If you are a small business owner, you might need or want a business loan for multiple reasons. For example, you might be expanding rapidly and want to ramp up production due to the unexpected popularity of your company’s product—that's a fabulous problem to have. But if increased production takes more cas flow than you have on hand, you might be stymied in expanding unless you obtain a business loan.
The same is true if you want to expand into fresh territory. If your product is selling well where you are, it makes sense that it would sell well in a similar area. Or, maybe you found out you need specialized equipment, which could cut costs down the road, but financing it is a stretch without a business loan.
Finally, many small businesses have steady revenue, but money flow might fluctuate month-to-month in a way that makes sustaining the company over the long term challenging. If the income is healthy overall, lenders will give you short-term loans to tide you over dry spells. This can be especially helpful for a seasonal business.
How Difficult Is It to Get a Loan?
Savvy business owners should also be aware there are many reasons lenders may view them negatively. In general, your business needs to be viable and operating in the black for you to receive a business loan. In other words, you’ll have a hard time trying to obtain a business loan to pay the rent on your place of business, pay employee salaries, or purchase essential business equipment. For most lenders, this reads like you do not have a company, but want the funds to start one.
If you have an idea for a business or a business plan but no actual income, you are in the start-up stage. For all the ink expended on the concept of start-up businesses, your ability to get a loan might be restricted to a personal loan, a personal credit card, or advances from friends and family.
But, let’s say you do have an operating business. You pay the rent and salaries and have a basic business set-up. Many lenders will still want to see at least a year of financial records showing you’re operating profitably before they give you a loan.
If you have that, let’s look at your business loan options, what you should consider before choosing a type of loan, and what you need to apply.
As a reputable business, you have many options for the type of loan you can apply for. Here are four of the most common choices.
1. Line of Credit for Small Businesses
For this type of loan, you receive a line of credit to be used for cash flow. This can be especially helpful to businesses where long-term revenue is robust but fluctuates. You will be given an amount available to your business from a financial institution, and interest begins only when you access the funds.
2. Small Business Term Loans
These are the everyday vanilla loans of the business world. They can be used for expansion, purchasing capital equipment or for smoothing out cash flow fluctuations. Generally, the term is from six months to three years. Installment payments are due monthly.
3. Small Business Administration Loans
The United States Small Business Administration (SBA) offers loans at lower interest rates than many bank and non-bank lenders. Repayment terms are more lenient, as well, as the credits are intended to foster small businesses and their contribution to the economy. The loan amounts can be as high as $5 million. Lenders work with the SBA, so you will need to find a lender advertising they handle these types of loans.
4. Small Business Credit Cards
These operate similar to personal credit cards and usually require the owner of the company to be responsible for the debt in addition to the company itself. Small business credit cards can be beneficial for businesses that need help financing capital equipment or other stock.
Considerations in Applying for a Loan
Before you apply for a loan, consider the following six factors.
1. Your Ability to Repay
There is no substitute for assessing your ability to repay a loan. If you can’t repay it, you will face multiple negative consequences. Your lender will commence loan recapture strategies, which range from calling you for the money to putting a lien on your accounts. Your credit score and credit history will be negatively affected, often to the point where you'll have bad credit for years. You may end up forced to declare bankruptcy, and you'll almost certainly lose the business if you can't pay back your loans.
So, your first consideration should be looking at your cash flow. Make sure you can operate the business, maintain a cash cushion and service your business loan debt.
2. Your Credit Score
Small business lenders are very likely to look at the credit history and scores of the owners and the principals to give them a sense of how well they’ve handled credit in the past. If you have bad credit (lower than average), you may be turned down.
It’s smart to know your credit score. If it needs to be higher for a successful application, you can raise it by paying your bills more promptly and lessening your personal debt. It’s also a good idea to do this before an average or poor score sinks your chances of a business loan.
3. Annual Percentage Rates
Shop around to get the best annual percentage rate (APR) you can. The annual percentage rate is the effective interest rate you pay per year. The higher the rate, the more you pay in interest. It’s essential to know the APR so you can compare loan terms. Lenders can advertise their business loan rates monthly, which may make the rate seem like less than it is. For example, 1.5 percent monthly rate equates to 18 percent annually, which is steep.
Credit cards are required to put the APR in writing. Other lenders will provide it on request if you don’t see it at first.
4. Types of Rates
As well as having a numerical value, interest rates can be variable or fixed. A variable rate can rise or fall over the term of the loan, depending on the direction of interest rates. A fixed rate is always the same over the life of the loan.
Be sure you know which type of interest rate you're getting. Variable rates can be advantageous if interest rates fall because the amount of interest you pay can decrease. But they also have a downside, which is that rising rates will cause you to spend more per month.
5. Terms of the Loan
If your business does well, you may want to pay off the loan more quickly than you have to in order to free up cash flow. Be sure to check that more rapid payment, often called pre-payment, is allowed. Some lenders will charge a penalty.
Many lenders assess additional fees and other charges. Be sure to compare these to ensure you’re getting the best rate possible.
6. Types of Lenders
Multiple lenders make business loans. Bank loans are one type. Major banks, such as Bank of America and Wells Fargo, make them, as do small regional banks. Credit unions do a brisk business in business loans. Both smaller regional financial institutions may offer more advantageous terms to local businesses than major banks. Both of these types of lenders are often community-minded and want to contribute to a robust local economy.
Recently, online, nontraditional, non-bank lenders have begun making business loans. Online lenders are not necessarily affiliated with any bricks-and-mortar institution, unlike banks or credit unions. Because they do not have bricks-and-mortar locations, they can often provide very advantageous terms for interest rates.
The Application: What You’ll Need
Business loans applications will be scrutinized carefully. You will need, at a minimum, the following:
• Statements of cash flow
• Income statements showing profit and loss
• Balance sheets
• Accounts payable and accounts receivable
These financial statements should be for the past three years at a minimum. If you haven’t been in business for three years, check with lenders to see what their minimum years in operation is.
Depending on the lender and the size of your business, you may also need all these statements year to date, current for the year in which you apply. Other requests could include showing:
• Shareholders’ equity, if any
• Proof of insurance
• Evidence of your corporate legal structure
• Any relevant inspections for your business and your premises
• Your tax returns
• Personal financial statements from the owner or principals
Business loans are essential for many projects and come in many forms. To succeed in obtaining a loan amount of any size, it’s crucial to choose the correct type of credit for your purpose, review the considerations in applying for them and put together a careful, well-organized application.