As we mentioned in our previous blog post, the lending process can be overwhelming. That’s why we sat down with Michael C. Danielson, Vice President, Business Banking, WaterStone Bank, to further investigate how and where you can get funding to start a business.
According to Danielson, where you are in the business building process and what you’re trying to accomplish really determines how and where you can get funding. Here are three scenarios:
- If you’re a business owner already and you want to borrow money to improve the space that you occupy, a good first step is to start with your existing bank. They already know you and understand your circumstances. You could also use a commercial loan broker. They have relationships with various banks, and they can do the loan shopping for you for a nominal charge. When using this approach, you will need to provide all the documentation required to acquire a business loan as discussed in our previous post, such as an executive summary of your goals and financials.
- If you’re looking to purchase real estate, again it makes sense to start with your existing bank. If that is not an option, talk to the realtor that’s showing you the property. They can always make a recommendation.
- If you’re starting a business from scratch, “Nine times out of ten you will need an SBA loan,” says Danielson, “Unless you have other assets that you’re willing to pledge.” SBA loans don’t require dollar for dollar collateral. SBA loans will also tolerate the greatest amount of risk. As previously discussed, you need to have a business plan and proforma. An SBA loan is a great solution if you’re starting a business from scratch.
To get a conventional loan you really need existing real-estate or large assets that you’re willing to pledge.
“I had a client recently that wanted to buy a building and do some tenant improvements,” says Danielson. “The building was $700,000 and it would cost an additional $300,000 to get the space ready for operation. If he would have used an SBA loan, the numbers would be added together ($1M), and they would end up lending more than the property is worth. In this instance the client had existing rental properties. We were able to refinance against the equity in the properties. $1M loan, secured for 10 mortgages for 10 properties. He now controls the funds. We secured a lower interest rate and longer repayment term.”
How much funding you will be able to secure is determined by the bank. Funding will be a product of the underwriting analysis. There are typically five things that will be looked at, “the 5 C’s of credit,” says Danielson.
- Cash flow – if it’s a start-up how realistic is the proforma, or how profitable is it if it’s an existing business?
- Collateral – as mentioned, with a conventional loan collateral is essential
- Character – character of the borrower
- Credit rating – this speaks to existing financial literacy
- Conditions of the marketplace – are the conditions good?
Another question often asked, is how much will I need to put down on my loan? The answer is that it really will depend. A conventional commercial real estate loan often requires 20%, an SBA loan can require anything between 10-25%. If you’re purchasing equipment it will depend. You might have to pay for part of the cost. “Let’s say that all in you want to buy a truck for $52,000,” says Danielson. “We might need you to put down $10,000 in and we’ll lend you the difference because the truck is only worth 40k.”
In our previous blog post we discussed what happens and what your options are when going over budget on a project. “I advise, in addition to vetting the contractor, have additional liquidity on hand in case you go over budget.” The bank will want to know that the borrowers have access to additional money in case budget goes over. Do you have assets to sell?
Danielson also recommends that you have the following key people in your life:
- Attorney – have someone you know that you can call for advice and make them aware of what you’re doing.
- Accountant – you should already have one if you’re running a business, you might even employ someone if your business is big enough. You need to be aware of how you’re doing financially every month.
- Banker.
- Insurance Agent.
“These are important people to have in your corner as a business owner,” says Danielson, “They are going to have your best interest at heart.”
Once you have received funding, it’s time to begin the project. At this point you may be ready to sign a lease and you’re probably asking yourself what you need to know before doing so. Read our next blog to dive deeper into this topic.