Getting a loan to help your business grow can be a challenge and take precious time away from running a successful enterprise.
That’s why it’s important to thoroughly evaluate if a small business loan is truly your best course of action. While you’re the only one who can determine if and when a loan is a wise move for your business, these 10 questions can help you assess your situation and arrive at an informed decision to pursue funding—or not.
1. Does your business need more funding to grow? If you’ve exhausted your startup funds and other options to enable growth, it may be time to pursue a loan, especially if your sales volumes are stable but not growing. In other words, you’ve maximized the amount of revenue you can make at the current level. In this scenario, a loan could deliver the capital to move to the next level—whether that’s by purchasing more inventory or equipment, expanding to another location, or pursuing new projects or offerings. On the other hand, if your business is rapidly depleting its cash or seeing sales decline, a loan payment is the last thing you need.
2. Do you have a business plan? Having a detailed business plan, including the purpose of the loan and how you expect it to increase profits, is a must before seeking additional funding. Define your specific goals for funding in your business plan to clearly articulate if the loan is for working capital or to finance a new location, acquiring another business, replacing equipment or adding new, or launching a new product. Not having a solid business plan can also prevent you from gaining loan approval since lenders must understand and validate the reasons you need a loan to ensure the funding is necessary. Your business plan should also reflect that you can address emergencies, such as equipment breakdowns, natural disasters and more.
3. Have you considered other options? Before you approach a bank or online lender to apply for a loan, be sure to consider other avenues for funding business growth, such as: friends and family, angel investors (private investors who make equity investments), venture capitalists (investors in businesses with the potential for high returns and those that have products or services with a unique selling point or competitive advantage) and crowdfunding, which raises small amounts of money from many people, typically via internet-based platforms like Kickstarter and Indiegogo
4. Can you afford a small business loan? Taking on debt must fit into your business budget so it’s vital to understand what your payments will be and the repayment terms—interest rate, APR (which includes other loan fees and costs), how often payments are due (weekly or monthly) and for how long. Once you have this information, consider your current cash flow to assess if you can afford the added loan payment along with payroll, inventory, rent and other expenses.
5. Will your loan positively impact your bottom line? Taking on business debt is a big step so it’s important to make sure that you’re using your loan to directly produce bottom-line results. Will this loan empower your business to make more money? Itemize how—expanding to a new location, buying new equipment, purchasing inventory at a discount or increasing marketing—to confirm that the loan funds will increase your revenues. In most cases, loan funding should only be used for expenses directly related to growing revenue.
6. Does your business require certain skills to grow? Sometimes a business must move from operating on a shoestring to adding talent that enables growth. Do you need a full-time bookkeeper instead of someone who is part-time or a contractor? Would your company benefit from a marketing consultant or an employee dedicated to developing new business? Using a business loan to increase your capabilities can be a good option, especially if you and your small team are stretched thin. Again, is there a clear connection between using the business loan for skills that will help increase revenues?
7. Do you need to build credit for the future? Your plans call for larger-scale business financing in the near-term future. In this scenario, having a record of successfully repaying smaller, short-term loans can help build your business credit score and history. This approach also may help you develop a solid relationship with a lender who could be more inclined to fund larger loans in the future—but only if you’ve made payments in full and on time.
8. Do you have collateral to secure the loan or can you personally guarantee it? Lenders typically aren’t willing to risk lending money to businesses without collateral to back the loan in case it’s not repaid. Assets such as equipment, real estate or inventory are examples of collateral, which would be forfeited in the event your business defaults on the loan. Other lenders require personal guarantees on business loans instead of collateral. Business loans are personally guaranteed, meaning if your business is unable to repay for any reason, you would be responsible to personally cover the obligation.
9. Do you have a good credit score and history? Generally, all lenders look at your business and personal credit scores to assess how likely you are to repay a loan. A good credit or FICO score indicates that you’ve prudently managed your finances by making on-time payments and avoided defaulting on a loan or declaring bankruptcy. A poor credit score means the opposite—you’ve been unable to fulfill your financial obligations. The credit score range is from 300 to 850—the higher, the better. If you have bad or weak credit, you can work to rebuild it by paying bills on time, paying down credit card balances, keeping balances low and using credit responsibly.
10. Can you meet minimum revenue criteria and time in business? In addition to credit scores, most lenders have minimum criteria for annual business revenue, which varies widely depending on the lender. The range can be anywhere from $10,000 to $30,000 in revenue per month or higher. Other lenders have a lower threshold, such as QuickBooks Capital, which requires only $50,000 in revenue in the past year. Time in business is another key factor for lenders, with traditional business loans requiring two to three years of business history and tax returns.