As a business owner, one of the most stressful situations you may face is needing more money to keep the business running. You will make some challenging decisions as a business owner. In the course of making decisions about loans, you may find yourself wondering if you need a business plan for a business loan. It’s important to understand from the start that the answer depends on the lender. A lender will typically require some type of plan, but the requirements may vary.
Applying for a loan can feel intimidating and daunting. We are here to make that process a little easier by explaining some basics that you need to know. This article will cover why business plans matter, what many lenders are looking for, and the best ways for you to prepare.
Why lenders ask for business plans
When thinking about applying for a business loan, you should consider the perspective of the potential lender. A lender is always looking at risk. Every loan they approve carries some risk. They want to know just how much. That number will be a factor in approving your loan. One of the items that helps a lender assess risk is a business plan.
When you provide a business plan, it gives a lender greater visibility into your business. It also helps the lender determine how viable your business is. A business plan shows the details of your business, what exactly you do, and how you are going to make money. A lender has an increased interest in how you make money to pay back the loan. They also want to know how the money will be used.
Some lenders are also looking for financial projections in your business plan that will show if your business is likely to generate enough cash flow to repay the loan. Your business plan can give lenders confidence that you have a clear strategy, understand the market, and can responsibly manage the debt. It’s important to keep in mind that a strong business plan does not promise loan approval.
Do you always need a business plan for a business loan?
While this is a simple question, it doesn’t always have a simple answer. It depends on the lender and the type of loan. You may want to consider providing a business plan even if your lender doesn’t require one. These plans help you show your financial plan and goals. It can strengthen your application.
When applying for a loan through a traditional lender, you will find that they most likely will require a detailed plan. Traditional lenders are banks and the Small Business Administration (SBA) loans. These lenders usually provide larger loan amounts. A startup business should expect to have a business plan requirement.
There are some more non-traditional types of lenders, such as online lenders, microloans, and short-term financing options, that may not have a business plan requirement. These lenders may place more reliance on bank statements, credit history, and business revenue. They may require you to provide a short summary explaining the way you intend to use the money.
What lenders look for in a business plan for a loan
When preparing a business plan, it helps if you understand how a lender is going to review your business plan. This can help you put together a business plan that will meet the needs of the lender.
Clear explanation of the business
You want to clearly describe your business and explain its purpose. In addition to the purpose, you want to discuss who the business serves and how it makes money.
How the loan will be used
A lender is always interested in knowing specifically how you are going to use the funds they provide to you. They want to know if their funds are connected to business stability or growth. You want to avoid displaying vague descriptions of your business spending.
Ability to repay the loan
Remember that a lender always needs to determine risk. Part of that risk is determining the strength of your ability to repay the loan. Some of the ways you can show your ability to repay are to have a revenue model to show how you create revenue. This includes showing an awareness of your cash flow and how solid it is. A lender also wants to see that you are making realistic decisions and have fair assumptions about your finances.
Management and ownership
The administrative details of your business are critical pieces of information. A lender wants to know who is running the business and what kind of experience they have. All potential lenders want to ensure your business is being run well. You should also include your ownership structure, which should include a chart if there are multiple players.
Business plan for a bank loan vs other loans
We mentioned that traditional lenders may have more requirements and tougher guidelines when it comes to obtaining a loan. Banks and SBAs require formal plans because they are more concentrated on minimizing risk. They are more heavily regulated by government agencies. As a result, they have more rigorous documentation and standards. When creating a business plan for a small business loan, you want to focus on your steadiness and predictability. These factors are important for more traditional lenders. You also want as much documentation as possible when applying for a loan.
Other, less traditional lenders may have less strict requirements, and you may not need a business plan. In many cases, they will accept a short statement from you discussing the details of your business. Keep in mind, you should consider providing a business plan even when not required to.
How to write a business plan for a loan
When preparing a business plan for a loan, there are some approaches you can take to strengthen your plan. You should start from the perspective of the lender, not from your business.
You want to have a clear purpose that begins your plan. Keep everything in your plan clear, especially when explaining why you need a loan, how much you are requesting, and how you will use the money.
Describe your business clearly and focus on how your business makes money and who your typical customer is. Do not add any extras to the plan. You must highlight your experience and how you manage your business. This includes your skills, experience, and success.
Stay realistic with your goals and your current financial situation. Your cash flow is a critical piece of your business plan. Be sure to show how receiving this loan will improve the stability, efficiency, and/or revenue for your business. Keep professional and clear throughout your entire business plan.
Common mistakes in loan business plans
There are a few common mistakes that businesses make when creating business plans. Some of the more common ones are listed below. Be careful to avoid making these mistakes with your business plan.
Overly optimistic projections
Remember, banks do not like risk. They do everything they can to avoid risk. You ought to be careful to avoid risks with your business. You don’t want to focus on unrealistic growth or assumptions. This shows the bank that you may make risky decisions once you have their money. In addition, do not inflate your revenue because that is a red flag to a lender.
Unclear use of funds
Everything that you provide in your business plan should be detailed, especially when it comes to a spending plan. Do not be vague when you are using funds from a lender. In the spending plan, you want to outline how you plan to repay the money. Do not avoid mentioning this point.
Incomplete or inconsistent information
A lender is going to closely review your documents. You want to ensure that your numbers match and make sense throughout your document. When numbers don’t match, lenders will be less willing to trust you. A lender gets nervous when numbers or details are missing. All of these items make a lender nervous.
Business plans are only one part of loan approval
While a business plan is important, it is only one piece of the puzzle for lenders when making decisions about loans. A business plan is extremely useful for you, but it does not negate other criteria. Some other areas of consideration include:
Credit history, which includes your business and possibly personal credit scores, can help a lender make a determination about your reliability to repay the loan. Financial statements include statements relating to cash flow, balance sheets, and income statements. These statements outline the current financial condition of your business.
Some lenders may require collateral. This could include assets like equipment, inventory, or real estate. They may even require personal guarantees. Be prepared for collateral to be requested. There are some things out of your control that make a difference, also. The state of the world and industry when you apply for your loan may make a difference in approval. If there are situations that may influence your business revenue, it may cause lenders to be less willing to approve your loan request.
Getting prepared before applying for a business loan
Before you start the loan application process, you want to make sure you’re prepared. Before you do anything else, make sure you have a legitimate business, and it’s been set up properly. You want to have a clear understanding and explanation of your business structure. Organization is key; you want to keep all your documents organized and available.
Be clear about what finances are specific to your business and which ones are personal. Lenders want to reduce risk, and your ability to prove that you are a credible and reliable business will help provide mitigation to risk for a lender. It’s important to keep in mind that hitting all these marks and having a solid business plan is not a guarantee of approval.
Conclusion
We hope you take away how important a business plan is to your loan application. While requirements will vary by lender and type of business loan, a business plan is always a good thing to have. It’s critical to plan well and keep your expectations realistic. You want to have realistic goals for your business and the money, if you’re approved for a loan. Focus on reducing risk for the lender and be honest about your business. Good luck with your business loan application!