4 Factors to Consider Before Taking Out a Small-Business Loan
If your company is running short on funds, applying for a loan may seem like the best next step. After all, an influx of cash can keep operations running, support expansion plans, and ultimately help to increase revenue.
Before borrowing money, however, it’s important to understand that you will be held accountable for repaying the loan, no matter what happens.
“In most cases, you will be required to sign personally,” notes Zalmi Duchman, founder and chairman of Fresh Diet, a meal-delivery service. “If the worst-case scenario occurs and you close down your business, you’ll be left on the hook for the balance.”
Follow these guidelines to make sure that you — and your small business — approach the application process fully prepared.
1. Know your credit score. If you’re applying for a loan with a traditional lender, your credit score is one of the main factors that will be considered. So, before you contact any bank, know your numbers. Request a personal credit report (get one for free at AnnualCreditReport.com). Check for errors, such as a payment you made on time but was reported as late. If you find a mistake, contact the credit bureau and company involved to resolve the issue.
If you have a high credit score (above 700), you stand the best chance of getting a loan with an attractive interest rate. In today's market, for commercial loans under $100,000, you can expect to pay an average rate of 6.89 percent interest, according to the Small Business Rate Report by Bloomberg Businessweek released in December 2013. If you have a mid-level score (600 to 700), you may be able to secure a loan but at a higher interest rate. And if your score is low (below 600), you may find it difficult — but not necessarily impossible — to get approved for a loan.
2. Understand your options. Lenders vary from the traditional (banks and credit unions) to the nontraditional. One of the latter options is OnDeck, a financial platform that extends loans to small businesses. While the interest rate you'll get through OnDeck will likely be considerably higher than the average rate today, you'll also find the approval process to be much speedier than at a bank. In addition, you'll start repaying the loan in small increments every day, thus reducing the risk of missing a bigger monthly payment that might come with a traditional loan. Another alternative is a merchant cash advance, which is based on future credit card sales. While you can expect higher interest rates and fees with this option, there are several perks to consider. It's easier to get approved for a merchant cash advance, even if you have a poor credit rating. Once approved, you'll receive funds quickly, and the repayment plan is based on your revenue.
3. Know what you need. If you’re not sure how much cash your company needs to operate or expand, meet with an adviser or an accountant before approaching any lenders. Be prepared to supply documentation to back up your request and to answer lenders’ questions about your finances, business model, and future plans. Also be ready to discuss exactly how the loan will be used. For instance, you might show how the cash will be used to purchase materials, to set up a new location, or to pay additional staff.
4. Recognize the process. Even if you don’t get the first loan you apply for, there may be some lessons to gain from the experience. Let’s say you were turned down due to poor credit. You could take time to improve your credit score and then seek a loan at a later date.
After initially being denied a large SBA loan in 2007, Duchman wrote a personal letter to the vice president of the bank. In the letter, he explained why he believed the bank should give him the loan. As a result, his request was granted. “The loan helped me make my first acquisition that catapulted my small business,” Duchman notes.
Rachel Hartman is a writer who frequently covers topics related to small businesses. Her work has appeared in The Costco Connection, Wells Fargo Conversations, Pizza Today, Bankrate.com, InsuranceQuotes.com, CreditCardGuide.com, and many other outlets.