Small Business Financing: Securing a Loan

At some point, most small business owners will visit a bank or other lending institution to borrow money. Understanding what your bank wants and how to approach it properly can mean the difference between getting a loan for expansion or scrambling to find cash from other sources.

Understand the Basic Principles of Banking

It is vital to present yourself as a trustworthy businessperson, dependable enough to repay borrowed money, and to demonstrate that you understand the basic principles of banking. Your chances of receiving a loan will greatly improve if you can see your proposal through a banker’s eyes and appreciate the position that the bank is coming from.

Banks are responsible to government regulators, depositors, and the community in which they reside. While a bank’s cautious perspective may irritate a small business owner, it is necessary to keep the depositors’ money safe, the banking regulators happy, and the community’s economy healthy.

Each Bank Is Different

While banks in general have a cautious attitude toward lending, they differ in the types of financing they make available, interest rates charged, willingness to accept risk, staff expertise, services offered, and attitude toward small business loans.

Selection of a bank is essentially limited to your choices from the local community. Typically, banks outside of your area will be more reluctant to make loans to you because of the higher costs of checking credit and of collecting the loan in the event of default.

Furthermore, a bank will typically not make loans, regardless of business size, unless a checking account or money market account is maintained at that institution. Ultimately your task is to find a business-oriented bank that will provide the financial assistance, expertise, and services your business requires now and is likely to require in the future.

Building Rapport

Establishing a favorable climate for a loan request should begin long before the funds are needed. The worst possible time to approach a new bank about a loan is when your business is in the throes of a financial crisis. Devote time and effort to building a relationship and goodwill with the bank you choose and early on get to know the loan officer you will be dealing with.

Bankers’ overriding concern generally is minimizing risk. Logic dictates that this is best accomplished by limiting loans to businesses they know and trust. One way to build rapport and establish trust is to take out small loans, repay them on schedule, and meet all loan agreement requirements in both letter and spirit. By doing so, you gain the banker’s trust and loyalty, and the banker will consider your business a valued customer and make it easier for you to obtain future financing.

Provide the Information Your Banker Needs

Lending is the essence of the banking business, and making mutually beneficial loans is as important to the bank’s success as it is to the small business. This means that understanding what information a loan officer seeks and providing the evidence required to ease normal banking concerns is the most effective approach to getting the financing you desire.

A sound loan proposal should contain information that expands on the following points:

  • What is the specific purpose of the loan?
  • How much money is required?
  • What is the source of repayment for the loan?
  • What evidence is available to substantiate the assumptions that the expected source of repayment is reliable?
  • What alternative source of repayment is available if management’s plans fail?
  • What business or personal assets, or both, are available to collateralize the loan?
  • What evidence is available to substantiate the competence and ability of the management team?

You need to do your homework before making a loan request because an experienced loan officer will ask probing questions about each of these items. Failure to anticipate such questions or providing unacceptable answers is damaging evidence that you may not completely understand your business and are incapable of planning for its needs.

What To Do Before You Apply for a Loan

1. Write a business plan. Your loan request should be based on and accompanied by a complete business plan. This document is the single most important planning activity you can perform. A business plan is more than a device for getting financing; it is the vehicle that makes you examine, evaluate, and plan for all aspects of your business. A business plan’s existence proves to your banker that you are doing all the right activities. Once you have put the plan together, write a two-page executive summary. You will need it if asked to send “a quick write-up.”

2. Have an accountant prepare historical financial statements. You cannot discuss the future without accounting for your past. Internally generated statements are OK, but your bank wants the comfort of knowing an independent expert has verified the information. Also, you must understand your statement and be able to explain how your operation works and how your finances stand up to industry norms and standards.

3. Line up references. Your banker may want to talk to your suppliers, customers, potential partners, or team of professionals. When a loan officer asks for permission to contact references, promptly answer with names and contact information; do not leave the officer waiting for a week.

Walking into a bank and talking to a loan officer will always be stressful. Preparation for and thorough understanding of this evaluation process is essential to minimize the stressful variables and optimize your potential to qualify for the funding you seek.

Seek Advice From a Tax Professional

The advice and experience of a tax and accounting professional are invaluable. Do not be shy about calling the office.

San Jose: (408) 252-1800
Watsonville: (831) 726-8500

Tax Implications When Employed in the Family Business

When a family member employs someone, the tax implications depend on the relationship and the type of business. Taxpayers and employers need to understand their tax situation. Here is what to know:

Married People in Business Together

  • Generally, a qualified joint venture whose only members are a married couple filing a joint return isn’t treated as a partnership for federal tax purposes.
  • Someone who works for their spouse is considered an employee if the first spouse makes the business’s management decisions and the second spouse is under the direction of the first spouse.
  • The wages for someone who works for their spouse are subject to income tax withholding and Social Security and Medicare taxes, but not to FUTA tax.

Children Employed by Their Parents

If the business is a parent’s sole proprietorship or a partnership in which both partners are parents of the child:

  • Wages paid to a child of any age are subject to income tax withholding.
  • Wages paid to a child age 18+ are subject to social security and Medicare taxes.
  • Wages paid to a child age 21+ are subject to Federal Unemployment Tax Act

If the business is a corporation, estate, or a partnership in which one or no partners are parents of the child:

  • Payments for services of a child are subject to income tax withholding, social security taxes, Medicare taxes, and FUTA taxes, regardless of age.

Parents Employed by Their Child

If the business is a child’s sole proprietorship:

  • Payments for services of a parent are subject to income tax withholding, social security taxes, and Medicare taxes.
  • Payments for services of a parent are not subject to FUTA tax regardless of the type of services provided.

If the business is a corporation, a partnership, or an estate:

  • The payments for the services of a parent are subject to income tax withholding, social security taxes, Medicare taxes, and FUTA taxes.

If the parent is performing services for the child but not for the child’s trade or business:

  • Payments for services of a parent are not subject to social security and Medicare taxes unless the services are for domestic services and several other criteria apply.
  • Payments for services of a parent are not subject to FUTA tax regardless of the type of services provided.

Questions?

Many people work for a family member, whether a child is helping at their parent’s shop or spouses running a business together. If you are one of them, your tax situation may be more complicated than you think. Please call the office for assistance if you need help understanding how your work situation affects your taxes.

San Jose: (408) 252-1800

Watsonville: (831) 726-8500