Say you’ve got a small business in need of a loan. You’re growing, and you’d like some extra money for an expansion project. Sales are going up, and you’re making a nice profit. Should be an easy sell to the bank, right?
Not necessarily, especially if you don’t do your homework, says Pat Latour, Senior Vice President, Financing and Consulting, at the Business Development Bank of Canada (BDC). “If you’re going to expand, you’ve got to have a plan. If you don’t, you can jeopardize the rest of the business that is doing well,” he says.
Many businesses walk into a bank’s office without the right planning—and then they’re surprised when their loan request is turned down. “Knowing the numbers is key. How will the expansion affect your profitability?” Latour asks.
“Growing businesses need more working capital because they’re often supporting additional inventory and more staff. And it often takes a while for the expansion to increase profitability,” Latour explains. “On the other hand, an expansion can also lead to unexpectedly rapid revenue growth. Entrepreneurs should also plan for that scenario and be ready to use the extra revenue to aim even higher,” he says.
How do you get your ducks in a row for a successful loan request? First, take time to work out your anticipated return on the investment, including not just the cost of the fixed asset, but also the way your business operations will change as you grow.
Second, it’s vital to think about your timing when applying for a loan. Businesses often wait too long, Latour says. Instead, they use cash flow to finance major expansions or, even worse, wait until they’re facing a cash crunch to see the bank.
“One of the biggest reasons businesses fail or an expansion doesn’t succeed is a lack of working capital. It’s always easier to get financing beforehand than when you have a timing crunch,” he says.
Latour advises fast-growing businesses to meet their banker every year to get a pre-approved loan for capital expenditures, which they can draw on instead of tapping working capital. Such a credit facility also lets a business react more quickly to opportunities, since it doesn’t need to apply for a new loan each time it needs funds.
Change to grow
Sean Darrah learned some of these lessons at his fast-growing food services business, Pace Processing. Starting from a 1,500-square-foot space in 2001, it had grown to a 10,000-square-foot location by 2007. But even that space was maxed out, and Darrah wanted to expand into a new, bigger building. He had always used working capital to finance his growth, but he now realized he needed a loan for the costly expansion.
He was in for a surprise when he approached a bank and was initially turned down. Despite sales growth of 25% to 30% per year, he had been spending all his operating cash and writing off equipment every year. “It looked like we didn’t have many assets,” Darrah says, who then hired an accounting firm to help him demonstrate his company’s true value.
The bank took another look and agreed to the loan, which allowed Pace to move into its own new 25,000-square-foot building in 2010. Darrah also got a line of credit for future capital spending. “What prevented us from taking the next step was always spending all our cash. It was really clear we needed to change to grow.”