Business Loans

A business loan is the most common source of funding for a small business.

Most people think of banks as the go-to source for loans. But lenders can also include credit unions, commercial lending companies, and the government (Small Business Association).

A lender must be willing to loan you money and in return, you must agree to their repayment terms.  When you sign for a loan, you are promising to repay the borrowed money plus interest in a certain amount of time.

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The Basics

While business loans are common, they are not always easy to get. Lenders assume a great risk and ask that borrowers meet certain requirements to receive a loan.

Borrowing money is a risky endeavor for the lender, but you are also putting your business and good name on the line. As a borrower you must PROVE yourself to be a trustworthy entity.  Get organized, do your homework, show that you’re loan-worthy by representing your business in the best possible light.

 

Lenders look for 5 things before they will establish a financial relationship with you:

  1. Strong Business Plan
    Do you have a business plan? A strong business plan is the KEY to securing a business loan. You must show a complete and thorough plan of action for how you run your business and what you intend to do with the loan. Where will the money go? Be detailed. Be specific. A good business plan includes a road map for how your company will succeed, projecting several years out and showing how you will grow your revenue over time.
  2. Good Credit
    If you are looking for a startup loan, you will need to provide proof of good personal credit for both you AND other business partners that are responsible for repayment of the loan. Lenders don’t want to see late payments and unpaid balances. If you have a one-time, bad mark on your credit report, you must be able to provide details about how that specific issue was resolved. Oftentimes a low credit score = no loan.
  3. Comprehensive Financial Statements
    A lender must be able to follow your paper trail. They want to know where your money came from and where it is going.  Do this by providing balance sheets, income statements, cash flow sheets, and tax forms.
  4. Assets
    A borrower must have proof of collateral for the loan in question. The way to do this is to show your business and personal assets. Examples of assets that would qualify as collateral are vehicles, machinery and equipment, and even intellectual property.
  5. Good Character
    Lenders often look for professional references before deciding to grant a loan. They may even do a background check to verify your trustworthiness. You are the face of your business, so it makes sense that a lender would want to see proof that your good personal financial practices carry over to your business. If you have expertise in a specific industry or knowledge in starting and running other successful businesses, this can also serve as proof that you can offer a good rate of return on investment.

Options

Generally speaking, there are two basic types of loans.

ALL loans are either secured or unsecured loans. Banks and other credit institutions offer both types. It is important to understand the differences between these two type of financing. The size and age of your business (start-up, new, existing) will determine which type of loan you qualify for.

Both secured and unsecured lending follow specific guidelines as to how the loan is administered.

Secured:

Collateral: To obtain a secured loan, the borrower offers an asset (collateral) that the lender can place a lien on until the loan is paid off. If a borrower defaults on the loan, the lender can sell the collateral and the proceeds will go to pay off the debt.

Repayment Terms:
The term or amount of time given to repay a secured loan is typically longer than the time given to repay an unsecured loan. For example, a mortgage is typically a secured loan where you can see repayment terms up to 30 years.

Rates: You will find lower interest rates on secured loans as lenders are assuming less risk by involving your collateral.

Borrower Limits: A secured loan often has higher borrower limits since collateral is involved.

Application Process: The application process and approval time for a secured loan can be lengthy. This is due to higher borrow amounts requested and providing proof of collateral.

Unsecured

Collateral: An unsecured loan does not require collateral but rather is based on a borrower’s good credit.

Repayment Terms:
Without collateral, an unsecured loan is considered a higher risk to the lender. Consequently, they want the loan paid back more quickly than with a secured loan so the term limits are shorter.

Rates: Because the lenders are assuming more risk without requiring collateral, rates are usually higher for unsecured loans.

Borrower Limits: Borrower limits are lower with unsecured loans to minimize the risk to the lender since there are no collateral assets to claim should the borrower default on the loan.

Application Process: The time to approve this type of loan is often shorter since it is based on credit and doesn’t involve collateral.

Types of Business Loans

Line-of-credit loan

A line-of-credit loan is where a borrowing limit is extended. In other words, you receive the ability to borrow up to a certain amount, and you are only charged interest after you make your first purchase against the line of credit. For example, you may secure a line of credit in the amount of $10,000. That means that the maximum amount you are able to borrow is $10,000. However, you will only pay interest on the amount that is actually used/advanced. This offers businesses working capital that can be used for daily expenses such as purchasing inventory and handling operating costs, but the money cannot be used for large purchases like equipment or property.

Micro Loan

A micro loan is not like a traditional loan that requires credit approval and receives funding from a bank. Rather, it is a small loan issued by individuals (or a group of individuals) to another person or small business that is trying to put a business plan into action. You might hear the term peer-to-peer lending when referring to micro lending.

Micro loans are considered unsecured because they are not backed by collateral. While repayment falls in line with a standard loan, paying back principal plus interest, the interest rate for a micro loan will tend to be higher due to the risky nature of this type of lending.

Micro loans are considered high-risk investments for the lenders. Why? Well, oftentimes a micro loan is given to individuals in countries where traditional lending is unavailable. Other times, people who have bad credit may look to a micro loan for alternative funding. And sometimes, borrowers may want/need a smaller loan amount than a bank is willing to lend. In all of these cases, the individual’s proven track record with repayment is unknown, therefore making the investment risky to lenders. And since a micro loan does not require collateral, if a borrower defaults, then the lender will have no recourse for compensation.

Term Loan

Also known as an installment loan, this type of financing is what people commonly think of when they think of a business loan. A term loan is a commercial loan where the lender offers its traditional loan to small businesses. With this type of loan, you borrow a certain amount and repay it over a specific term (typically 1-5 years). The lender sets the terms for repayment and in turn, the borrower repays principal plus interest in monthly installments. The interest rate can be either fixed or variable. Lenders will want to know the purpose of the loan and you will need good business credit and in many cases, collateral. Early repayment is not penalized.

  • Short-Term Loan
    If your business needs working capital for making payroll, paying for inventory, or other temporary cash flow problems, a short-term loan could be the solution. The term for pay-off is shorter than a traditional term loan and the interest rate is usually higher. Additionally, this type of loan often requires a daily payment, rather than a monthly one. These types of loans are similar to traditional term loans in that you borrow a specific amount of money and pay it back over a set term.
  • Long-Term Loan
    Term loans can be written to meet any type of business need and are correlated to the purpose of the loan. Real estate and renovation loans, for example, involve a larger amount of capital, so they are considered long-term loans. A loan is usually considered long-term when it is 10 years or more. Depending on the repayment amount and term, installments can be made monthly, quarterly or even annually.
  • Balloon Loan
    A balloon loan is easily recognized by its repayment terms.  Balloon loans are paid back with interest-only installments. Then, the final payment is a “balloon” payment of principal. The monthly payments are lower because you are only paying on the interest. If a borrower is waiting on a big payment from a client, then a balloon loan is a great option. Borrowers beware: Be sure you know upfront what the final payment amount will be and if you can handle that large of a payment all at once. Carefully review the details of a balloon loan with your lender before signing a contract.

Guaranteed Loans

These loans require a written promise from a business owner or 3rd party that states who will be responsible for paying the loan in the event that the business itself is not able to repay it. Guaranteed loans are considered unsecured because a lender is relying on the guarantor’s good character rather than collateral.

  • Business Loan with Personal Guarantee
    A personal guarantee is when the business owner provides the written promise of loan repayment. Lenders may want this added assurance to prove commitment by the business owner of his endeavor. When you sign a personal guarantee, you are assuming the risk of your personal credit and assets. If your business fails, creditors will go after you for the repayment.
  • Standard Guaranteed Loan
    This is where a third party investor, spouse or the SBA guarantees repayment.
  • SBA Loan (Small Business Association)
    This is a type of guaranteed loan. The SBA doesn’t actually loan money to small businesses. But the SBA plays an important role in the business loan process. The United States Small Business Administration was established in the 1950’s as an independent federal agency responsible for counseling, helping, and protecting small American businesses.

When a business is trying to raise funds, the SBA can help with:

  1. acquiring the loan
  2. guaranteeing a bond
  3. funding some of the venture capital.

Simply put, the SBA sets lending guidelines and then acts as a guarantor for the borrower.  And, this makes lenders more willing to lend to new businesses. One benefit of getting a loan that is supported by the government is that you’ll get a lower interest rate and a longer repayment option. BUT, it’s often difficult to qualify.

To be clear, the Small Business Administration does NOT directly loan money.

But, the Small Business Administration DOES:

  • Set guidelines for the loan.
  • Facilitate the loan with a 3rd party lender. Money is acquired through traditional lenders (banks), community development programs, and micro lending institutions.
  • Guarantee repayment. This means less risk for the lender.

The SBA’s Guaranteed Loan Program is the government’s term for debt financing, where you, the business, need money for your operations and you are agreeing to the pay back the principal plus interest to the lender.

Bridge Loans (Interim)

If you need money for a short period of time in order to “bridge” an upcoming expense, this might be a good option for your business. For example, a construction company may use a bridge loan to pay contractors while building an office complex. When the construction job is complete and the financing comes through, the bridge loan can be paid off.

Other Loans

Lenders write loans under a variety of names. These include:

  • Real Estate
  • Equity
  • Asset
  • Invoice Financing
  • Revolving
  • Equipment

Other Types of Financing

Merchant Cash Advance

An MCA is where a lender provides an advance on expected credit card sales.  As the borrower, you give the lender part of your credit card sales each day plus a fee to repay the cash advance.

Factoring

Factoring acts as a cash management tool that delivers cash fast without strict credit or collateral requirements.


Tips

Bad Credit

If you have a low credit score, it can be difficult for your business to secure financing.

The worse your credit score, the higher your interest rate will be. Why? You are considered a high-risk investment for a lender when you have bad credit. In other words, there is a greater chance that you will default on a loan.

The main thing lenders want to see before they lend to someone with a bad credit history is the past 3 years of your business’s performance. If you haven’t been in business that long, they will ask for financial projections and a solid business plan.

Even with bad credit, you CAN still qualify for a traditional business loan.  But keep in mind that banks will be tougher on you in several ways:

If you qualify for a loan:

  • Bad credit brings a higher interest rate.
  • Bad credit may require more collateral.
  • Bad credit may entail more stringent terms of repayment.

If you CAN’T qualify for a traditional business loan, don’t worry! There are still other options available like Micro Loans and Merchant Cash Advance.

How to Choose a Lender

Lenders are unique, just like your borrowing needs. It is important to thoroughly assess your company’s needs before deciding what type of loan you want and which lender to choose. For example, if you need cash quickly, a traditional loan won’t suffice. You may need to look at lenders that offer cash advances or factoring to get the money fast. If you need a term loan with a low-interest rate, then choosing a lender with the lowest interest rate will be your top priority.

If you have good credit history, then you have the luxury of finding a suitable lender that will cater to your business’s financing needs.

  • Look at various lender’s interest rates.
  • Paying a loan off early will help you avoid long-term interest.
  • Ask if there are any fees when funding a loan or paying off the loan early.
  • Find a reputable lender. Check reviews and ratings of specific lenders.  You should choose a company that has an A+ rating with the Better Business Bureau.

How a Lender Chooses You

Lenders want to make money by lending to you, but a reputable lender also wants you to find the right loan to meet your business’s needs. When you successfully repay your loan, it is a win-win situation. Reputable lenders will advise you on the right borrowing options. An ideal borrower will be prepared to prove not only their worthiness in receiving a loan but also their trustworthiness in repaying it.

Business Loan Check List

Every lender has their own list of requirements for what they want to see before they will accept your application. Most lenders will post a list of their specific requirements on their company website to help streamline the loan approval process and allow you to get your money as soon as possible. Talk to your loan officer about what they require. The more legwork you do in the beginning, the less time and effort you will spend once you’re ready to start the application process.

Standard documentation needed for a business loan includes all of the following:

Business Information:

  • Business tax returns for the last 3 years
  • Current and year-end balance sheets
  • Business credit report
  • Financial statements
  • Bank statements
  • Equipment inventory
  • List of existing business debt including terms, rates and payments
  • History of business
  • Operating agreement for an LLC or LLP
  • Signed 4506-T
  • Written explanation of unusual trends or one-time expenses
  • Business plan and projections if business is less than 3 years old
  • Detailed description of proposed collateral

Personal Information:

  • Personal tax returns for the last 3 years
  • Current personal financial statement and balance sheet
  • Personal credit report
  • List of personal debt including terms, rates and payments
  • Copy of driver’s license
  • Personal background information such as previous addresses, names used, criminal record, educational background, etc.
  • Resume

Before You Sign on the Dotted Line

You’ve done your homework. You need money. You have all the documentation required by the lender. But, do you REALLY know how your loan will work? Before signing your loan agreement, ask yourself these questions.

  • What will I pay each month and over the life of my loan?
  • What am I promising the lender?
  • What is the lender promising me?
  • Can I afford to pay back the loan in a timely fashion and without straining my budget?

Don’t be afraid to ask you lender for an explanation of your loan and repayment details. Equip yourself with the knowledge you need to be a smart borrower.


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