How Will the Bank Decide Whether or Not to Approve my Loan?

Remember, banks are in the business of making money. So, in order for a bank to lend money, it has to be sure it can get it back. To determine this, your bank considers the following about your small business:

1) What is its capacity to repay the loan?
2) How much capital has been invested?
3) How much collateral have you put up?
4) What are the conditions of the loan?
5) What is the character of the small business (and its owners)?

What is its capacity to repay the loan?

The most important factor in determining if your business is a suitable candidate for a loan is its capacity to repay the loan. The prospective lender will want to hear exactly how you plan to repay the loan. The lender will consider the cash flow from the business, the timing of the repayment, and the probability of you successfully repaying the loan. The lender will look at your payment history on existing lines of credit, both personal and commercial, to determine your overall payback ability. Prospective lenders also will want to hear about your conditional sources of repayment.

How much capital has been invested?

The next factor the prospective lender considers is the amount of capital, or money, you personally have invested in the business. The capital is an indication of how much you will lose if the business is unsuccessful. Prospective lenders and investors will expect to see that you have contributed your own assets and are willing to undergo personal financial risk to establish the business. Only if you are willing to take these risks will potential lenders and investors consider committing their own funds. Their rationale is this: if you have made a personal investment in this business, you are more likely to try with all your might to make this business a success.

How much collateral have you put up?

Collateral is an additional form of security you can offer the lender. The lender will want to see that there is some source of repayment if profit from the business is not enough to repay the loan. Collateral can include assets such as equipment, buildings, accounts receivable, and in some cases, inventory, as the bank can sell them for cash. Collateral can consist of either business or personal assets. Both business and personal assets can be sources of collateral for a loan. Another option is to offer a guarantee. This means that a second individual, called a guarantor, signs a document pledging to repay the document in the event that you cannot make the repayments yourself. Be prepared: some lenders may ask for a guarantor in addition to collateral in order to secure the loan.

What are the conditions of the loan?

Another consideration the prospective lender will make is the conditions, or intended purpose, of the loan. For example, will the loan money go towards working capital, or purchases such as additional equipment or inventory? Other conditions the lender will consider are the local economic conditions both within your industry and in other industries that could impact your business.

What is the character of the small business (and its owners)?

A final factor the lender will consider is the personal impression you and the other higher-ups in your small business have made. Subjectivity will likely play a role in the lender’s decision to subjectively decide if you seem dependable enough to pay back the loan or generate a return on funds invested in your business. Part of this decision will be based on your educational background, and your experience in business and in your industry. The prospective lenders will also consider the quality of your references and the background and experience of your employees.