Loan Packaging

Before inquiring about debt financing, an entrepreneur should assess such things as:

Do you actually need more capital or can you manage existing cash flow more efficiently? How do you define your need? Do you need money to expand or as a cushion against risk? How urgent is your need? Do you want money to expand or as a cushion against risk? How great are your risks? All businesses carry risks, and the degree of risk will affect cost and available financing alternatives.In what stage of development is the business? Needs are most critical during transitional stages.

For what purpose will the capital be used? Any lender will require that capital be requested for very specific needs.

What is the state of your industry? Depressed, stable, or growth conditions require different approaches to money needs and sources. Businesses that prosper while others are in decline will often receive better funding terms.

Is the business seasonal or cyclical? Seasonal needs for financing generally are short term. Loans advanced for cyclical industries such as construction are designed to support a business through depressed periods.

How strong is the management team? Management is one of the most important elements assessed by money sources.

Perhaps most importantly, how does the need for financing mesh with the business plan? If you don’t have a business plan, make writing one your first priority. All capital sources will want to see your plan for the start-up and growth of your business.

A business advisor such as a small business development center counselor can review your business plan and help you determine the amount of financing your projections will likely support. The counselor can also help you identify potential sources of financing and help you prepare a loan package. You will then need to approach potential lenders to explain your project in detail and apply for the loan. It may be helpful to contact several lenders prior to preparing loan documents to learn about their lending practices and determine the feasibility of applying for financing.

Regardless of the specific type of loan or credit facility, almost every debt financing instrument will contain specific terms and conditions or “rules” relating to how the borrower uses the funds and conducts its business until the debt is repaid. These rules are contained in the credit agreement and ancillary documents, primarily in sections referring to “representations and warranties” and “covenants.” The borrower’s compliance with these covenants also serves as the means by which the lender monitors the loan and assures itself of a return on its investment. Compliance with covenants also serves as the means by which lenders demonstrate to federal and state regulators that they are in compliance with the rules and regulations applicable to the types of loans they are permitted to make.

The Minnesota Small Business Assistance Office has a free book “Loan Documentation: An Introduction for Small Businesses” which provides an overview of how loan documents are structured and discusses common terms contained in most credit agreements. Representations, warranties and covenants are discussed as are security interests, guarantee agreements and other forms of collateral commonly required to secure a loan. A discussion of the consequences of failure to comply with loan covenants and a lender’s rights upon borrower default is also included in the book. A free copy is available from the Minnesota Small Business Assistance Office.

Past Credit Problems

In starting a business, your personal credit history is a key factor in any lender’s decision to make a loan. If your credit report shows a history of late payments, judgments or tax liens, it will be very difficult to obtain a loan until the adverse entries are removed from the credit report. If you have ever declared bankruptcy or defaulted on a student loan or other federal loan, you may be permanently ineligible to obtain a federal loan such as an SBA-guaranteed loan.