Your Business Loan Proposal

When applying for government business loans or a regular business loan, you'll need to put together a package of information addressed to the prospective lender that will clearly set forth the exact loan proposal that you require. Put succinctly, your proposal should tell the lender the purpose of the needed financing, the justification for the funds, and the structure of the proposed loan. These elements, and others necessary for a well-constructed proposal, are described in detail below.

Purpose of the financing. The lender will require a concise statement of exactly why your business wants to borrow money. It's therefore very important for the borrower to provide the lender with a detailed explanation of the purpose of the loan, along with how and where all of the funds will be used. Furthermore, don't be surprised if the lender is not fully satisfied with a statement of merely wanting or needing to purchase an asset. He or she will need a more thorough explanation as to what you're seeking to accomplish with the asset. For example, you may want to buy a new forklift in order to increase productivity in your warehouse operations by lowering labor costs and reducing the company's exposure to job-related injuries. It's important for the lender to understand the related costs savings that could effectively pay for the forklift.

Justification of the funds. A well-prepared borrower will provide the lender with a statement explaining how a business loan is the best source of the funds being requested. The lender may be aware of alternative sources for the required financing and will often test whether the borrower has knowledge of them as well. You should therefore be prepared to explain why a loan is your most advantageous and feasible source of financing due to more reasonable costs, better terms, higher leverage, or any other factors that convinced you to choose to apply for the loan.

Additionally, you'll need to be very specific as the method by which you determined the amount of funding that you require, as well as how much equity you're prepared to place in the deal. If there's a logical reason to limit the company's investment, be sure to identify it to the lender. Otherwise, be prepared for the lender to insist that you contribute a minimum amount into the transaction.

Structure of the proposed loan. It's best for the borrower to offer input on how the loan should be structured at the time the loan request is submitted. Loan structure simply refers to the conditions and terms that define the transaction between you and the lender. You have the most viable opportunity to influence the structure of the loan at the beginning of negotiations. By introducing your preferences right up front, you actually set the tone for all subsequent discussions, and you could end up getting a better deal by demonstrating active concern for those issues instead of waiting to allow the lender to dictate its own terms.

Of course, the lender will always have the ultimate say in determining the terms of the deal. But your suggestion of reasonable terms in the proposal is an important message to the lender that could influence his or her decisions as negotiations proceed. Loan structure components typically include:

  • Loan amount - Again, specify exactly how much money you need and why, and be ready to defend it with supporting data and information.
  • Loan term - Define the period over which it would be advantageous for the business to repay the loan. Remember, of course, that the lender will set maximum (and perhaps even minimum) terms.
  • Interest rate - Interest rate is a function of the lender's risk. It certainly does no harm to ask (unless your offer is simply so low as to be blatantly insulting), but be realistic about how much risk your deal presents to the lender. Real estate loans are generally safer than equipment loans, and equipment loans are typically safer than working capital loans.

It generally goes without saying that lenders typically have absolutely no appreciation for a borrower's desire to maintain cash reserves, especially when part of the loan request is specified for that purpose. It's therefore wise to be prepared to discard that part of your proposal, since most lenders don't feel that it's prudent to fund cash that cannot be guaranteed to be used in the manner for which it was requested and may instead end up enlarging the lender's loss exposure.

Additionally, before initiating negotiations about loan structure, be sure that you know how to calculate the loan payment using the amount, interest rate, and repayment term that you're requesting. Being able to do this accurately is essential for you to determine whether the payment is within your company's budget. There's certainly no sense in agreeing to terms that you'll not be able to fulfill. Being able to calculate the payment can also act as a safeguard for you; lenders are no more perfect than anyone else, and they've been known to make errors.

Use of loan proceeds. If the borrower does not specifically declare exactly where, when, and how much money is needed, the lender will decide based on limited information, which can slow down the approval process. Your loan proposal must therefore include a specific schedule that defines how the proceeds of the loan will be used. Furthermore, in all honesty, the lender deserves to know precisely where every dollar of its money goes. If you're purchasing an asset, this amount is easy to track and define. However, if you'll be using a portion of the borrowed funds for working capital, specifying where these funds are applied is a bit more difficult.

For working capital financing, be prepared to produce a detailed month-to-month cash flow projection chart, predicting how and when the cash proceeds will be used and describing the expected expenses or purchases that will be paid. Approval will undoubtedly be less difficult if you restrict the use of working capital proceeds to larger-ticket items such as inventory, contracted services, or other major costs that the lender can readily identify without too much documentation.

Collateral. The borrower should precisely define the assets that are available to reasonably secure the loan. Collateral is very important to lenders because it provides a tangible alternative to the normal liquidation of a loan, if such action becomes necessary. They'll typically require coverage for 100% of the loan amount (depending on the strength of the borrower, this percentage could be less), with assets valued on a discounted basis.

For example, if you're planning to purchase a building with the proceeds from your loan, the lender will discount the value of the property in order to determine a collateral value. If the lender's normal policy defines an advance rate of 75% on commercial real estate, the lender will reduce the value of the property that you're purchasing by 25% to determine its collateral value. On that basis, it will then lend you up to 75% of the cost of the building. Should you require a larger amount, the lender may consider more money but will demand that you pledge additional assets in order to secure the extra funds.

Lenders usually margin real estate at 80%, but that figure can vary substantially depending on the loan policy of the specific lender and the condition of the local and national real estate markets. Unimproved property (raw land) is typically margined at 50% of its market value. Equipment and furniture is generally valued at 50% of cost, and little or no value is given to leasehold improvements or fixtures unless the real estate also secures the loan. Accounts receivable and inventory (or current assets) are typically also of little, if any, value to the lender unless they're monitored regularly.

Loan application form. Many lenders choose to use an in-house application form that requests the borrower's basic information. This document is generally used by the lender internally to facilitate the proposal's orderly movement throughout the lending organization as part of the normal approval process.

Special information. If there are special circumstances (whether positive or negative) that might affect the borrower's access to financing, they should be presented to the lender at an early stage in the application process. It's not at all uncommon, especially with business loans, for borrowers to have extraordinary conditions that require special handling by the lender on a case-by-case basis.

Over the years, thousands of individuals with unimpeachable character and impeccable credit have encountered situations beyond their control that have had the ultimate effect of tarnishing their otherwise strong financial track records. The unpredictable economy, failing marriages, and unavoidable bankruptcies have all damaged thousands of borrowers while not necessarily reflecting negatively upon their character or competence to repay a loan.

It must be remembered that lenders, during their due diligence procedures, will likely discover these conditions early on, so it's better for you as a borrower to introduce any relevant topics yourself and provide a full explanation. This voluntary disclosure will help to remove any lender suspicions that you may have attempted to hide such information, and will also provide a forum for you to better clarify the events to the lender.

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