A Strategic Guide to Preparing Startups for Access to Capital

Preparing a startup for access to capital involves more than just compiling financial statements. It requires a comprehensive evaluation of the business, addressing factors beyond the numbers. A strategic approach helps assess a business’s readiness by focusing on five key criteria: the owner's experience, financial behavior, personal capital injection, alternate repayment sources, and available collateral. This method provides both business owners and lenders with a clear understanding of the company’s strengths and areas that need improvement before applying for funding.

By thoroughly evaluating these factors, businesses not only increase their chances of securing capital but also set themselves up for sustainable growth. Access to capital is crucial for business expansion, and a well-planned approach ensures companies are prepared for both the loan process and long-term success.

Experience: A Critical Factor in Access to Capital

Lenders place significant importance on the business owner's industry experience when considering a loan. This evaluation helps determine whether the owner is prepared to handle the complexities of running a business and managing potential challenges. When assessing experience, lenders look at both direct industry knowledge and management skills.

• Direct experience includes prior roles, employment, or relevant training within the industry.
• Management experience involves overseeing teams, managing finances, and running day-to-day operations.

Lenders want to be sure that the owner understands not just the technical side of the business but also the strategic and operational hurdles. For entrepreneurs who lack deep industry experience, building a support network of experienced managers or advisors can enhance their credibility and increase the likelihood of loan approval.

Owner’s Injection: Demonstrating Financial Commitment

Lenders also examine the personal capital that the business owner invests, often referred to as the “owner’s injection.” Typically, lenders expect the owner to contribute 10-15% of the total project cost. This financial commitment demonstrates that the owner has "skin in the game" and is willing to share in the financial risk.

A significant personal investment reassures lenders that the owner is fully committed to the company’s success. Entrepreneurs who invest their own capital are more likely to make cautious and strategic decisions because they stand to lose personally if the business does not succeed. For startups, raising the required capital can be challenging, but options such as personal savings, liquidating assets, or family investments can help meet this requirement.

A strong personal investment not only improves the loan application but may also lead to more favorable loan terms, such as lower interest rates or extended repayment periods.

Assessing Creditworthiness Beyond the FICO Score

Lenders look beyond just credit scores when evaluating a borrower’s creditworthiness. Instead, they assess the borrower’s credit behavior over the past five years, focusing on responsible financial management rather than just a high FICO score.

If there are issues in a borrower’s credit history—such as missed payments or financial setbacks—lenders expect transparency. Responsible borrowers who can provide explanations and documentation of how they resolved these issues are often viewed more favorably.

Demonstrating recovery from financial challenges can open doors to funding opportunities that might otherwise be unavailable based solely on credit scores.

Alternate Source of Repayment: Ensuring Stability Beyond the Startup

Lenders want to see that borrowers have additional sources of income beyond the new business to ensure loan repayment if the startup struggles to generate cash flow. The "alternate source of repayment" acts as a safety net, reducing the lender’s risk.

One key metric in this evaluation is the Debt Service Coverage Ratio (DSCR), which compares available cash flow to required debt payments. A strong DSCR, such as 1.89, shows that the borrower has nearly double the income needed to cover loan payments, providing a buffer against financial fluctuations.

For new entrepreneurs, alternate sources of repayment might include income from other businesses, rental properties, investments, or a spouse’s salary. Demonstrating these additional income streams reassures lenders that loan obligations can be met, even if the business faces challenges in its early stages.

Collateral: Offering Security to Reduce Lender Risk

Collateral is another critical factor in the loan approval process. Lenders generally require around 80% collateral coverage, meaning the value of the pledged assets should cover 80% of the loan. This mitigates the lender's risk by providing tangible security that can be claimed if the borrower defaults.

Collateral may include:

• Real estate, which typically holds stable value and can be easily liquidated.
• Equipment, which can be leveraged despite depreciation.
• Inventory or accounts receivable, particularly in businesses with reliable cash flow.

For startups lacking sufficient assets, personal property or a combination of different assets can meet the 80% collateral requirement. By offering collateral, borrowers increase their chances of loan approval and demonstrate their commitment to repaying the loan.

The "Scoreboard" in Action: A Strategic Evaluation

Before submitting a loan application, it is essential to assess the business’s readiness for funding. This strategic evaluation process offers a clear view of the likelihood of loan approval by focusing on key factors like experience, character, personal capital injection, alternate repayment sources, and collateral.

This proactive approach saves time and resources by refining the application before submission, improving the chances of approval. It also helps businesses identify which lenders are most appropriate for their current financial situation, allowing for a more targeted application process.

Matching Lenders with Business Needs

Securing the right financing depends on the stage of the business. Different lenders serve businesses at various points in their development:

• Startups may find more flexible terms with Community Development Financial Institutions (CDFIs) or Certified Development Companies (CDCs), which often provide microloans to help early-stage businesses get started.
• Growing businesses can access larger amounts of capital through Small Business Administration (SBA) loans, which usually offer favorable terms and lower collateral requirements.
• Established businesses looking to expand further may turn to conventional lenders for lines of credit or refinancing options to support their growth.

Aligning the right lender with the specific needs of the business ensures that companies receive the appropriate type of financing at each stage of their development.

Securing the Right Financing for Sustainable Growth

Each stage of the loan process requires a strategic approach to secure the right financing at the right time. Whether it’s a startup seeking its first loan, a growing company pursuing an SBA loan, or an established business looking for capital to expand, a tailored financing strategy ensures that businesses can fuel growth and build long-term success.

Ready to take the next step in securing capital for your business? At FAJ Consulting, we specialize in helping businesses navigate the loan process, ensuring you receive the right funding at the right time. Contact us today to learn how our strategic approach can help your business grow and thrive.