Image of a man getting a small business loan from a bank
Articles

Starting a Small Business: Getting A Business Loan

By Jonathan Horton

Getting A Business Loan

Sooner or later, many small-business owners consider taking out a loan, either for startup costs, or to supplement their business’s growth. By now, you’ve organized your finances, and now you’re ready to obtain financing. There are a number of possible avenues for startup funding for your new business: personal savings; personal credit; loans or investment from family, friends, business partners, or investors; business credit cards; bank term loans or lines of credit and of course, SBA loans.

We’ll focus on obtaining a business loan, business lines of credit and SBA loans here–however, the information you would gather to present to a lender would not only be appropriate to present to private investors–it is also the information you need to know and understand, even if you’re pulling money from your own personal savings.

This isn’t just fluff to check off a box on the lender’s application form–you really, really need to understand how much money your business needs, how much debt your new business can handle, and what kind of financing options are available.

Show Me The Money

Small-business loans can be tricky to obtain, especially if you don’t know much about the application process. You can save yourself stress and hassle by thoroughly preparing before you even approach a bank.

That preparation begins here with these three crucial steps for nailing down a business loan.

1. Decide What Type of Business Loan You Need

To choose the type of loan you need for your business, you first need to articulate your reason for getting the loan.The lender is going to hand over a significant amount of money to your business, and they’re going to want to know how and why it’s being spent. It’s a valid concern: how you invest the loan will affect your business’s income and ability to pay it back.

General rationales for small businesses seeking loans include managing daily expenses, expanding or purchasing equipment, building a cash buffer against possible future shortfalls, or just starting a business. Determine exactly how much money you need–don’t ballpark this number. If you end up with too much you may struggle to pay it back, or, best case scenario, end up paying interest on monies you didn’t need. Alternatively, too little could kill your business before it ever leaves the ground, as you won’t have enough to cover your expenses.

As you formulate a reason for getting a loan, you’ll have a better idea of how much you need–which will lead you to determine what kind of payments you can afford. Use a business loan calculator to help you determine how much your payments would be, including your interest rate.

A good rule of thumb is to ensure your total income is at least 1.25 times your total expenses, including your new repayment amount.

That means if your business income is $10,000 per month, your expenses should top out at $8,000. If you already pay $7,000 in rent, payroll and other costs, you should be able to afford a $1,000 monthly loan payment.

Now that you know your reason for obtaining a loan, as well as how much you need, you’re ready to review the multiple types available, beyond traditional personal and business loans. Here are some of the types of loans available, along with a detailed look at the most common:

Table showing common types of business loans

(click here for a larger image)

  • Term loans. With term loans, business owners receive a lump sum of money from their lender, which they’ll repay over an agreed-upon time. Along with repaying the principal loan amount, borrowers will repay interest accrued on the loan. Term loans are best for established businesses with solid credit that need expansion cash quickly.
  • SBA loans. The U.S. Small Business Administration backs bank loans that meet strict borrower guidelines. This backing instills the confidence in banks and lenders to take chances on applicants who’ve previously been turned down. SBA loan interest rates are typically low, but the approval process can take months.
  • Business lines of credit. Less rigid than a bank loan, a business line of credit gives you access to as much capital as your credit limit will allow, but you pay interest only on the cash drawn. Business lines of credit work well for covering short-term expenses or annual downtime for seasonal businesses.
  • Business credit cards. Like business lines of credit, business credit cards give business owners near-instant access to a revolving line of credit. Business credit cards often come with rewards and even sign-up bonuses, which you won’t get with lines of credit, but the repayment terms are typically stricter and the APR is much higher.
  • Microfinancing. Microloans, or short-term loans under $50,000, can help business owners build their credit score as well as their cash flow. They’ll work with less than stellar credit, and can approve you quickly, however microloans and microcredit have a few drawbacks, the biggest of which is the inflated interest rate involved. While you’ll pay less interest than a typical credit card, you will most likely pay higher rates than if you went with a traditional bank. But a missed payment on a microloan can still hurt your credit just as much as defaulting on a conventional loan

2. Compare Small-Business Lenders

You’ll typically want to get the business loan that offers you the best terms. But other factors, like funding speed, may matter to your business and different funding sources may be better in certain instances than others. You’ve figured out why you need the loan, how much you need, and even what type of loan would be best suited to your small business–the next question is who? Who will you get your loan from?

When to get a business loan from banks and direct lenders:

  • You’ve been in business for at least two years.
  • You have good credit.
  • You don’t need cash fast.

Direct lenders usually include banks, wealthy investors, asset-management firms, credit unions, and other traditional lenders. These types of lenders deal one-to-one with borrowers—you don’t go through a third party to acquire a direct loan. Traditional bank options include term loans, lines of credit and commercial real estate loans to buy properties or refinance. Getting funded by a bank tends to take longer than getting a loan from an online lender, but banks tend to offer the lowest APRs.

Through banks, the U.S. Small Business Administration guarantees general small-business loans with its 7(a) loan program, microloans, and disaster loans. The SBA also has a 504 loan program that helps fund the purchase of land, buildings or equipment through long-term, fixed-rate financing. Taking out a small-business loan from a bank can be difficult if you’ve been in business less than two years or don’t have consistent revenue. Add bad personal credit or no collateral to that, and many small-business owners come up empty-handed.

When to get a business loan from online lenders:

  • You lack collateral.
  • You lack time in business.
  • You need funding quickly.

Online lenders generally provide small-business loans and lines of credit of up to $500,000. The average annual percentage rate on these loans ranges from 6% to 99%, depending on the lender, the type and size of the loan, the length of the repayment term, the borrower’s credit history and whether collateral is required.

These lenders rarely have APRs as low as what traditional banks offer, but approval rates are higher and funding is faster than with banks — as fast as the same day in some instances.

When to get a business loan from microlenders:

  • You have bad credit or no credit history.
  • You are a new business.
  • You can’t get a traditional loan.

Microlenders are nonprofits that typically make short-term loans of less than $50,000. The application may require a detailed business plan, financial statements and a description of what the loan will be used for, making it a lengthy process.

The size of the loans is, by definition, “micro.” But these loans may work well for smaller companies or startups that can’t qualify for traditional bank loans due to a limited operating history, poor personal credit or a lack of collateral.

Determine if you qualify for a business loan

You’ve figured out why you need the loan, how much you need, what type of loan would be best suited to your small business and you’ve now identified who offers what you need. The next question is, do you meet the lender’s qualifications? Lenders often look at the following criteria:

  • Credit score and history. If you’ve repaid loans responsibly in the past, the potential lender will find out—and they’ll also find out if you haven’t. Banks can assess business and personal financial histories through a variety of avenues, but most loan processes begin with a credit review.
  • Collateral. What do you own that could cover the loan in case of default? Most (but not all) banks and direct lenders will require something of value to shield the lender. Typical business items that qualify as collateral include real estate, buildings, vehicles, equipment, inventory, and accounts receivable.
  • Cash flow. The more money your business is currently making, the less of a loan risk it’ll be to the lender. Banks and lenders will not only look at the amount of profit you’re bringing in but also examine how you’re managing it.
  • Time in business. If you’ve been functioning as a business for several years, you’re probably doing something right. Startups and newer businesses won’t have time on their side, but a solid, executable business plan for reaching milestones will go a long way toward evening the odds in a lender’s eyes.
  • Industry. What’s the forecast for your line of business? For instance, if you had a successful local brewery last year but six more are fermenting in the area this year, your competitors might start to cut into your business’s profits. Lenders might take current industry trends into consideration when deciding whether or not to approve your loan request.

3. Apply for a Business Loan

Step one was to figure out what loan you needed. Step two: determine which lender would best meet your particular business needs. Now, you’re ready to apply for the loan. Some common items you may need, especially for a more involved business loan application can include the following:

    • Your business’s name and address
    • Your business tax ID number
    • Your business plan (This is an outline of your business’s financial goals and explains how you’ll achieve them)
  • Your business loan proposal (While some information is similar, this isn’t to be confused with the business plan. A business loan proposal is more streamlined to focus attention on the loan amount you want and your repayment plan)
  • Business financial statements
  • Personal details about your company’s owners

Be Ferocious

“Play by the rules, but be ferocious.” – Phil Knight

It’s good advice. Whether you have an established business or are just starting out, there are many attainable ways to get funding. Put your best foot forward and go for it. (Note that credit bureaus don’t differentiate between business and personal inquiries. If you use your personal credit history, your credit score could be affected when applying for a small business loan, which is why it’s important to go with your best bet).

Talk with a business consultant at Ingenium to help you hone your business plan and establish a clear, strategic plan for getting funding for your business journey ahead.