5 Important Questions to Ask Before Seeking a Loan

Source: Jeff Wright, Hitachi Business Finance

When applying for any type of funding, it is essential that you are in tune with all aspects of your business. You need to have a deep understanding of exactly what you will be using the money for and how much is needed before you obtain it. Ask yourself these five questions before approaching a lender:

1) What do I really need the funding for?

Different needs for cash require different types of funding. For example, let’s say cash is needed to fund purchase orders. In this case, inventory will need to be purchased and additional equipment and staff may be required to process the order. Funding growth is a good problem, but it must be done with care. This type of funding is suitable with an asset-based line of credit.  By leveraging your assets, it provides an immediate source of working capital to meet your needs. Cash flow projections should be done and updated frequently so you understand the timing of how much and when it’s needed.

2) What is the credit score of my business, as well as the credit score of my clients?

If the credit score of your business is phenomenal, a traditional bank loan may be a solid route, provided you have the time and assets to apply for one. If the credit score of your business is mediocre or worse, it will likely be easier to look into asset based lending (ABL) or A/R factoring. ABL and A/R factoring focuses on the quality of the collateral and strength of their debtors, as well as the credit score of your clients when providing funding.  Sales that are not collected in a timely matter may present significant cash flow problems which could lead to the insolvency of your business. With A/R financing, your invoices are funded quickly giving you access to fast and easy cash flow.

3) Am I going to need a continuous line of credit or just a one-time lump sum?

Understanding the cash flow of your business holds the answer to this question. Many times cash flow is uneven which requires a source of funding. If it’s a one-time issue, shareholders may agree to step in and provide the cash needed, or management may be able to speed up the collection of receivables or stretch payables.

Unexpected seasonal surges or overall growth can occur. It may be necessary to secure a line of credit with a bank or finance company to meet these needs as they arise. Management should always review the cost and benefit of each alternative.

4) What do I have for collateral and what percentage of it will actually be funded in the deal?

Management should understand the collateral and its value that can be leveraged when requesting financing from a lender. Different lenders tend to offer different rates. For example, a traditional bank usually offers up to 70%-80% on receivables, whereas an alternative financing lender usually offers closer to 90%, thus providing more availability to borrow.

When you have identified a lender, ask them about the collateral and advance rates they use and what they do/don’t consider as eligible collateral for borrowing purposes. Be upfront with the lender about any issues that would prevent them from offering financing. Questions to ask:  is there an issue in collectability of the receivables? Is the inventory slow moving or obsolete? Do the machines and equipment have lines that are secured by another party? Understand that the eligible collateral value for each asset will determine what cash is available to borrow.

5) What funding do I already have, and what can be used in conjunction with it?

Even if your company has adequate cash, it’s still beneficial to be aware of other options, in case your circumstances change. You may end up needing a bigger line of credit than what your bank extends, or a different form of financing not offered by your current lender. Combining one or more sources of funding can ensure your business has the consistent cash flow it needs to operate smoothly. Knowing what each source of funding allows you to do is important, which is why you should always review the terms and conditions of financing before committing to any lender. Relying on trusted advisors like CPA’s, attorneys, and consultants will provide you the experience and connections necessary in making the right decision.

Applying for funding is something that requires proper research. Jumping into a loan without exploring all possible options can be detrimental. Research what type of funding will put your company in a position for success.

About Scale Finance

Scale Finance LLC (www.scalefinance.com) provides contract CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance has multiple offices in the Carolinas including Charlotte, Raleigh/Durham, Greensboro, and Wilmington with a team of more than 45 professionals serving more than 120 companies throughout the region.