Applying for a small business loan can be one of the most complicated tasks that an entrepreneur undertakes. Unlike mortgages, small business loans standards are highly specified by the lending institution.
A small business loan is among the best ways to firmly establish expanded business operations. Of course, being able to fund your own operations is ideal. Other options for funding such as seeking investors or using investing tools like infinite banking, may also be worth examining depending on the business.
There's no uniform approach to small business lending that can guarantee a successful experience. But there are a few important elements entrepreneurs must have in place for a strong application.
Here are three important elements to have completed for a strong small business loan application.
#1 - Developing a business plan
Many small businesses begin as a slow evolution from home based micro production to the entrepreneur realizing they can scale their business.
In order to scale a business to a point where it can be solvent and profitable, capital is needed. Banks and other lending agencies all have different methods to figure out if a business can pay back the loan in the prescribed time frame. Regardless of the method of the lender, they will want to see a developed business plan.
A developed business plan means showing not only how a product will be brought to market, but includes plans regarding product life cycle, marketing, customer service, payroll projections, and financial management. A good way an applicant to start this process is by thinking of what has to be done within their company from the time the order is placed to the time either the product they made is thrown away or the service they provided is no longer needed.
Some questions to answer in a developed business plan:
- How much capital is required to produce the good or service, before payment can be expected?
- How frequently will costumers need to reorder the product/services, if at all?
- How many employees, if any, will be needed to sustain operations, and how will payroll be met?
- How will products and services be marketed?
#2 - Understanding the economies (and diseconomies) of scale
Economies of scale is the process in which the average price to produce a good or service falls as the total production increases. Most products experience economies of scale.
The less familiar brother of economies of scale is diseconomies of scale, which is the process in which the average price to produce a good or service climbs as the total production increases. The best example is subsequent land acquisitions.
If a firm continues to purchase property in an area they are creating scarcity and thus increasing price, we can also see this phenomenon is the refined diamond market.
The reason this is important to understand in regards to a small business loan is because it allows a lending institute to understand how scalable operations are. An additional benefit is it allows the owners of the small business to offer discriminating pricing based of quantity, referred to as second degree price discrimination.
Understanding the ability for a firm to scale can heavily influence the likelihood of acquiring not just traditional small business loans, but also private equity. Companies like Amazon and Walmart are examples of scaling massively. Scalability is desirable because it represents continuous opportunities for market share increase which results in increased profits.
#3 - Identifying a positive market outlook
A business profitable today may not be profitable tomorrow.
Entrepreneurs want to know, for themselves and for their prospective lender, that the business is being structured to compete in a growing market, or has a competitive advantage in a mature market. This provides assurance to the loaning authority that the note will be paid back in the agreed upon time frame.
Small business loans can span 20 years. By showing a bank that the market will continue to demand their services or products, and entrepreneur can paint a great picture of the likely health of the loan.
There are multiple ways that a small business owner can look at projected market trends. Understanding the customer and his or her journey is one aspect, as well as the age of the customer. If the likely consumer is a man between 25 and 44 years old, that customer will have several journeys an entrepreneur can follow and continually serve through new products or services.
Including this information, plus the projected population of the customer group, helps show the projected market growth. The more robust the analysis, the better.
Don't be afraid to take on debt
Some people are taught that taking on debt is the worst thing you can do. So many millennials are afraid of debt due to the student loan debt crisis. But debt isn't necessarily a bad thing. To learn more about how to properly use debt, watch this video featuring the founder and CEO of Capitalism.com, Ryan Daniel Moran.
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