would equal the amount of the line of credit or loan. It’s here that the owner will often balk, become personally offended and say how unfair that is.
From the lender’s side, they need to know that they can get their money back if the business owner defaults. Imagine if a business owner draws 100% of the line and then goes out of business? Remember, the lender is always looking to reduce risk, where a business owner is generally someone who will take a risk. So, if you’re still willing to take the risk, then bet on yourself again and put your money where your mouth is- in this case it’s called collateral. Here are a few examples:
- Real Estate: Personal home
- Real Estate: Commercial property
- Vehicles
- Equipment
- Inventory (sometimes)
- Unpaid receivables
- Life Insurance Policy
Refusing to do a Personal Guarantee
Recently I had a business owner not understand why he could not obtain a business loan without a personal guarantee. It was a small LLC without much collateral and the bank needed more to help reduce risk. Lending institutions need to ensure that they will be repaid on the funds the lend out, so yes, often a business owner will be required to sign personally to secure their funding.
But why you ask? Basically, a personal guarantee is considered to be providing an added layer of protection for an institution to lend the funds. It signifies to the lender that the business owner is truly committed to the long-term success of their business. Think of it this way: the business owner is like a co-signer on the loan, like mom and dad for their child’s first car. You, the business owner, are agreeing to be held liable on a personal level, so if the business defaults on the loan, the lender can come after the personal belongings of the business owner. The car, the house, the boat, the vacation home, stocks (not a 401k), bank accounts, etc.
Again, the disconnect in this case for many business owners can be that their mentality is about taking a risk, whereas the lending institution is about reducing risk. However, once a business owner can wrap their head around this point, moving forward is much easier for them.
Poor Personal Credit
When a business is starting out, everything is based on the personal credit history of the owner. Most of the time there is no way around it unless the owner has secured private funding from a family member or friend. Most banks will allow the owner to get a business credit card, but if the business owner happens to have bad credit, then the institution will not lend to that individual. Later down the road, if your company is generating a good amount of revenue, yet you still have bad personal credit, don’t be surprised if you continue to get turned down.
So, take the time, preferably before you open a business, and repair your personal credit. Here are a few suggestions:
- Remove anything old and derogatory.
- Pay off debt that is owed, then have it removed if possible.
- Pay down any personal credit cards to zero.
- Don’t close the cards, instead use them for Netflix or Hulu.
- Keep any credit card debt to below 15% (even though you’ve heard 30% is the target)
- Remember this when it comes to credit:
- Keep lines open
- Keep lines active
- Paid on time
- NEVER late!
- Zero balance
Pro Tip
Need more funds for working capital? Sell more of your products and services. Seriously, sell more. Far too many times when I consult with a business owner who is focused on extra capital, I almost always discover that they simply lack enough revenue. And they lack revenue because they aren’t selling anything. Think about it: if you sold an extra $100,000 or $500,000 of your product or service, wouldn’t that be a good amount of working capital?
So, get off your duff, quit complaining, get out there in front of customers and prospects, and sell more of your product or service.
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