Last month, we discussed the need for small businesses to become loan-ready and the funding milestones along the way, from self-funding, to CDFI-ready, to bank-qualifying. Now, let’s talk about making the transition between the first and second milestones, to become CDFI-ready.
Using someone else’s money to fund your business is a big step and comes with new levels of accountability and scrutiny. You’ll have to explain details and answer questions you never had to think about as a self-funded business. Here are three things to keep in mind as you navigate the process of getting funding from a mission-based lender:
1. Understand your funding needs.
Why do you need a loan? Although it might seem obvious, having a clear answer to this question is critical to determining how much funding you need, what type of loan you should get, or even if you need a loan at all. Let’s unpack this.
Sometimes you don’t need a loan but a better plan. Asking why you need a loan (five times) will help you uncover if money is actually the solution to your challenges or if you just need a different strategy for your business. You might need to renegotiate a contract, revise your pricing, reevaluate your market-fit, or even create systems to increase efficiency. Any of these strategies might be better than borrowing money to throw at unprofitable endeavors and then having to pay additional interest. Multiplying inefficiencies is always a bad idea. Instead, take the time to seek help, get fresh eyes on your business to identify what steps to take, and then once you have a plan, seek funding. It never works the other way around. Many organizations provide coaching and support to entrepreneurs free of charge (although not free of effort), such as the Florida Small Business Development Centers, SCORE, Branches, Prospera, Accelerate South Dade, and many others. Don’t be afraid to take advantage of their help when you need it.
“As Much As I Can Get” is not a loan amount. This type of answer does not serve you well. Taking out as large a loan as possible might mean borrowing more than you need. If you do, you’ll end up paying unnecessary interest on money you don’t need. This sends a red flag to lenders that you haven't properly prepared.
Determine how much funding you need and for what specific uses. Do you need to pay the bills while you wait to get paid by your clients? Is it for startup capital, to invest in marketing, to buy equipment or even a commercial property where you will operate? Some of these are short-term financing needs where you’ll recover the money sooner. Others, like large equipment purchases and real estate, are long-term costs that will take years to fully mature. As you clearly answer how much and for what for, it’ll be easier to determine the funding terms you should negotiate with your lender, so you can get what works best for you.
2. Understand how CDFI lenders assess your business's creditworthiness.
Expect scrutiny. It’s true that CDFI lenders like CFNMD have more flexible requirements than traditional banks. But they’re also not-for-profit organizations responsible for making good loans that will be paid back so that they can lend the same capital to other small businesses that also need to grow. Before CFNMD makes an investment in your business, you must be able to show that your business is creditworthy and has a solid foundation for long-term sustainability. This means CFNMD will ask to verify the information you provide to better understand your business model and to test your assumptions. While you might be a bit intimidated at the thought of having someone pick apart your business and challenge your strategies, know that it’s not personal. It’s all part of the standard due diligence process of establishing your business as a good investment. Remember, the success of lenders like CFNMD is the success of its borrowers. Be prepared to produce documentation and answer many questions to help the lender understand you and your business. Doing so builds the best case for your business and increases the odds of loan approval. In many cases CDFI lenders will guide and assist you in obtaining the documentation needed, such as business plans, projections or financial reports. However other things, such as filing tax returns, building your credit and separating business and personal finances, are all up to you.
Character. Small businesses are highly dependent on their owners for operation and direction, so a business owner’s character is of utmost importance to CDFI lenders. Your personal credit is seen as a measure of your character in honoring your past debts. Another important measure of your character is how forthcoming you are in answering questions about anything that can affect your business or finances. Providing half truths or failing to disclose other personal or business loans, or even additional bank accounts, can significantly damage the trust a loan officer has in you. It’s better to be upfront about everything, even your past mistakes, rather than risk them being found out.
Repayment capacity. Because even flexible lenders like CDFI will need to know that your business can repay a loan, you’ll be asked to demonstrate “repayment capacity” in several ways. This might include providing records about your business cash flow, past sales, expenses, and future reporting, too. Don’t be surprised if you are asked to produce your unpaid invoices, an explainer of your financial situation or a list of your current clients. You’ll be asked to provide several months worth of bank statements to identify cash flow needs, business activity, balances in red or surplus. In the case of a startup, the business plan and financial projections help the CDFI understand your future ability to repay a loan, supported by the evidence of your company’s proof of concept.
Skin in the game. CDFI Lenders like CFNMD like to see borrowers with skin-in-the-game. Being willing to bet your own resources on the endeavor you’re looking to get financed shows your belief in the project and commitment to see it to success. You can do this by using your own capital to fund 10% or more of the project, providing business assets as collateral to be liquidated in case of non-payment, or even by putting up a real estate property to cover your loan. This increases your chances of loan approval.
3. Prepare and gather your documents
Now that you know what CDFI lenders like CFNMD look at when they consider extending credit to you, it’s time to prepare documentation for your loan application.
Some documents will be easy to gather—like your business license—while others require more preparation and proactive planning, such as tax returns, financials and bank statements. While you gather the documents, you’ll also want to pay attention to what they say about you and your business. Do your bank statements show overdrafts or personal expenses? Do your business taxes show losses every year? Do your financial statements make sense? For more tips, check out our previous post about how to use numbers to show your business is fundable.
Loan-readiness is a cultivated state. The sooner you start preparing, the higher your odds of getting loan approval from a CDFI like CFNMD, with better terms for your business.