Loan approval generally depends on passing at least one of these two simple tests that potential lenders may apply to your business.
Lenders Look for Low Risk
Many lenders will include an assessment of risk in their approval decision process. No measure of risk will be completely accurate. In general, these measures will be based on a series of assumptions, to some degree. However, since lenders are seeking to maximize their profits, they do need to use some measure to minimize their exposure to risk.
The tendency of lenders to reduce risk is one of the reasons that business loans for startups can be difficult, if not impossible, to obtain. The risk of a startup business is considered to be high, but is in many ways impossible to quantify. Potential lenders do not have an operating history to review and have no insight into what the level of sales will be, or how effective the management processes will be when implemented.
Capacity and Collateral
Lenders have often based lending decisions on character, capacity to repay, and collateral to offset potential risks. In a business loan, character may be a factor to consider, but capacity and collateral will generally be the most important factors. Borrowers will need sufficient capacity or collateral in order for a loan to be approved.
Capacity to repay may be determined by the statement of cash flows, which offers lenders insight into whether or not the business will generate a sufficient amount of cash to meet the expenses of operating a business and servicing the debt. A projected cash flow statement will not be a perfect tool, but it may be among the best information available. Collateral could help business owners without sufficient cash flow to obtain a loan, since the lender would have recourse if the loan cannot be repaid.
Most lenders would prefer never to take possession of collateral, but posting collateral does minimize risk and banks are usually seeking to minimize risk when reviewing credit applications.