When you want to start a new venture or plan an expansion, you likely need to secure additional funding through small business loans. This solution can cover any need, whether it’s to purchase expensive equipment, sustain the payroll, and virtually any other purpose that relates to your business.
A Comprehensive Guide to Small Business Loans
You can reach your targets and objectives with the right financing options, one of the most crucial elements of a company’s success. Business loans exist to give entrepreneurs immediate access to cash.
There’s a caveat, however: if you pick the wrong loan, you could wind up with an inadequate financing offer or wait for months to receive the money that you otherwise need fast. It’s very important to choose a suitable loan that meets your needs.
This guide helps you understand what a small business loan is and whether you should consider applying for one. We at Booster Financial want you to understand the various loan types that can be made available to help your startup or small company flourish in the market today.
Small Business Loans: What are They?
A small business loan is a type of financing offered to companies by lenders to fulfill different purposes. It is a way for you to get a hold of money to fund your enterprise, whether it is to build, expand, or maintain it.
Most of your daily operations rely on the working capital, which is the total cash you have in your checking account after all liabilities are paid. This amount excludes the pending invoices to be paid by your customers. In some cases, your capital might not be enough to run your day-to-day operations.
Getting a loan makes it easy for business owners to maintain liquidity by supplementing the working capital. It’s the buffer for your short-term requirements like payroll, daily expenses, and seasonal hires. You could also use this money to renovate or remodel your business to usher in long-term growth.
Small business loans are considerably cheaper to get compared to credit cards. You would not have to give up a portion of your business to investors because you can fund your needs and plans through this loan.
How does a Small Business Loan Work?
Companies needing access to fast cash for various projects and operations can rely on a small business loan to fund their venture. These financial products can be offered to you depending on different factors like your credit standing and the financial health of your business.
When a lender assesses your eligibility for a loan, they will look closely into how much debt your company can afford. Lenders can treat your credit history as the guarantor, which refers to an individual held accountable for repaying the loan.
If you apply for a small business loan, your business and personal credit score might be the basis for which a lender assigns the loan amount and interest rates for you.
What do Lenders Require?
Small business lenders will investigate different debt, credit, asset, and operational factors that indicate your capacity and risks as a borrower.
Time in Business
Generally, a business that has been running for several years is perceived as more stable than startups and new businesses. Many lenders consider a company’s time in business a significant marker for borrower credibility.
A company with a proven track record of income for at least two years is a more attractive borrower than those with only six months’ worth of spotty revenue statements.
The lender may ask for a cash flow projection from you. This document shows when the cash is collected, when the money goes out, and the remaining balances after everything is settled. Knowing the details of your cash flow demonstrates to the lender how thorough your understanding is of your financial operations.
Your credit history is another factor that lenders use when inspecting your reliability as a debtor. In general, your credit score should reach at least the 600s mark to qualify for various financing products. However, several lenders may still approve you for a loan even if your score is as low as 500.
Collateral is any asset that a lender can seize by law should you fail to pay your debt. It could be anything of value to your business such as equipment, accounts receivable, or your company building. Lenders may also allow you to put up your personal properties like the house as the collateral on small business loans.
The debt-to-equity or D/E ratio is your company’s total debt divided by the equity of your shareholders. This data point helps the lender gauge your company’s capacity to cover a new debt based on the existing loan you’re already paying.
High D/E is a common trait in industries like telecommunications and utilities, and capital-intensive sectors like oil and gas. A higher ratio may indicate that the business is financed mostly through debt than their own funds.
Even if your business is included in such industries, it should be your goal to keep your D/E ratio the lowest possible.
The working capital is the available money your company uses to fund daily operations. This is the difference between your current assets (cash, customer invoices, accounts receivable, inventories) that are convertible to cash and your total liabilities (accounts payable and debts).
Types of Small Business Loans
There’s a broad range of small business loans to choose from so you can choose the best product that matches your company’s needs. Every loan type has varying terms and financial requirements that may differ from one lender to another.
Small business term loans are the most popular financing product for companies that need additional funds. The borrowing business will be given a lump-sum payment upon approval of this type of loan. This money can be used for a myriad of things, from paying business expenses to expansion or renovation and more.
In exchange for the loan, you will have to make recurring payments with interest, the schedule depending on the agreed terms with your lender. You may also have to pledge collateral, whether in the form of cash, equipment, property, inventory, or other assets accepted by the lending agency.
Small Business Administration or SBA loans are government-backed products that have similar attributes to bank term loans. The SBA itself does not lend cash to businesses; instead, it collaborates with banks and credit unions to provide guarantees on loan applications that meet the SBA’s requirements.
There are four types of small business loans under this type:
7(a) loan program. The 7(a) loan is the primary program offered by SBA, which is also the most flexible. It can be used for different purposes, which include working capital, purchase of equipment or land, and debt refinancing. The maximum loan amount is $5 million with a loan maturity of up to 25 years for fixed assets and 10 years for working capital.
Microloan program. SBA’s microloans can be offered by intermediary lenders that make loan products up to $50,000 with a maximum repayment term of 6 years.
Real estate and equipment loan programs. SBA also offers CDC/504 loans to provide businesses with long-term financing at a fixed rate. These programs are structured in a typical manner: 40% of the total project expenses are funded by SBA, while the participating lender covers 50%. The borrower will shoulder the remaining 10% of the costs.
Disaster loans. Businesses of all sizes may apply for disaster loans of up to $2 million from SBA. These funds can be used to replace or repair assets that were destroyed or damaged in an officially declared disaster.
Small Business Lines of Credit
Lenders may offer a small business line of credit for companies that need flexible access to cash in periodic intervals, as opposed to borrowing a lump sum. Once you are approved, the lender gives you access to a fixed amount of money within a set period.
This type of small business loan is like a credit card wherein you can pull out money up to the loan limit during the draw period. You will only need to pay for the interest incurred on the money you used. When you repay your debt, you may re-borrow it within the set period as well.
However, business lines of credit may have higher spending limits and lower interests compared to credit cards.
If you don’t have the capital to purchase large equipment, you can consider equipment loans offered by several lenders. These loans can help you finance expensive vehicles, machinery, and equipment with retainable value like furniture or computers.
Most lenders will treat the purchased equipment as collateral in case the loan defaults because you missed paying your dues.
Small Business Credit Cards
Company-related expenses may be paid using small business credit cards without needing to disrupt the cash flow. When you get approval for this type of loan, you can use the credit card to finance your needs, especially if you require fast access to cash.
The downside to this loan product is the higher interest rates that are typical for credit cards. Ideally, you must maintain a high balance to ensure that you’re not paying more than the amount you borrowed in the long run.
Merchant Cash Advances
MCAs or merchant cash advances are the fastest way for you to access additional capital. However, this should be your last resort when thinking of applying for a small business loan. This product provides you with a sum upfront against your future sales. You will receive the loan amount in exchange for some of your future sales.
The lender may ask for a cut from your debit card and credit card sales to repay the money you owe. Alternatively, they can also pull your payment from your business bank account through Automated Clearing House or ACH withdrawals every week.
Invoice Factoring and Invoice Financing
If your business struggles to receive payments on time, you might find accounts receivable financing or invoice factoring useful. Through invoice factoring, you can sell your unpaid invoices and receive a portion of the receivable upfront.
In invoice financing, the unpaid account receivables are used as collateral in exchange for cash advances on the amount you are owed.
Commercial Real Estate Loans
Commercial mortgages can assist you in financing new or existing properties for your business, like a retail space, office, or warehouse. Real estate loans act like traditional term loans and allow you to buy a new commercial property. You can also use it to expand your existing location or refinance another mortgage.
Franchise Startup Loans
If you want to own a franchise, you can benefit from a franchise startup loan. This financing product offered by banks and lenders can be utilized to help you realize your dream of becoming a franchisee. The loan can be used to pay for franchising fees and equipment, as working capital, and to build your establishment.
What are the Benefits of Business Loans?
A business loan is a great way to keep your business afloat despite the ever-changing market trends and financial issues you encounter along the way. It’s a short-term solution to boost your cash flow or purchase much-needed pricey equipment.
For owners who unfortunately stacked their obligations, business loans can also become the exit plan for this dilemma. It can be used to consolidate debts with high interest, allowing the company to repay multiple debts using a single loan product.
Other than business growth and expansion, a small business loan can provide other benefits for your enterprise.
Full Control of Your Company
When you borrow money from the bank or alternative lender, they will usually not command you to use the money in a specific way. The same cannot be said when you receive funding from investors. Shareholders typically have a say in how you run your business.
If you seek funding from a lender, you have more freedom to decide on how to best maximize the money you borrowed. Although loans come with fees and interest, you don’t have to give up a portion of your profits. You can also maintain total control of your day-to-day operations.
Do you need immediate access to cash for your business? If you opt to raise capital through investors or venture capitalists, it could take you months or years to gather the money. Alternatively, small business loans are the better option in this scenario.
Borrowing money from online lenders, credit unions, and banks can provide you with the amount that you need at a much faster pace. Some alternative lenders may even approve your loan application in a matter of minutes.
Lower Interest Rates than Credit Cards
Credit cards have a higher cost to borrow than business loans. If you have a stellar credit history, you can avail yourself of loan products with as low as 2% interest rate. On the other hand, credit card interests can go as much as 13.9% and up.
Therefore, it’s crucial for you to maintain a good credit standing if you want access to loan products with attractive interest rates. It may also improve your chances of getting approved for the loan you prefer.
Variety of Loan Products
Business owners can choose from a wide variety of small business loan types offered by different lenders. Every business has varying needs, which makes this solution perfect for just about any financing purpose.
However, you must be careful in choosing the most suitable loan product for your company. For example, some loans are used specifically to purchase equipment, while others are made for refinancing and as growth capital.
What are the Drawbacks of Small Business Loans?
Business loans offer plenty of advantages, but they also have a few downsides to consider.
Your Credit Score Matters
Getting low repayment rates often has to do with your credit score. Usually, the lender will provide you with loan products depending on how good (or bad) you are as a creditor. If you have a below-average rating, you are less likely to enjoy lower interest rates. As a result, you might be paying more for the loan privilege in the long run.
Banks Prefer Established Businesses
Startups and small businesses may find it difficult to apply for a loan from banks and other traditional lenders. Some financing institutions want borrowers that show signs of success such as in stellar revenue projections or sales statements.
Companies with spotty revenues or those that don’t have a lengthy time in business may be treated as high-risk by lenders. It could be more challenging for upstart companies to secure a loan with better terms and interest rates.
Lenders May Require Collateral
Financial institutions prefer borrowers that can offer collateral, which will be used as security for the money owed. If you apply for a secured loan, you will be expected to pledge company assets or properties before you can get approved. Collateral is a way for lenders to recoup their losses if you fail to pay your debt.
That means if you’ve put up your pricey equipment, buildings, or your house as collateral, the lender can legally seize and sell the asset if you cannot meet your obligations. You can lose the valuable investments you offered as collateral in the process.
Questions You Should Ask Before Applying for a Loan
Before deciding on getting a small business loan, it’s essential to determine whether going into debt makes sense for the future of your company. Here are a few questions to ask yourself before shopping for business loans.
How much cash do you need?
What will you spend the money on?
How long will it take for you to pay back?
How long have you been operating your business?
What’s the current financial status of your company?
What is your credit score?
How much collateral can you manage to put up for the loan?
Do you have other existing loans?
Do you need a long-term or short-term financing option?
How to Get Small Business Loans
The process of applying for a small business loan is different for every lender and loan type that you seek. In general, short-term loans have less paperwork compared to long-term financing. Equipment financing, for instance, does not demand a lot of documentation unlike business lines of credit.
While the requirements differ from one lender to another, it’s ideal to have these documents prepared in case the lender requests a copy.
Researching Available Lenders
These days, it’s not too difficult to find the right lender that can provide the most suitable loan product for you. A simple online search can turn up several page results—the key is to understand what each lender could offer you.
Large Commercial Banks
Traditional loans are often offered by commercial banks with branches nationwide, making it convenient to transact. However, the approval process in banks tends to be longer because of stricter loan underwriting criteria.
Community banks can offer various loan products and are typically designed to help small local businesses kickstart their venture.
Lenders Backed by SBA Guarantees
Even if the SBA does not provide loans itself, you can still apply for SBA-backed loans offered by partner banks and lenders. Although it’s not easy to qualify for an SBA guarantee, you’d be privy to loan products with more attractive terms if you meet the specified requirements.
Borrowing businesses that fail to qualify for traditional loans can seek peer-to-peer lending sites, which act as the middleman between the debtor and various lenders. However, there’s always the risk of sky-high interest rates.
Alternative lenders offer a myriad of small business loans with easy online application and processing. Financing agencies like Booster Financial help startups and small companies finance their needs by providing loan products with fast approval and favorable terms.
Organizing your information
If you want your loan application approved, you must first ensure that you can provide detailed information regarding your business and yourself to the lender. A different lender may ask for different requirements, but these types of info are almost always included:
Name of business, which includes any “Doing Business As” or DBAs
Federal tax ID
List of your company’s executive officers including their background
Legal structure (C corporation, S corporation, LLC, etc.)
Projected financial statements
Good standing certificates, certificates of incorporation, and other state filings for the business
Copies of insurance policies
Loan amount requested
Business credit report
Potential collateral for the loan
Personal financial statements if necessary
Business plan and executive summary
Bank statements of the business
Preparing Your Financial Statements
Profit and Loss Statement
Also known as the income or P&L statement, this paperwork is a summary of the revenue and expenses of your business, with profits or losses over a specific period (quarter, fiscal year, etc.) stated in detail.
Cash Flow Statement
This document tracks your business’ cash on hand at a specific time. The cash flow statement helps you understand how much money is left to cover monthly expenses, unlike P&L which takes non-cash costs such as depreciation into account.
The balance sheet details your assets and liabilities for a specified period. As there’s no standard format to it, the balance sheet may vary depending on what industry your company belongs to.
The business plan is your portfolio that bears the scope and nature of your operation. It includes your projected income and costs. This document is essentially your guide to decision-making. For lenders, investors, and partners, the business plan is useful in evaluating your company’s potential.
Tax returns, both business and personal, might be asked of you once you apply for a loan. These documents help the lender verify your income and inspect your capability of repaying the debt. You can assign your business accountant to prepare the tax returns for your small business loan application.
Preparing the Specifics of Your Loan
When applying for small business loans, it’s important that you have a clear picture of how much you are borrowing and where you will allocate it if approved. Will you purchase additional equipment? Are you planning to renovate or expand? Do you need to stabilize your cash flow or supplement your working capital? Will you use the money to boost your marketing and sales?
Also, you might want to consider adding a little extra to your preferred loan amount in case you meet financial difficulties along the way. This tactic allows you to avoid a loan default.
Providing Security or Guarantee
The lender’s biggest concern is if you can repay your debt once you get approved for a small business loan. You might have to give a security interest on company assets like commercial property, accounts receivable, equipment, and more. This way, you can increase your chances of being offered a loan with favorable terms.
Other lenders ask for a personal guarantee from the owner or principal shareholder of the company. However, it’s better to avoid this scenario as it puts your personal assets at risk.
What is the Easiest Loan to Get?
If you need money ASAP and are confident with your credit score, you can approach online lenders as they are typically the easiest route to funding. Application and approval can happen in a matter of minutes, and you can receive the money in just a few days.
Do Loans Cost Money During the Application Process?
Some lenders may have fees associated with their loan application. The lender could tie different charges to the process, such as payment for appraising your collateral or running a credit report.
What are the Things to Consider When Choosing Alternative Lenders?
Before you choose an alternative lender, you should consider:
Interest rates. Small business loans are meant to be repaid relatively quickly. Before you agree to the terms, make sure that you can pay the loan plus interest within your capacity.
Fees and policies. It’s good to ask about all the fees that can be incurred throughout the loan application and approval processes. You should also ask your lender about the policies regarding the loan, such as how the repayment schedule can affect your cash flow.
Lender review and rating. Any lender can claim that they have the best loan products in the market, but not everyone is telling the truth. Before you go ahead with your application, make sure to read up on the lending agency’s reviews and rating with the Better Business Bureau.
Is a Personal Guarantee Necessary for Small Business Loans?
Ideally, a borrowing business that can provide a personal guarantee from its owner or principal shareholder can have more attractive loan products offered to them. However, it comes at your personal expense—your assets and personal credit score can take a hit once your loan goes into default.
What is the Best Business Loan for Startups?
If you are starting a business but lacking the necessary capital to fund your venture, reaching out to online lenders might be your best choice. Unlike banks and other traditional lenders, online financing agencies may approve your loan even if you haven’t been in the business for a long time.
What’s Next if the Application is Denied?
If the lender denies your business loan application, the best course of action is to determine why they decided to sack your request. Is your business credit score too low? You can focus on building or repairing your credit if that’s the case. Knowing the reason allows you to fix the issue so that you can try applying for the loan again.
As a business owner, you have plenty of options when it comes to small business loans. The key is to know your company’s most pressing needs and determine which financing products are the best solution to your woes.
Is your business in need of additional funding? Our experts at Booster Financial are ready to answer your questions and give salient advice on how a small business loan can foster your company’s growth. We have a broad range of funding options that fit your every target and goal. Our financing agency will be more than happy to take you on as our valuable customer today!