2019-09-20 09:00:52 Loans English Financing can be a confusing process. Rest assured, with the following roadmap, you can easily find and secure the small business loans... https://quickbooks.intuit.com/r/us_qrc/uploads/2019/09/Small-business-loans.jpg https://quickbooks.intuit.com/r/loans/small-business-loans/ Small business loans in 2019: How to apply & resources to guide you

Small business loans: How to apply, pros, cons, and resources to guide you

18 min read

If your existing or newly founded small business needs working capital, but securing investors, a personal loan, or a small business grant isn’t an option… a loan might be your best route.

Business financing can be a long and confusing process.

But rest assured, with the following roadmap, you can easily manage the process and find the loan terms—whether long-term or short-term loans—as well as the monthly payments that best suit you.

Here are the four steps we’ll follow together…

  1. Know the types of small business loans
  2. Learn how to get a small business loan
  3. See if you qualify for different loans
  4. Apply for the best loan for your needs

1. Types of small business loans

  • SBA loans
  • Traditional business loans
  • Business lines of credit
  • Invoice factoring
  • Specialty loans
  • Loan alternatives

Small Business Administration loans

SBA loans are funded through small business lenders but guaranteed by the US Federal government. Because the Federal government backs the loan on behalf of your business, your small business is more likely to get approval than if you went directly to lenders. SBA term loans range from $500 to $5.5 million.

Who can apply?

For-profit businesses that operate in the US or US territories, with existing equity investment, with no additional lenders providing financing, that meet certain size standards are eligible to apply for SBA loans.

Pros

SBA loans are flexible from an amount and term perspective. Both short-term and long-term options are available, and SBA loans typically have some of the lowest interest rates available.

Cons

The application process is long and burdensome. Business owners may be required to disclose personal credit information and approval can take months. SBA loans are some of the most prized loans; therefore, they are often limited to those with a strong credit history, financial record, and adequate collateral to back the loan.

Traditional business loans

You apply for traditional business loans directly to the banks and financial institutions that loan funds. Loan amounts range depending on the lender requirements, lender size, and your business’ industry, size, and history.

Who can apply?

No one-size-fits-all answer exists for this question. You can spend days researching business and small business loans and find seemingly endless options. To explore options in the traditional business loan space, conduct your search with your company size, balance sheet, history, and personal risk in mind.

Pros

Flexibility is the key benefit to traditional business loans. You can apply for loans that fund general business purposes, or loans specific to capital investment (e.g. equipment, inventory, additional employees). The sizes of loans available also vary. But keep in mind, the larger the loan your request, the more information you will need to provide.

Cons

If you don’t have good business credit, a solid business history, or don’t want to personally back your business loans, you may have trouble gaining approval for traditional business loans.

Business lines of credit

A business line of credit is similar to a loan in that you apply for access to a specific amount of money. Once approved, you have access to the funds. Unlike a loan, a business line of credit allows you to withdraw only the amount of cash you need, and you only pay interest on that amount of money.

Who can apply?

The approval process is similar to a traditional bank loan; however, the process is more detailed and restricts your business from certain activities. For example, if you provide a certain type of collateral to secure the line of credit, the lending bank may disallow you from offering that asset as collateral for another line of credit or loan. Often, credit unions offer best-fit financing options.

Pros

Lines of credit are a great way to ensure access to cash is available in the event that your business needs it. At the same time, you don’t pay interest unless you use the cash available.

Cons

In exchange for the credit line approval, you will likely restrict your ability to secure debt financing from other sources. As mentioned, the credit line agreement your business will execute to secure the credit line may prevent you from offering your business collateral to other creditors, including suppliers and financial institutions.

Invoice factoring

Invoice factoring — or, invoice financing — is a business practice where your business sells your accounts receivable to a third-party company (the factoring company). The factoring company immediately pays your business a large percentage of the invoice amount (often 80% – 90%).

Your customer pays the invoice amount to the factoring company according to the payment terms of the invoice (30 days, 45 days, 60 days, etc.). Once your customer pays the factoring company the invoice amount, the factoring company pays your business the remainder of the invoice, less a fee to the factoring company.

Who can apply?

Factoring is generally available to any company that issues consistent invoices to customers on payment terms. If you have a sizeable customer base that pays your business consistently through invoices, your business may be an invoice factoring candidate.

Pros

Your business gains immediate access to cash due on each invoice. Instead of waiting the 30, 45, or 60 days for cash due on an invoice, your business gets the majority of that receivable immediately. This immediate payment from the factoring company increases your cash flow.

Cons

You never receive 100% of your accounts receivable. Even if the factoring company is able to collect 100% on the invoiced amount, you will pay a fee to the factoring company.

Specialty loans

Specific small business loan programs support certain people groups or causes. For example, the SBA’s Office of Women’s Business Ownership and Women’s Business Centers help female business owners find loans. The USDA helps small business owners in rural areas secure loans.

Who can apply?

Specialty loans are available to business owners with certain characteristics or businesses that participate in a specific category of work. To see if you qualify for specialty loans, search for loans based on your unique criteria (e.g. age, gender, ethnicity, disability) or industry (e.g. non-profit, agriculture, medical, research).

Pros

The average small business will not be eligible for a specialty loan. Specialty loans exist to bolster underserved demographics or causes. If you qualify for a specialty loan, you will face less competition in the approval process.

Cons

Specialty loans can require extra paperwork to prove your business meets the criteria, and the loan may restrict your ability to utilize funds. For example, if you receive a USDA backed loan, you may be able to buy farm equipment with equipment financing, but not buy new computer equipment.

Alternatives: Microloans, marketplaces, and credit cards

If you can’t qualify for a business loan or line of credit, you may consider loan alternatives: microloans, business loan marketplaces, or credit cards.

Microloans are loans with significantly lower principals than standard loans. Depending on the lender or lender marketplace, microloans can range from fifty dollars to a few thousand dollars. Microloans are often funded through crowdsourcing platforms and don’t always require the rigorous approval process associated with traditional loans.

Think of loan marketplaces (often, online lenders) as dating sites for debtors and creditors. Individuals may not be able to fund an entire business loan, but if their money is pooled with other individuals, they may be able to collectively fund a loan.

These individuals together become a creditor in a loan marketplace.

On the other side of this transaction, a small business that cannot get loan approval from standard lenders may be able to secure a loan from a loan marketplace. A pool of individual lenders is more likely to approve a risky debtor because the risk is spread across the multiple creditor lenders that come together to fund a single loan. Business loan marketplaces are growing in popularity for both individual creditors and debtors.

Finally, don’t forget about credit cards. Strangely enough, your business might not get approval for a $10,000 small business loan, but it may get approved for a $10,000 credit card limit. Many credit card issuers have specific programs tailored to small businesses.

These three loan alternatives might be good options, or the only option, for businesses that cannot obtain a business loan. If you have trouble landing a business loan, consider your credit card options.

Pros

All three offer your business buying power when your business is unable to secure a traditional business loan.

Cons

Microloans, loan marketplaces, and credit cards all tend to carry higher interest rates than small business loans.

2. How to get a small business loan

  1. Determine how much money you need
  2. Decide if a loan is the right method
  3. Select the type of loan that fits best
  4. Review the lenders available
  5. Review each lender’s requirements
  6. Collect information and apply

How much money do you need?

It may seem obvious that you should determine how much money your business needs before you start looking for a loan. But, don’t skip this step for three reasons.

First, the bigger your loan, the more you will pay towards interest. Your loan is an interest-bearing debt that will weigh on your balance sheet. You want to pay off your loan as efficiently as possible. The more you pay towards to principal, the quicker that loan will disappear from your business liabilities.

Second, remember that lenders make money on your interest payments. Accordingly, lenders want you paying interest for as long as possible. If you know how much money you need before you talk to the lender, the less likely you will fall victim to a lender convincing you to take out more money than you need.

Finally, loans affect your credit score. Too much debt negatively impacts that score. The less debt you take on, the less likely the loan will bring your credit score down.

Is a loan the best way for your business to access capital?

Before jumping into debt, consider your other options. Would it be better for your business to take on an additional owner in exchange for equity capital?

Instead of taking on a loan to higher additional employees, is it possible to outsource the work to a freelancer and avoid the need for the loan?

Loans aren’t necessarily bad, and they are a normal capital raising strategy for businesses of all sizes. However, many businesses burden their balance sheets with so much debt that they can’t recover. Make sure a loan is the right fit for your business before committing to a debt financing strategy.

What type of loan is the best fit for your business?

As mentioned, there are plenty of loan options for your business: SBA loans, traditional small business loans, specialty loans, lines of credit, and loan alternatives. How do you determine which one is the right fit for your business? Go through a list which each loan to determine suitability for your business:

  • Qualifications
  • Restrictions
  • Interest rate
  • Loan terms
  • Impact to credit

First, take a look at the loan qualifications to see if your business qualifies. If you qualify, review any restrictions that might apply to the loan. If restrictions disallow you from applying the funds as your business needs, the loan is not a fit.

Next, look at the interest rate and the term to see if your business can afford the loan. Look for any early pay penalties that may apply in the event that you can pay off the loan before the end of the term. Remember, lenders make their money on interest!

Finally, consider the impact of the loan on your business credit score. Some debt can improve your credit rating, but too much debt will pull that number down.

Review the lenders available to your business

Once you land on a loan type for your business, find applicable lenders. Think of your business as a customer during this process. Shop around. Play one lender against another, and search for the best deal possible.

Because lenders make their money on interest, they may not offer you their best rate at introduction. Don’t be offended by this. Push back. Let the lenders know that you are shopping their rates and terms against competitors.

A word of caution as you shop lenders: If you give a lender permission to check your credit score, the check will show up on your credit history. You don’t want your credit score checked too often in a short amount of time.

Get as many details as possible from a potential lender before you give permission to check your credit score.

What are the lender’s requirements?

Once you have narrowed down the list of lenders, make sure you understand their requirements before applying. For example, most lenders require collateral to secure the loan.

Collateral is an asset that your business owns. Typical collateral acceptable to lenders includes inventory, equipment, accounts receivable, and other business assets that have a value which is easily calculated.

The collateral needs to be similar in value to the loan principal to adequately secure the loan.

In the legal documents your fill out to finalize the loan, you will offer your business collateral as the backup. If you don’t pay the loan, the lender has the right to seize your collateral, and then sell the collateral to repay the loan.

In the event that a lender is not satisfied with your business collateral, it may require that you find a co-signer with better collateral. In this case, you want to find a co-signer before the loan documents are ready for signing.

Asking for a co-signer to risk his or her collateral to secure your loan is a big decision, and it isn’t fair to spring this on a co-signer at the last minute. A co-signer needs to make an informed decision about co-signing just as the lender makes an informed decision about loaning you money.

Understand collateral minimums, and any other loan requirements, early in the process. Give yourself time to determine what risks you are willing to take to secure your loan.

What documents and information do you need available?

The documents required to secure a loan vary from lender to lender and based on your business history.

If your business carries enough cash to cover the entire loan, you likely won’t need much more than a balance sheet and some recent financials. However, the fact that you are considering a loan probably means you don’t have that much in the bank.

In this case, you will need a few years of business financials, a written business plan, your business credit history, personal financial information, contact information, references and possibly more.

Lenders to specific industries want proof of your specialty.

For example, if you run a law firm, construction business, accounting firm, medical practice, or real estate agency; the lender may require you to show your professional licenses indicating your authorization to practice your business.

If you are a researcher, or your loan furthers product development in an advanced field, the lender may want to see your educational history and copies of your degrees.

If you are building new property, developing land, or laying new infrastructure, the lender may want to see surveys, blueprints, scopes of work, or other documents related to the project.

The more business information you have available, the more prepared you will be. If specific licenses, qualifications, or permits tailored to your business exist, have associated documentation ready for review when you apply for a loan.

3. Qualifying for a business loan

  • Basic loan requirements
  • How to improve your business credit score
  • Tips for getting approved

Loan requirements

Some baseline requirements exist to secure a loan:

  • Credit history
  • Business history
  • Business plan
  • Collateral

Credit history is ideally your business credit history. However, if you are a startup, lenders may require your personal credit history. In this case, make sure that you understand what your personal responsibility is if the lenders ask to check your personal credit history. If you co-sign a business loan, you are personally responsible for the debt incurred by your business.

Your business history is a brief description of your business and its financial track record. Prepare at least five years of financials and bank statements if you have been in business this long.

Lenders look at your history to predict the future.

They want to answers to questions like:

Is your business growing? Is your business profitable? If your business isn’t profitable, is it on a trajectory of profitability? The more information you can provide, the better your chances of getting approved.

Lenders want to know how you will use the funds. Unlike your pitch to investors and customers, lenders aren’t concerned with your groundbreaking ideas.

Your pitch to lenders should specifically address how you will apply the funds and how your business will pay off the loan.

For example, they want to hear that you will hire software developers with the loan money, and the applications the developers build will start generating revenue within six months of hire. They don’t care about the software itself, only that the software will allow your company to pay interest when due for the life of the loan.

Finally, lenders need a clear understanding of your business collateral. If you don’t pay off your loan, the lender needs to know how it will recoup the money it loaned you.

Collateral in cash form or a form that is easily converted to cash is most attractive to lenders. Accounts receivable is cash due from customers, so it is ideal collateral for lenders. Equipment and inventory are easily valued and can be sold to third parties in the open market; so, they are typically good sources of collateral.

Because your equipment, inventory, and accounts receivable all change in value as you operate your business, most lenders will require multiple types of collateral to finalize a loan.

If you have no collateral, the lender might require someone with adequate collateral to co-sign or guarantee the loan. Lenders don’t dish out money without being secure. Make sure you understand collateral requirements.

How to improve your business credit score

Your business credit score serves similar purposes as your personal credit score. However, because your business conducts more transactions than you do personally, there is more data available to base the score off of.

Examples include transactions, daily balances, outstanding debts, and payment history.

First, to start improving a bad credit score, start by obtaining your current scope through an agency like Dun & Bradstreet, Equifax, and Experian. Free options include CreditSignal, Nav, Credit.net, and CreditSafe.com.

With your credit score known, you can start improving it.

Start by paying your bills on time. Your creditors can and will report bad payment history. Pay on time.

Second, improve your credit utilization ratio. Your credit utilization ratio is the amount of credit used compared to the credit available to you. Some suggest a 15% credit utilization ratio to improve your credit score while others suggest 30%. Consider this range as acceptable, but do what you can to lower the number. You can lower the number by:

  • Paying off balances
  • Increasing credit limits
  • Decreasing debt and credit card spending
  • Paying bills on a more frequent than required basis

Third, open credit accounts with suppliers when possible. The more suppliers you pay on a timely basis, the better your business credit score will become.

If your business ends up in collections, make sure you pay off the amount as soon as possible and ensure that the collection agency deletes the negative report from your credit report.

A good business credit score is key to getting loans that you need. Consider these steps to improve your score.

Tips for getting a small business loan approved

Preparation is the single best thing you can do to increase your chances of getting approved for a business loan. Start the entire process earlier than you think is necessary. Research loan types, loan terms, and loan requirements before you actually need the money.

The same goes for your credit history. Know your business credit score now, and start taking steps to improve it. When it comes time to apply for the loan, hopefully, you will have already improved upon your initial score.

Get your finances in order, and your business plan together. Talk to others who have gone through this process. Lenders are always changing what they expect and what they look for. The more information you have walking into the loan application process, the better your chances are.

Think about the business loan application process as you would a sales pitch to investors or customers. After all, it is a business transaction. The lender needs to believe you will pay the interest and the principal to make sure the deal makes sense from their perspective. Be prepared. And, as a final tip, be wary of merchant cash advances.

4. Applying for a business loan

Once you have narrowed down the loan type for your business and determined you are qualified, it’s time to apply. To apply for a small business loan, you need:

  • Reason for the loan
  • Credit history
  • Business plan
  • Annual revenue
  • Tax returns
  • Financial statements

If you have followed the steps in this article, it should be as simple as bringing everything together.

Not only should you have identified the reason for the loan, but you should also have ruled out other capital-raising options, and ensured that you aren’t asking for more money than you need. You should have a very specific number in mind for a plan for using the funds.

Not only should you know your current credit score, have your credit history in hand, and it should be improving as you progress towards applying for the loan. Your credit utilization ratio should be improving, and you should be paying your bills on time. Don’t forget to clean up any negative reports on your credit report with the credit agencies.

You should be on the third or fourth draft or your business plan. This draft should include updates from experts and others who have been through the business loan process. Ideally, you know someone in the lending space who can give some tips as well.

Finally, your documents should largely be prepared. If you are a startup, you won’t have that many business documents, so have your personal documents ready to go.

Applying for a business loan can be intimidating. But, with some intentional preparation, you can increase your chances of approval and get the money you need to take your business to the next level.

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Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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