Several owners? Here’s how to prepare your loan application.
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June 24, 2016
5 minutes to read
Opinions expressed by Contractor the contributors are theirs.
If you are a small business owner looking for financing, your personal finances will play an important role in your loan application. Lenders will look at your personal credit score and ask you for a personal guarantee to back up their principal. For them, your life is not entirely separate from the health of your business.
But what if that business has more than one owner?
Commercial loan applications with multiple owners are not that different, but there are some important considerations you need to keep in mind, especially when it comes to of which that these lenders will carefully consider.
Follow these steps before completing this loan application if you are one of the many business owners in need of a loan.
1. The 20 percent rule.
If you own 20% or more of your small business, chances are your finances will be reviewed by your lender. This 20 percent rule was pioneered by the Small Business Administration, which requires a personal guarantee from all homeowners who own 20 percent or more of property requesting a SBA-backed loan. Personal guarantees allow lenders to recover their funds in the event a borrower defaults, and that was how the SBA protected its lending partners from irresponsible business owners.
Many banks and lenders have followed suit, look to the personal assets of all homeowners with 20 percent or more to serve as collateral for their loans.
But it’s not just a question of personal guarantees. Lenders too examine credit scores homeowners holding 20% or more when deciding whether to extend a loan offer or deliberate on its terms.
In short, if you are applying for a loan, check which owners have invested the most in your small business: they will have the greatest impact on your application.
2. Understand the strength of your application.
Then be sure to discuss with business owners whose credit scores and personal assets will be important to the lender.
- Is Each Homeowner’s Credit Rating High Enough? Or will a homeowner’s low credit score hurt your chances of qualifying for the loan you need? Talking about your personal credit scores can be an uncomfortable conversation – some people may be afraid of being judged, blamed for a business problem, or feeling defensive about their own personal spending habits.
However, this discussion should take place before you apply, as a lower credit score can hurt your overall application. And what’s more, your application may be affected even if no owner has low credit, but the total average is not that high. Lenders may be concerned about the aggravated risk of multiple homeowners with less than ideal credit scores.
- Is each owner able to sign a personal guarantee? And are they comfortable doing it? A personal guarantee may scare some off because it puts your personal assets at risk if your business loan defaults. If some homeowners with more than 20% ownership absolutely refuse to sign – or are unable to do so for some reason – then your loan application may not proceed.
If so, your first step should be to understand their concerns and try to address them. Personal guarantees are standard loan practice for small businesses without a lot of collateral, because lenders need a way to protect their money, and they’re a lot less scary when split between multiple owners. Try to conjure up possibilities like a limited personal warranty, which limits the loan amount each homeowner owes, or personal guarantee insurance, which can cover up to 70 percent of your liability.
3. Change your ownership percentages.
While it is time consuming and complicated, changing your business ownership percentages could help you qualify for the financing you need.
First, understand the policies of the lender you are trying to work with. The ASB has a six month retrospection policy, for example, which means that you will have to adjust the percentages well in advance. Other lenders might look at your articles of incorporation or tax forms. Other alternative lenders might not follow the 20% rule at all, but instead require that 70% or even 50% of the company’s total ownership be represented.
Then work with an accountant and a lawyer. Each entity type has its own ownership rules, which can also vary by state, so you don’t want to go wrong.
S corporations and C corporations require owners to buy shares of each other or the corporation, register the transfer of shares, and file new incorporation documents with the state. For limited liability companies, you will need to exchange shares in accordance with your LLC operating agreement, but you will not necessarily have need to update incorporation documents.
Don’t try this on your own no matter how much legal knowledge you have. Playing with the ownership terms in your company’s articles of association could have serious repercussions, so you’ll want to check everything with the experts.
If the fear of a personal guarantee is delaying your claim, it is worth looking for alternatives like insurance or adjusted ownership percentages. Just be sure to work with legal and tax professionals. But if the problem lies with your credit scores, a lender may be able to say that you faked the numbers to cover up a deeper financial problem. It might be better to settle for the most expensive loan and increase your business credit by managing that debt responsibly.