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Getting your startup off the ground not only takes a lot of hard work, it can also be expensive. A lot of new entrepreneurs turn to loans to finance their business, either from traditional or alternative lenders. However, having access to capital involves a process, part of which is being asked qualifying questions by lenders.
In this blog post, we will discuss the common questions that lenders ask startup owners before lending them money. Keep in mind that the answers to these questions may vary depending on your business and the lender you work with.
Common questions lenders ask startup owners
1. Why do you need a loan?
One of the first questions lenders will ask when you apply for a business loan is what you plan to use it for. There are a few reasons why lenders ask this, from determining whether the funds will be maximized to knowing the terms and rates that come with the loan.
On top of that, some business loans come with restrictions on how they can be used. For example, Small Business Administration (SBA) loans must be used for “qualified” business purposes, which include things like working capital, inventory or equipment purchases, and business expansion. If you’re not sure how you would use the loan proceeds, a lender can help you figure out if the loan product you’re interested in is a good fit for your needs.
Knowing what you’re going to use the money for will also keep you from borrowing more than you need. Take note that small business loans are still debts, and any late payments will affect your credit rating.
2. What is the nature of your business?
Lenders refer to the nature of your business to help them determine the appropriate loan product for your needs. For example, if you’re looking for a business loan to buy a new piece of equipment, they may recommend a term loan. However, if you’re looking for working capital to finance inventory or expansion, they may suggest a line of credit.
Aside from that, the nature of your business can impact the collateral that lenders will require. For instance, if you’re starting a restaurant, lenders may require that you put up your personal home as collateral. On the other hand, if you’re expanding an existing manufacturing business, they may be more willing to accept machinery and equipment as collateral.
During the pandemic, some industries had a harder time getting a nod from lenders. Those in the food, entertainment and travel industries found it more difficult to get a loan compared with their peers. This was because lockdown protocols had been implemented, and not many business owners were able to show a solid plan on how they’re going to repay the loan.
When a lender asks about the nature of your business, simply provide a straightforward answer. Be sure to have a clear and concise explanation of your business goals and how the loan will help you achieve them.
3. How much money do you need?
No matter what your business loan purpose is, lenders will always ask how much money you need. And there are actually good reasons for it.
First, they want to make sure that you’re borrowing enough to cover your business expenses. Second, they want to see if you have a clear idea of how you plan to use the loan funds. Third, lenders want to ensure that you’re not asking for more than you can pay for.
Lenders also use this question as an opportunity to assess your financial literacy. If you can’t clearly explain why you need financing and how much you need to cover the costs, it may be an indication that you’re not ready to get a loan.
If you can show lenders that you’re not borrowing more than you need and how the loan will be used, you’re more likely to get approved.
4. How long have you been in business?
Lenders want to know how long you have been in business to gauge your startup business’ stability and success. The longer you have been in business, the more likely it is that your business is doing well.
If you are a new business, lenders will usually require more information from you such as a business plan and financial projections. Since startups and small businesses don’t have sufficient credit history to determine their creditworthiness, lenders may ask for collateral to reduce their risks of lending you money.
A collateral is an asset that can be used to secure the loan if you default on the payments. Assets may come in the form of mortgage, equipment or invoices, and are often used by borrowers to prove their commitment in repaying the loan.
Do note that generally speaking, startups and small businesses are considered risky borrowers and therefore have a hard time getting approved for a loan due to a number of factors, such as having poor cash flow forecast or having no sufficient credit history.
In fact in 2019, a Goldman Sachs report involving 10,000 small business participants said that one out of three respondents had a hard time securing the full amount (or any) of the capital they initially applied for.
5. Where do you see your business in the next five years?
Lenders want to make sure that you have a concrete plan on generating income for your startup. This is where a solid business plan comes in.
A well-crafted business plan will show that you’re serious about your business and that you have the ability to repay any money you borrow. Also, a business plan can provide insights into the potential risks and challenges associated with your business. This allows the lender to assess whether your business is a good fit for their loan products.
So if you’re looking for a small business loan, be prepared to share your business plans with potential lenders. It could make all the difference in getting approved for financing.
When seeking capital, it helps to put yourself in the lender’s shoes
Even before submitting your loan application, it’s important to think about the possible questions lenders may ask. So even before that happens, make sure all your requirements are ready. Know your business by heart, and know the primary reason why you could use additional capital now. Seeking financing may take some time, but the rewards will be worth it.