The time-tested answer to that question is "when you don't need the money." Although not entirely accurate, it gets to an essential underlying truth: to get a business loan from a bank today, you need to be well-prepared, which means knowing the 5 C's of Credit.
The 5 C's of Credit represent bankers' criteria when doling out business loans. Before we get into the 5 C's and before you even think about approaching a banker for a loan, the first thing to know is that banks generally are only interested in lending money to established businesses.
As one of my local bankers explained, bankers are not Venture Capitalists or Angel Investors; they want to see a legitimate, operating business before considering making a loan.
If your business isn't up and running, you'll probably have to rely on personal savings, friends & family, or credit card debt to get your company up and running. The U.S. Small Business Administration does provide loan guarantees. Still, one of the conditions of these guarantees is that you use "alternative financial resources, including personal assets, before seeking financial assistance." You can learn more about SBA 7(a) loan guarantees here: https://www.sba.gov/partners/lenders/7a-loan-program/terms-conditions-eligibility.
In addition, the SBA does provide grants, but only to a very limited number of specific businesses and organizations (companies engaged in scientific research or providing business support services to veterans). You can learn more about SBA grants here: https://www.sba.gov/funding-programs/grants.
For those of you that have a business and want to approach a bank for a loan, here are the 5 C's of Credit that you need to familiarize yourself with:
1. Character
Translation – can the bank trust you to be a good steward of the bank's money? One of the first things a banker will evaluate is the character of the potential borrower. Character includes factors such as your credit attitude and aptitude. Do you come across as someone with integrity and the ability to manage the bank's money competently? And although this C has a subjective element, the banker will use some objective tools to round out the view of your character. These include your credit bureau, Equifax credit bureau for businesses, and your company's accounts payable aging. Your banker may ask you to rate your credit, describe how your vendors would rate your payment history, and discuss whether or not you have any blemishes on your credit, such as late payments, past due bills, tax liens, or collections actions.
2. Capacity
In a nutshell, the bank wants to know if you can afford the debt. The bank wants to see if you have sufficient income, cash flow, and cash reserves to service existing and potential new debt. What will your monthly disposable income be after debt service? The bank will want to know what sources of repayment you have available, including income and cash sources outside the business. You may need to provide information on your customer base and any seasonality or unusual aspects of your business that may affect regular cash flow. And don't be surprised if you get this question: what do you do for fun? Your banker may have second thoughts if you say you spend every weekend in Las Vegas at the blackjack table.
3. Capital
The capital C in the 5 C's of credit refers to what kind of capital you are bringing to the table. The bank is taking on risk by loaning money to your small business. Your banker wants to know what kind of personal financial risk you are willing to take. Sometimes referred to as "skin in the game," the bank will assess how much of your own money you are willing to invest in your company. The bank will also want to know what additional resources you have if your income and cash flow are insufficient to support the debt. When assessing these other resources, liquidity will be the key. The bank will look for cash, marketable securities, and brokerage accounts.
4. Conditions
What is the current state of your industry? Is the economy booming, or is a recession on the horizon? How would you continue to make timely debt payments if the economy turned downward or your industry suffered a shock? The bank will consider all of these external factors when evaluating the risk level of your loan. Your banker will also delve into the specifics of your company's position in your industry. What is your company's competitive position? How do you differentiate your business from the competition? Be prepared to defend your business model and your strategy for winning in the market.
5. Collateral
In blunt terms, collateral is the property you will forfeit if you can't repay the loan. This property can take the form of real estate, equipment, inventory, or accounts receivable. Banks are not in the business of repossessing property and trying to dispose of it but require collateral as a last resort for non-payment of debts.
Along with being well-versed in the 5 C's, there are some items you will want to have prepared ahead of time so you can make a great first impression. Below is a list of recommended documentation to have when you apply for a business loan:
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A business plan containing a standard summary of the company, product, market, team, and financials and includes two years of revenue and expense projections
Business financials including all current and past loans and debts incurred, all bank accounts, investment accounts, credit card accounts, and supporting information including tax ID numbers, addresses, and complete contact information; year to date Balance Sheet and Income Statements along with three years of business tax returns
Accounts receivable and accounts payable to include aging, account-by-account information (for checking their credit), sales and payment history and credit references, companies that sell to your business on account that can vouch for your payment behavior
Personal financial data to include social security numbers, net worth, details on assets and liabilities such as your home, vehicles, investment accounts, credit card accounts, auto loans, and mortgages
Personal tax returns for the last three years (For businesses with multiple owners, or partnerships, the bank will want financial statements from all owners with significant shares). Expect to sign a personal guarantee as part of the loan process
Agreement of future ratios: most commercial loans include loan covenants. The company agrees to keep some key ratios—quick ratio, current ratio, debt to equity, for example—within certain defined limits. If your financials fall below those specific levels in the future, then you are technically in default of the loan
Details on the collateral you are pledging. For real estate, the bank will want to know the location and condition of the property and competing properties and rents in the area. If equipment is pledged, the bank will require the age, condition, and current value
So when is the best time to ask your banker for a loan? The best answer is probably still when you don't need the money. However, if you do need the money, the best time is when you can meet the 5 C's of credit and have the documentation you'll need to make your case.
Good Luck!