Applying for and obtaining a small-business loan can be a long and complicated process. Not only do most financial institutions have high lending standards, but they are also more inclined to invest in larger, well-established businesses. Although intricate, the process of deciding on and applying for this type of loan can be greatly expedited with a little research and preparation.
Before starting the application process, think about the following:
1. Consider Why You Need the Loan
To what area of your business will you apply the funds? Evaluate whether they will be used to cover payroll, daily operation expenses, marketing campaigns, necessary equipment, or serve as a cushion or emergency funds. Once you have identified the intended purpose of the loan, determine the amount of money you will need to cover those business expenses. Try to make accurate and realistic projections about the financial needs of your company – asking for more than what your business requires could negatively affect your loan application.
2. Determine Which Type of Business Loan Meets Your Needs
If your company is a start-up, your odds of qualifying for a bank loan are slim. Nevertheless, there are other options you may want to consider, such as crowdfunding sites, credit cards, personal loans, grants, microloans from the U.S. Small Business Administration (SBA), or alternative online lenders.
Businesses that have been in successful operation for over a year have a greater range of financing options available. Banks, SBA lenders, credit unions, and online lenders offer alternatives such as term loans, lines of credit, and accounts receivable financing, among many others.
Here are a few examples of different types of loans available for small businesses and some of their relevant features:
• 7(a) Loan Program – Basic and flexible, these loans can be used for a variety of purposes, but eligibility depends on specific aspects and principles of the business. The maximum loan amount is $5 million and the maximum loan term is generally 10 years or 25 years for real estate. The maximum interest rate can be either fixed or variable, composed of a base rate and an allowable spread. According to the SBA, loans with maturities of less than seven years have a maximum spread averaging 2.25%. For loans with maturities of seven years or more, the maximum spread is 2.75%.
• Microloans – A good option for those who do not qualify for traditional small-business loans. This program provides loans of up to $50,000 for small businesses and certain non-profit childcare centers through intermediary lenders. The SBA states the average microloan is about $13,000 and the maximum repayment term is six years with an average fixed interest rate of 7.9%.
• Real Estate and Equipment Loans – This program grants financing for major fixed assets such as equipment and real estate. The maximum loan amount is $5 million or $5.5 for manufacturers and energy efficiency projects. The maximum loan term is 20 years with a fixed interest rate of 5.44%.
• Disaster loans – These are low-interest loans that can be used to repair or replace real estate, machinery, equipment, inventory, and assets damaged or destroyed in a “declared disaster.” The maximum loan amount for qualified businesses is $2 million.
Conventional Loans from Banks and Alternative Lenders
• Term loans – Term loans have specified monthly or quarterly repayment schedules and fixed or variable interest rates. They typically require collateral and a thorough approval process but maturity dates can run from less than three years to 25 years, depending on the type of term loan.
• Short term loans – Short-term loans are similar to regular term loans, but have maturity dates of less than a year. Some lenders may require collateral or verify the borrower’s credit, depending on the amount borrowed.
• Working-capital loans –They finance the continued operation of small businesses attempting to increase their revenue. These loans can have high interest rates and some can potentially damage the credit of the business owner in the event of missed payments.
• Equipment loans –These allow business owners to make monthly payments towards the purchase of office equipment, machinery, tools or vehicles. It is easier to qualify for this type of loan that for a conventional bank loan because the equipment qualifies as collateral. In addition, there is less paperwork involved and interest rates are generally low.
• Merchant cash advance –Merchants are able to receive an advance from future credit card sales or revenue with this type of loan. Some lenders deduct a fixed, daily amount of money out of the borrowing business's account and others a percentage of the daily credit card sales. They are easily approved and the funds arrive quickly, but interest rates can be much higher than those of traditional loans.
• Lines of credit –These types of loans are also provided to cover the daily operating costs of small businesses. A maximum loan balance established by the lender is available for the company to use at any time. They may not take more than what is available and are obligated to make minimum payments, but the business only has to pay interests on what they have used. As they are unsecured loans, they don't require collateral and have longer repayment terms. When considering this option, be wary of additional fees and keep track of how much you borrow.
• Accounts receivable financing – This type of financing agreement offers the borrower an advance of 70% to 90% of the value of their outstanding invoices or receivables, which also serve as collateral. The lender charges a factoring fee and bases the lending amount on the size of the borrowing business and the age of the invoices -- they are considered less valuable the harder they are to collect.
3. Select Which Type of Lender to Work With
Is your business a start-up? Has it been in successful operation for over a year? If so, what are your business’ annual revenue and net profit? Do you have collateral? What is your credit score? Do you have a business plan? Answer these questions and consider the following options:
Small Business Administration Loans
The Small Business Administration (SBA) offers several loan programs for different types of businesses. The loans are financed by partners such as banks and microlending institutions while the SBA sets the guidelines for those loans. Since their system works through intermediary lenders and each one determines their lending and credit requirements, each loan type offered through the SBA has particular repayment parameters, limiting how the funds may be used and when they must be repaid.
SBA loan terms tend to take into account the needs of the business owner while minimizing risks for the lender through a government guarantee. However, this option would entail additional paperwork and fees, making the approval process much slower.
Traditional Bank Loans
Some banks may provide SBA loans, yet conventional bank loans differ from SBA loans in that the government does not guarantee the bank will be paid back for the money borrowed by the small business. That means the loan approval process is typically faster than that of SBA loans, but getting approved could also be difficult. Also, conventional bank loans tend to have lower interest rates but significantly shorter repayment times.
Online lenders and lending marketplaces are good options for small businesses with a less-than-optimal financial history, who need funds quickly, or lack collateral. Since these lenders offer online applications, the approval process tends to be faster, but the rates can be higher than those offered by banks. The loan parameters and APR rates vary widely from company to company, depending on the size of the loan, the repayment term, the small-business owner’s credit history and the collateral, if required.
4. Compare Various Lenders
Before making a decision, think about the needs of your business and gather information about different lenders and the types of loans they offer. Once you have selected a financing method, consider the following elements and compare how they vary between lending institutions:
• Interest rates – The amount charged by a lender for the use of assets, in proportion to the outstanding principal or loan. These can be fixed or variable, depend on the loan type, and are often calculated on an annual basis – also known as annual percentage rate or APR. Lending institutions tend to charge low interest rates to low-risk borrowers and high interest rates to high-risk borrowers.
• Origination fees –The bank will deduct a percentage of the loan for “processing” from each loan disbursement received by the borrower. Since the amount you will receive will be less than what you borrowed, include any loan fees when calculating what you want to request. There are many other types of fees or penalties, among them late payment fees, unsuccessful payment fees, and check payment fees. Some institutions will also charge prepayment fees, which penalize you for paying off the loan early.
• Loan maturity dates and amortization– Loan maturity refers to the final payment date of a loan, or life of the loan. When a loan reaches maturity, it doesn’t necessarily mean it has been paid off. Since a portion of repayments go towards interest and another towards the principal, it may be a while before the greatest portion of your payments are allocated to the principal alone.
• Loan repayment – Use an online tool to help you calculate and stay on track with monthly loan repayments. This will require basic information about your loan such as the principal amount, interest rate, loan term, and start date.
5. Decide Whether You Can Meet the Qualifications
Banks and alternative lenders have different lending standards, which also vary depending on the type of loan requested. Here are some general considerations to keep in mind before applying for any loan:
• How are your finances? – Between income and expenses, is your business able to cover monthly loan payments? Lending institutions may ask to see balance sheets, income statements and cash-flow statements to analyze financial strengths or weaknesses.
• Do you know your credit history? – A healthy credit score is a valuable asset. While banks may require your credit history and consider your credit score, online lenders may not.
• Do you have collateral? – To secure loan repayment, banks often ask for something to be pledged as collateral, an asset to be forfeited in the event of default. The collateral required will depend on the size of the loan. For smaller loans, assets such as equipment and even livestock may be pledged.
6. Track Down the Necessary Documentation and Apply
As previously mentioned, banks and lending institutions each have particular loan requirements, but having certain documents at hand – such as a completed loan application form and a business plan – could save you time and effort. A well-crafted business plan is not only essential for the success of your business venture, but also a common requirement when applying for small-business loans. Some lenders and creditors may ask for additional information, but the basic elements of a business plan are the following:
• Mission Statement & Company Description – A concise introduction that describes your business, business model, aims, and values.
• Description of Products or Services – A description your products or services and how they differ from those offered by your competitors.
• Market Analysis – A comprehensive description of your industry, the market you are trying to enter, your potential customers, their needs, the place your business aims to have in that market, and how your products or services will cater to potential customers.
• Organization & Management – An explanation about how your business will be organized. It should introduce your management team, highlighting their individual strengths, qualifications, and previous experience.
• Marketing Plan – A description of your marketing and sales plan, detailing the tools and advertising strategies you will implement to give your business a competitive advantage.
• Revenue & Cash Flow Statements – An estimate of revenue, cash flow, and expenses that contains both prospective and historical financial data, profits, losses, etc.
• Executive Summary – A powerful and succinct description of your business, briefly touching on the aforementioned points and highlighting the company’s strengths, current financial status, and long-term goals.
Small-business loans are a great way to obtain funding for your start-up or thriving business, whether to cover day-to-day operational expenses, equipment, renovation costs or property damage. Regardless of your reasons, there is a great number of products and services available from both government and private institutions. Although long and often complicated, the process of applying for and obtaining a small-business loan doesn’t have to be an uphill struggle. There are numerous factors to consider, so shop around, compare, and read the small print. The better informed you are, the more confident you will be in your decision.