It’s easy to see why a small business owner might be intimidated by lenders when submitting a loan application. It requires an awful lot; hence you cannot just wing it. As a first-time borrower, you’ve got to take it seriously and make the necessary preparations. In fact, you will likely need three months, more or less, to scout for potential lenders and prepare your documents business bank statements, among other things. It would also help to research and learn how business loans work and what is out there.
But before you even get either too excited or nervous about your initial foray into securing small business financing from a traditional lender, ask yourself, “Do I really need a business loan? Am I qualified? What do I need to do to get a loan approval? ” This article aims to help you answer these questions and prepare you for your small business loan application. It will hopefully increase not only your loan approval odds but also strengthen your commitment to repay your lender without fail.
Setting your expectations
It is not unusual to feel optimistic when you consider applying for a small business loan. After all, a good amount of positivity can help carry you through whatever situation that may be. However, you have to be realistic in your endeavor.
First of all, most lenders will have many requirements from a startup business or a new borrower, and they probably won’t waive any of them. And the irony is business owners are applying for a loan because they don’t have the funds to finance their local business. Yet, the creditor should see if you have enough assets as security and your business income is high based on a positive cash flow to repay them. If everything fits, you are a source of profit for these lenders.
In any case, the burden of proof essentially lies in you. You can’t expect banks to make concessions at this point, and nothing is personal. If at all, it’s the client who will come after them, and not the other way around. You shouldn’t be disheartened nonetheless; you have to put in an effort, especially since getting the funds you need can make all the difference for your business growth.
Build your credit/ risk profile
Credit scores are everything; you cannot get funding from major lending channels like commercial banks without a solid credit history. And it’s not just loans; they can prevent you from renting an apartment, assigning utilities to your name, and worse, even landing a job.
Your credit score is based on the details of your credit report at the time of verification. It is important to know your current credit score before you pursue your loan application. You can get this information through credit bureaus or any credit reporting agency for free.
If it turns out you don’t have a strong personal credit score, you still have an opportunity to do something about it. The same goes for your business credit score, which is basically non-existent when you are a startup or without any prior business loan. As such, your creditor will depend on your personal credit score that you must check. Unless it is erroneous, which you can correct by raising a dispute with the credit bureau, you can work on your creditworthiness when your score falls short of the target. However, you will have to put your loan application on hold. Anyhow, below are steps you may consider to give your credit score a much-needed boost.
1. Use your credit card responsibly through small purchases that get paid in full every month.
2. If you can only pay the minimum due of your credit card or credit line each month, make sure you keep your usage to a maximum of 30 percent of your credit limit.
3. Always pay your credit card, utility bills, and loans, if any, on time. However, these accounts should be under your name, so they get recorded in your personal credit history.
4. Be watchful of identity theft which can negatively impact credit scores, by checking your credit report frequently.
5. Don’t disregard credit cards that you haven’t been using for a while just yet, especially if you’ve had them for years. Tenure is also an important factor that impacts your score.
6. Check if you have other bills with maxed-out balances and prioritize their payment to lower your credit utilization rate.
7. Apply for a short-term credit builder loan from credit unions and online lenders. It works by holding loan amounts in a bank account until borrowers finish paying them in installments. You can hit two birds with one stone: build credit and save at the same time.
How long does it take before you see any improvement?
If you’re trying to repair bad credit, it may take more than a year for your score to increase substantially after performing all the credit-rebuilding measures. But if you’ve just fallen short of the acceptable credit score, you may be looking at up to 6 months to see any noticeable change. Hence, you should expect to put off your loan application for several months to a year.
Learn about your loan options
A business owner will have to make the right choice regarding the type of loan they will apply for. There are two general loan criteria; collateral and interest rate. You have secured and unsecured loans, which refers to having a collateral requirement or not. The other would either be fixed or variable interest rates. Both criteria can be crucial in getting the best loan possible for your needs.
Online lenders would usually have the same loan offerings as traditional lenders. California finance lender loans, for instance, also require collateral during application. Below are the different loan products you can consider getting to serve your business purpose:
Perhaps the loan that many people are familiar with, term loans involve direct borrowing that should be repaid within a specified period or term. For entrepreneurs, term loans provide a great source of working capital to cover shortfalls in operational expenses, among other reasons. The loanable amount can be as high as 2 million dollars, payable between a year and five years for qualified loan applicants. This loan is released as a lump sum, carries a fixed rate as low as 6 percent, and often requires collateral.
Business line of credit
A line of credit is ideal for those looking for flexibility but need a little less than what a term loan can accommodate. It works in such a way that once you are approved for this type of loan, you don’t have to use the funds right away. Instead, they are on standby, ready to be accessed anytime you need them. Your interest is charged based only on the amount you take out from your pool. It is revolving such that all your repayments will replenish your credit line. Hence, there is no fixed term; it depends on how soon you can pay off your withdrawn amount.
Small Business Administration loan
SBA loans are funding instruments by the Small Business Administration or SBA, a federal agency. They focus on assisting small businesses that would otherwise have difficulty getting help from a traditional lender. They have different loan programs similar to standard small business loans, except that the government backs them. SBA does not grant them, but banks and authorized lenders do; hence they are more appropriately called SBA-backed loans instead. In case of a business defaulting, the government shoulders up to 80 percent of the borrower’s outstanding balance.
Merchant cash advance
This loan is a type of receivable financing which differs from other business loans in the premise. The business owner is given an “advance” of their projected income. They repay it based on a percentage of their credit card sales or sales deposits to their business bank account. You can get approval in one day without involving heavy paperwork. Often, the borrower would only need to present their cash flow statements and a few other documents. However, a higher interest is a price to pay for ease of processing and convenience.
Accounts receivable financing
Your sales are doing great, but where is the money? Oh wait, you have piles of unpaid invoices! This scenario is very common, impacting your company’s cash flow. You can’t put your operational expenses on hold while you wait to get paid. Hence, one option for small business owners is to secure accounts receivable financing from a factoring company. They finance up to 80 percent of the total amount of open invoices and purchase orders, which you can repay within a year.
When you need money to purchase equipment or anything related to your business, such as processing software, equipment financing might be your best bet. Many lenders can accommodate up to five million dollars for this type of business loan, but you will be required to put up a down payment for the purchase, which is usually twenty percent of the purchase amount. The item you will use the loan proceeds for will serve as the collateral for the loan.
Gather financial documents
When applying for a business loan, lenders need assurance that the money they will lend you will be repaid within the agreed period. As such, borrowers should substantiate their loan request by providing business financial statements and business licenses. Organizing these documents is important because they serve as proof of the existence of your business and provide comprehensive information on your personal finances.
Financial reports such as a profit and loss report, balance sheet, and cash flow statement can further increase your loan approval odds. If you have a startup, you can submit personal financial statements or apply for personal loans instead. These documents should reflect your capacity to repay your loan as they are also used as bases for lenders on how much interest they will charge you. Ensure that you have an audited financial statement or one that a CPA or Certified Public Accountant has at least reviewed.
Meanwhile, you might find that alternative lenders who are generally less stringent with documentation may require the same. However, it also depends on the type of business loan you will apply for. Small business loans such as merchant cash advance, invoice financing, business credit card, and equipment financing may require fewer documents.
Create a business plan/ loan proposal
Aside from financial documents, borrowers should submit a formal business plan along with their application. You want to convince your lenders that your business, especially if it’s a new one, that your idea is viable and has strong growth potential. A good business plan must be comprehensive and includes your financial projections, which are crucial. Lenders are also curious to know what product or service your business offers, your competition, your key employees, among others. When your business has been operating for several years or more, you can present your past financials along with forecasts.
Key points of a business plan
1. Include an executive summary where you will briefly describe your business and the current economic climate that surrounds it.
2. A market analysis will present an overview of your industry and its outlook, your target patrons or niche if any, and a brief marketing strategy.
3. Present an organizational structure, its description, and projected salaries.
4. Your financial analysis should be at least three years, or up to five years if necessary.
5. Explain why you need small business financing but itemize your reasons, including how much cash you need.
Look for potential lenders
When considering a business loan, one should take the time to “window-shop” and compare lenders and financial institutions. Not all share the same loan offers, each having its terms and, more importantly, interest rates.
Types of lenders
– commercial banks
– online lenders
– community banks
– peer to peer
It is important to know the right questions, such as their recommended business loan for you, documents you need to submit, processing time, collateral requirements, and other details. That’s why arming yourself with some financial fundamentals so you will be more confident in throwing technical inquiries, and at the same time, you’ll be able to understand the answers. If you consider an SBA loan, you can also ask if your bank has a preferred lender status. The advantage of being an SBA preferred lender is a shorter processing period for SBA loans.
Tips in choosing a lender
1. Check their requirements
As mentioned earlier, some lenders have more relaxed guidelines and qualifications. This option may be good to note, especially if you cannot meet a high credit score, for example. Some business lenders put more weight on other elements like collateral or the type of loan you are applying for.
2. Review their terms and fees
Ask your potential lender for a copy of their terms which you can go over in detail. You should not take it for granted as it can be crucial, especially when you encounter unforeseen events. Also, consider how much they charge in other fees and penalties.
3. Reasonable interest rates relative to the type of loan and requirements.
When comparing interest rates, they should be in the same loan category. For instance, lender A offers 6 percent for a short-term loan while lender B is 7 percent. You cannot compare if it’s two different loan types. A business line of credit will generally have a higher interest than an SBA-backed loan. But sometimes, you might go for lender B even if it has a higher interest because they do not require collateral. Hence, your decision to choose the best lender based on the interest rate can also be influenced by other factors.
On the other hand, make sure that you know the rates that are being quoted to you by your lender. The interest may be low, but the APR is different and usually higher because it includes other fees that come with your loan. When dealing with alternative lenders, be wary of factor rates which can be deceiving. Hence, you should always ask the APR as it gives a more precise cost of your loan.
Find out what form of security you can offer
Realistically speaking, financial institutions are likely to require collateral for your loan. Although it doesn’t guarantee your approval, it increases your odds of getting it. A secured loan is also one way to snag a lower interest rate from your lender. For instance, if you require 100,000 dollars, you should find collateral that has a slightly higher cash value.
Often, lenders will cover a percentage ranging from 80% to 90% of the asset value to cover the depreciation cost. While many borrowers prefer not to present collateral, it can be beneficial for them because they can use it as leverage to get better loan terms. It also helps you be more responsible and diligent in your loan obligation because you would not want to risk losing your asset to your creditor.
Meanwhile, here are examples of business collateral and their corresponding value that the lender is willing to finance:
Real estate – up to 75 percent
Inventory – up to 50 percent
Equipment – up to 80 percent
Bank deposit – up to 90 percent
Other personal assets – up to 70 percent
Analyze your business ability to repay
As already mentioned, lenders will always want to know if you can repay the loan money they will loan you. They use your debt service coverage ratio, which measures your cash flow against business debts, to assess your paying capacity. It is computed by dividing your annual net income from your annual debt payments. Typically, lenders prefer a ratio of 1.15 or higher. Having a value lower than one only means you have a negative cash flow. In short, you don’t have enough money to cover your debts, and if at all, you would be using your savings a lot more, which shouldn’t be the case.
Borrowers can compute for this financial ratio, so you can still do something to improve it before submitting your loan request. If you find your DSCR lower than 1.15, you can look for other means to increase your business revenue and reduce your operating expenses. In doing so, you don’t only increase your loan approval odds, but you also get to improve your business finances.
The Final word on Small Business Loan Financing
Once you have decided to secure a small business loan, make sure that you consider one that is most suitable to your needs and your ability to repay. It also helps consult a financial planner before inking a loan deal to avoid grey areas and ensure everything is in order. Remember that this loan should ultimately help your business, not add an unnecessary burden to you.