Thinking about applying for a small business loan?
Today’s economy has made banks and other financial institutions more selective when it comes to approving business loans.
Forget about startups and small businesses, even the ones who have been in business for years have a tough time getting their loan approved.
But that doesn’t mean it’s impossible to do so. In fact, there are many online lenders who are specialized in providing loans for new and small businesses.
This guide will walk you through the steps you need to follow before applying for a small business loan. Consider this as the ultimate guide.
Determine why you need to pursue a small business loan
The most common reasons for an entrepreneur to pursue a small business loan are listed below.
To start a new business
Sorry to break it to you but starting a new business can be very expensive.
You need money to rent or buy office space, pay employee salaries, buy machinery and equipment for both production and operational use, pay utility bills and etc.
It can be difficult to cover all these startup costs by yourself from the get-go so taking on a business loan is a good move.
To cover seasonal ups and downs
A lemonade stand near a beach can make much more money during summer than in winter. This type of businesses are called seasonal businesses.
You have to keep your business running even during seasons that bring little to no customers. A small business loan can help you get through the slow seasons and prepare your business for the next big season.
In addition, a loan will help you to stock up the inventory, hire temporary employees, and etc during busy seasons.
To cover emergencies
You never know what might happen to your business tomorrow or the day after. Technical and electrical breakdowns, pipe bursts, and damage caused by fire and natural disasters are some examples of business emergencies.
Unexpected things do happen and if you don’t have enough money to cover for them, taking on a business loan is wise.
To seize an opportunity
Opportunities don’t pass you by everyday. When you see a good enough opportunity, you must seize it.
Say that a new technology or machinery came out which can make production much more efficient and fast, or say that you came across a highly skilled and talented accountant who can turn the tables of your business finances.
These are all great opportunities but what if you don’t have enough cash on hand to seize them?
This is where small business loans come into play.
To close gaps in cash flow
If your business operates under a model where you invoice other businesses and wait for them to pay for the work you have already done, there may be some gaps in cash flow.
You can pursue invoice financing to close these gaps. This works by submitting your outstanding invoice to a financial organization and receiving a percentage of the invoiced amount before the customer actually pays you back.
This is a great solution against customers who bind up your cash in-flow.
Determine how much money you need from a small business loan
Now that you know why you need a small business loan, it’s time to figure out the loan amount you need.
Most of the time it’s pretty straightforward. If you want to purchase some machinery or equipment, the loan amount required is probably the same as their cost.
Also, if you pursue invoice financing, the loan amount would be a percentage of the sum in the outstanding invoice (usually 70% – 85%).
However, some businesses may find it difficult to figure out the exact loan amount required and whether or not it’s affordable.
You can figure this out by calculating the DSCR.
What is DSCR?
DSCR or Debt Service Coverage Ratio is a number that loan lenders use to determine whether or not your business has enough money to pay back the debt in the future.
It also helps to determine whether your business can afford to pay back the requested loan amount on time.
To calculate it, just take your average monthly cash flow and divide it by the monthly loan payment. If you get a number greater than 1, you are safe. If not, you may have to consider requesting a smaller loan amount.
Determine the type of small business loan to pursue
Now that you know how much money you need, it’s time to figure out which loan option to pursue.
This is the first thing that comes to everyone’s mind when talking about types of loans and is by far, the cheapest financing option out there. So if there is a chance to get a bank loan, go for it.
To qualify for a business bank loan you will need either an impressive credit score or a long term financial relationship with the bank. If you are not sure whether or not you qualify, just visit some local banks and discuss with the bankers there, or just go ahead and apply.
Bank loans are way cheaper than any other financing option but nothing comes without a price. If you need cash quickly, relying on a bank loan is not your best bet since your application can take quite some time to be completed and reviewed.
It will take weeks and sometimes even months before you hear anything back from the bank. That said, if time is not a concern for you I highly recommend taking on a business bank loan. That’s the best deal you can get.
The next best option is to pursue a SBA loan. While it is slightly more expensive than a traditional bank loan, it is still affordable. You can apply for a SBA loan online, thus making the process faster and more efficient.
The SBA is not lending loans themselves but just guarantees a portion of the loan amount to a lender, encouraging them to approve your loan.
It’s still hard to get approval but their document requirements are way less than that of banks.
If you have a decent credit score and your business brings in decent annual revenues ($200,000+), chances are high that you will get approved.
Business line of credit
In a business line of credit, you are given a pool of funds that you can draw money from anytime and once you pay back that amount + the interest, your credit line will be refilled.
Most businesses use credit cards as a line of credit, however, there are many online lenders that offer dedicated lines of credit as well.
Some are more affordable and easier to get than others so check out multiple lenders before settling with one.
This option suits businesses that invoice other businesses for the work they did. Some customers may take a while to fulfill your invoice and pay the amount due to your business. This creates a gap in the cash flow of your business.
Invoice financing will advance a certain percentage of the value of your outstanding invoice, usually 60% – 90%, keeping the rest in reserve.
The financing company will charge what’s called a “factor fee” from the reserved amount for every week your customer delays the payment (usually 1%). Once your customer pays the outstanding amount, you will get the remaining reserved amount.
It’s very easy to get money from this type of loan and the acceptance rate depends entirely on the reputation of your business and the value of your invoices.
Invoice financing companies such as BlueVine and Fundbox allow you to submit applications online and after approval, you can upload the outstanding invoices to get cash deposited into your bank account within 24 hours.
This type of loan provides funds to purchase new/used equipment for your business that you just can’t afford to pay from your pocket.
Equipment financing companies will advance you the cash to cover the down payment or upfront cost of the equipment.
You will be asked to pay back the loan with fixed monthly payments with the interest on top. Interest rates will range from 8% – 30%.
In case you default on your equipment loan, lenders can simply seize the equipment from you to compensate their loss.
Determine the type of lender to do business with
Banks are just one type of small business loan lenders. There are so many other lenders out there and the main ones are listed below.
Online lenders make the process of applying for a loan very simple and fast. Companies such as Swift Capital provide short-term loans, working capital loans and cash advances with loan amounts ranging from $5,000 – $500,000.
You should consider online lenders if you lack collateral, time in business, or if you just need funding quickly without any delay. Compared to traditional banks, the approval rates of online lenders are much higher.
Micro lenders are non-profit financial organizations that provide short-term loans under $35,000 for small businesses. The APR on these loans are typically higher than that of bank loans.
They may require you to submit a detailed business plan, financial statements, as well as a document explaining how the loan amount will be spent in detail.
This is a pretty good choice for startups and small businesses that couldn’t qualify for a traditional bank loan due to limited time in business, poor credit score or lack of collateral.
Some popular micro lenders are Accion Kiva, the Opportunity Fund and the Business Center for New Americans.
Peer-to-peer lending sites
Determine what documents and pieces of information you need to submit when applying for a small business loan
Depending on the lender and type of small business loan, the documents required will differ. But most of the time, lenders would want to access the documents and pieces of information mentioned below.
Lenders will look at your personal and business credit score to determine how trustworthy you are as a borrower. If you have no outstanding credit and if you had paid the previous credit amounts on time, you probably have a high credit score from that bank.
A low credit score will not disqualify you from getting a bank loan but your lender may ask to submit more documents and details to compensate the credit score. A credit score of around 650 is considered good but anything above 700 is just perfect.
Time in business
How long have you been in business for? If it’s only been a few months, lenders will hesitate to approve the loan because new businesses often have less experiences. Lenders need to be assured that your business would not fall apart after a year or two.
If you show them that you have been in business for two years or more, they will be more likely to approve your loan and may even introduce more loan options.
Profit and loss statement
Profit and loss statements (also known as income statements) allow lenders to see where your money is coming from and where it goes to.
This way they can see whether you are getting money from any illegal or unethical sources and will assure them that your business has what it takes to pay back the loan amount on time.
Make sure the income statements you submit are updated to the last 60 days.
A balance sheet can show how your business is doing financially and therefore is something that lenders are very interested in.
This document shows lenders how much you have in assets and how much you owe to external individuals and companies. If your business has more liabilities than assets, your loan application will be rejected.
Another thing that lenders want to know is whether or not your business is profitable. Even if your business is not profitable yet, it at least needs to have a decent annual revenue.
An annual revenue of $250,000 is good but $500,000 is even better. If the annual revenue of your business is less than $250,000 your options might be limited.
Keep in mind, lenders are more likely to approve loans of businesses which are already generating profit.
Personal and business tax returns
Just like your personal credit score, lenders take into account your personal tax returns to verify your income before approving your business loan. They focus on the lives of small business owners more because their businesses are still new and it’s hard to estimate their success.
Determine what other fees are associated with a small business loan
When calculating the loan APR, you should also take into account other fees that lenders could charge in addition to the interest. Let’s take a look at some of these fees below.
This fee is charged to compensate the lender for any direct costs incurred while approving your loan, such as administration costs.
This fee is specific to SBA loans. Companies that issue SBA loans must provide a small portion of the guaranteed amount to the government and they often pass this fee onto the borrower.
Some lenders may charge an application fee when applying for a loan to cover the costs of processing documents, running background and credit score checks, and etc.
Check processing fee
This fee is charged when you repay your loan with a check so most borrowers make their payments through ACH to avoid this.
You will be charged each time you fail to make the loan repayment on time.
Some lenders may even charge you for paying off your loan earlier than expected. This is done to recoup their costs from servicing your loan.
You’re all set!
Now you know how to get a small business loan.
Take your time to browse through as many lenders as you can to get the best possible offer. Just make sure all your personal outstanding balances with banks are settled before applying for a business loan.