Ravi Chandran
Before you approach someone you know for money, you should first understand the typical loan approval thought process of a traditional lender, such as a bank.
By: Hitesh Khan/
This is important for two reasons:
- The person you approach for money may follow a similar thought process, and you will need to provide the necessary information just like you would to a traditional lender before loan approval.
- Even if the person you approach doesn’t follow this thought process, by providing some or all of this information you are demonstrating your business knowledge and professionalism, both of which can increase your chances of obtaining the money you need.
The typical loan approval thought process:
Table of Contents
1. Management Experience & Expertise. Lenders need to feel comfortable that a borrower has the necessary background and skill set to effectively operate the small business.
2. Detailed Business Plan. Lenders usually require start-up businesses to have a business plan that includes income and expense projections for the first three years of operation.
3. Cash Injection. Lenders want to know how much money the borrower has at risk. For start-up businesses, commercial lenders typically require at least a third of the total project costs to be covered by the borrower.
4. Collateral. To reduce their risk in case of default, lenders often require the borrower to secure the loan with collateral. This is usually hard goods such as office equipment, vehicles, etc., but sometimes it can be against accounts receivables depending on the business’ current cash flow.
5. Personal Character. In addition to your experience, lenders also try to understand who you are as a person. As a result, some lenders will conduct background checks that can include looking for any previous litigation or bankruptcy information.
6. Credit History. Lenders like to see a good credit history. If there are any credit issues, an explanation will be required. Different lenders have different levels of tolerance when it comes to credit issues.
7. Personal Financial Statements. Lenders like to see a list of personal assets and personal liabilities. Do not include debt paid by your business. Include other sources of personal income.
Understanding the thought process for loan approval is especially important because investments by family and friends account for more than 50 percent of all investment dollars for start-ups.
At first, trying to determine who to approach for financing may seem like a challenge. Many small business borrowers feel they don’t know enough people who are in a position to lend them money, and who they are comfortable approaching.
To formulate a list of potential lenders for loan approval, consider these helpful steps:
- Write down the names of everyone you know, regardless of how remote the relationship. This might include family, friends, colleagues, mentors, teachers, neighbors, etc.
- Circle the names of the people who have some insight into your character and/or personal and business skills.
- Think about a realistic amount of money each person might be able to lend you, and write down that amount next to their name
Consider borrowing from several people rather than trying to get it all from one person. This way, you can ask for an amount from each person based on what they can afford to give you, and not on what you need.
When approaching someone you know for money, it is important that you develop a strong loan proposal that backs up your request with facts and figures. Merely asking for the money is practically a guarantee that you will be turned down.
Potential lenders may object to giving you money for a variety of reasons. Sometimes they may tell you why, other times they may not. Either way, it is important for you to understand these objections so you can respond to them appropriately.
The key to approaching friends, family, and other people you know for money is to be open and honest. Focus on the people you believe not only have the resources, but are also likely to have insight into your character and will be interested in your business.
Ask only for an amount that your potential lender will be comfortable giving, and make it clear that a refusal won’t offend you or hurt the relationship.
Agree to terms formally in writing, and detail how you will repay the loan. Consider using an outside loan servicing company to manage the payment process and maintain accurate records.
Above all, be as business-like as possible.
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