Small businesses might be the product of dreams and career passions, but they can’t open their doors on simple hopes alone. They also require loads of money to get the ball running.
Sometimes that money can come from family members or years worth of savings. Sometimes that money can come from Angel Investors and well-off partners. However, most likely your money will come from one of the many options for small business loans that are available.
Even if you don’t need a business loan when you first open, there are always chances that you’ll need one somewhere down the line. Expanding your business, your product line, your customer reach, and more all costs money. Money that the banks are more than willing to lend you, if you can get their attention.
But how do business owners construct the perfect small business loan application? What sort of information is needed to get the attention of lenders and convince them that your business plan will work? And how do your personal finances factor into your application? Can your personal credit habits get in the way of being approved for a business loan?
Fiscal Tiger is here to help you understand the ins and outs of your small business loan application. We’ll dive into business credit scores, business plans, and how you can really catch the eye of any lender. Small businesses are the backbone of our economy, and banks or lenders will want to see you succeed. You just have to prove yourself through your application.
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Understanding Your Lending Options
In the world of small business, there are a surprising amount of options available to meet your needs. Besides the average loan, there’s also lines of credit, specialty loans, and so much more. Before you make a trip to the bank, you will want to research your options and make an informed decision about which loan works best for your business. Here are some of your options:
- Small Business Line of Credit: this is similar in concept to a credit card. You will have a capped amount of money that you can withdraw from the bank (such as $90,000 or so) that you can utilize to help manage your cash flow and pay for unexpected expenses. Traditionally, there won’t be any interest until you withdraw money, and there might sometimes be a yearly renewal fee, depending on your bank. If you do not renew the line of credit, you will be asked to pay the amount you owe in full. This option is very useful for companies that are first starting out and need some extra help through their rocky first year. However, it can also be dangerous if you find you’re relying on it too heavily. The purpose is for emergency funds only, and be sure to keep that in mind if you choose this option.
- Working Capital Loans: these loans tend to be short-term loans that last anywhere from 30 days to a year. They function as a way for businesses to transition through a low-traffic season back into normal traffic, or any other fluctuation in cash flow for a business. Many working capital loans can function as secured loans, meaning if you have very little credit history with the bank you will have to provide collateral in case the debt is not paid back.
- Equipment Loans: this loan allows businesses to purchase equipment necessary for their business. Just like a typical car loan, this loan requires a downpayment of 20% of the purchase price of the equipment and the item is collateral for the loan (in case you fail to pay it back entirely). The loan accrues interest over the lifetime of repayment (which is typically two to four years), and can be used to purchase vehicles, heavy machinery, or even software.
- Accounts Receivable (AR) Financing: as noted by Forbes: “An accounts receivable line of credit is a credit facility secured by the company’s accounts receivable (AR). The AR line allows you to get cash immediately depending on the level of your accounts receivable, and the interest rate is variable. The AR line is paid down as the accounts receivable are paid by your customers.”
- Small Business Term Loans: these loans are typically for a set dollar amount and can be both secured or unsecured (depending on your business credit score). Monthly interest is accrued and can be fixed or unfixed, and the principle can be paid off within 6 months to a few years. They work well for businesses that are looking to grow and expand, or who need financial support to help get their operations in order.
- Small Business Administration (SBA) Business Loans: the SBA is a government run organization that functions solely to help support and fund small businesses in America. They do not provide the loans directly, but they work with banks to ensure that their specialty loans have low-interest and reasonable repayment plans. They can be hard to get — since they have an extensive application process — but they are some of the best options available for small businesses.
- Small Business Credit Cards: another line of credit option, rather than a loan, these specific credit cards can function as short term solutions to financial problems within a business. Your interest rate and max-limit will vary, and some banks or credit card companies require that the owner (aka you) becomes co-liable with the company. Since small business credit cards are similar to regular credit cards, they require a small business credit score check before being approved, which can be difficult for new businesses. Additionally, since the owner is co-liable, your own personal credit score can be effected if anything negative happens on this line of credit.
Where to Apply for Business Loans
However, outside of the options available for the type of loan, there are also options on where to get that loan. Here’s a list of places that typically loan to small businesses:
- Large Commercial Banks — US Bank, Wells Fargo, JP Morgan Chase, etc
- Local Community Banks — Check your area for banks or credit unions that cater to small businesses.
- Peer-to-Peer Lenders — These places act as the middleman between your business and potential lenders, big and small. They tend to have answers for you faster than traditional banks.
- Direct Online Lenders — These websites help you get loans or cash advances from lenders on their online platform. Whereas Peer-to-Peer connects you with interested lenders, Direct Online has you fill out an application that gets you a loan of some sort. They work as a lead generation service for lenders.
- SBA Guaranteed Lenders — You can find a list of their SBA approved lenders here.
All of this information might seem intimidating, but it’s important to know what to expect when you walk into a loan office. What loan will best fit your needs, and which lender will be most likely to get you the amount and rates you asked for? However, there are other factors to consider, mainly your personal and business credit score.
Why Your Personal Credit History Matters
When you’re first starting out as a business, you most likely will not have a credit score. Business credit scores are based on tax IDs instead of Social Security Numbers, and you’ll get a Tax ID if you file your business taxes with the government. This tax ID, however, is vital to getting approved for loans, and if you don’t have one yet then the bank may rely on your personal credit score to make a decision.
As we have covered in the past on Fiscal Tiger, personal credit history can have a major role in determining your application for a small business loan. Even if your business has a blank slate, you might not, and banks will want to look at your credit history so they can get a better glimpse of your potential as a borrower. If you have a shady history of not paying back credit cards, that could come back to haunt you when you apply for a business loan. Just another reason why you should always be building positive credit habits.
But this isn’t the only way your personal credit history could play a part: it can also be damaged if you make poor decisions on your small business loan. If you default on a loan, fail to make payments, or your business goes bankrupt, you could be held liable for repayment. It all depends on the way your loan is written and the agreement set up between yourself and the lender. Essentially, it comes down to how big of a risk you are to the lender: both as a business and as an owner.
You can learn more about your credit score, including ways to raise it, at our credit score learning center.
Now that you know a bit more about what to look for and how your personal credit can play a part, here’s how you can build an awe-inspiring application.
Your Business Loan Application Outline
Since small business loans are dependent on the risk they create for a lender, it can be tricky to actually get approved for a loan. For many new, small business, it might seem nearly impossible because they don’t have the cash flow just yet. However, there are ways to get small business loans and prove yourself to the banks.
According to one anonymous banker with Quickbooks Small Business Center, banks are looking for an almost unachievable threshold: “To be able to lend to a small business at a more reasonable rate of 6% to 9%, the bank must be at least 95% sure that the loan will not default.” This is why it can be so difficult to get approved for a loan, but there is still a small chance that you can make it, as long as you have all your ducks in a row.
As this banker suggests, there is a checklist of issues that the lender will cover with you. They are the ten common areas of focus for banks and lenders when considering an application:
- Your Industry: If you are thorough with your market research, you will be able to paint a detailed picture of your industry, competitors, and target market for the lender. You can also provide them with detailed demographics that help bolster your argument. Additionally, some industries are more susceptible to failure than others, and this unfortunately can hurt your chances. However, the more prepared you are, the better your chances of winning the bank over.
- Age of Business: If you’re first starting out, this will be tough. However, if you’ve been doing your craft for some time — say you were a freelancer or contractor and are just now opening your own firm — you could show the bank the history of your company and how you have built a strong client base already. If you’re an older business with years of success behind you, the bank will be more likely to approve your application.
- Financial Ratios and Profitability: Banks are interested in your cash flow. They want to know how you will make money, how you will pay the bills, and how you will profit. If there is little wiggle room for profit margin, you could be out of luck. On the flip-side, if you don’t have a lot of cash flow yet but a lot of expensive assets, the bank could use that as collateral for your loan. In your business plan you should have a detailed layout of how your profits will be laid out in your company, and you should share this information with the lender.
- Business Model: The lender will want to make sure your model is able to address any potential changes within the market. Additionally, they will want to know your strategies for mitigating risk in case cash flow decreases.
- Credit History: This is for both personal and business credit history. Again, they will be interested in the risk you pose the bank, and will look at your personal and business credit scores to help make their decision.
- Personal Guarantee: It takes more than a stack of paperwork to prove you believe in your business. Your attitude and belief in your company will also come into play when making the decision to fund your dream.
- Tax Liability and Legal Troubles: The bank will want to make sure there are no liens against you or your company, and that all taxes have been paid appropriately. Any lawsuits against you or the company could also put your business at risk, which might scare off investors and lenders. It’s important to keep in mind the IRS, as well: “Especially when it comes to IRS liability, the banks want to make sure there isn’t a significant amount of taxes due, because the IRS is incredibly efficient at collecting their money before the bank gets a chance to collect payment on their loan.”
- Owner’s Equity: The bank will want to look at the owner’s current collection of debt (such as any previous loans) so as to better assess the risk of default. If you already owe money to other banks, it will be harder for the bank to collect from you, meaning you will be at a higher risk than what they feel comfortable approving.
- Use of Funds: The bank will want to know how you plan to utilize the loan they are potentially granting. Will you be expanding your business? Opening your doors for the first time? Or potentially growing your outreach and product line? How will that benefit your business (and how will that benefit the bank’s interests)?
- Receivable Concentration: Essentially, this looks at the concentration versus diversification of a business’ revenue streams. Are you getting all your money from one source, or many sources? Are you seeking out new opportunities everywhere, or simply sticking with your small pool of customers? There are benefits and risks to both sides, but if you don’t have a diverse source of revenue, then you have a higher risk of defaulting. For example, companies that sold primarily General Motors cars suffered (and many closed) after GM declared bankruptcy. Their portfolio wasn’t very diverse, and their main client eventually led them to failure. It’s important to make sure your business won’t do the same.
Outside of these top ten reasons, the bank is also interested in your relationship with them. Have you had a personal account with this bank, or is this the first time you’ve outreached them? Banks that you have a long history with might be more comfortable with lending your business some money. They can see how you spend your money and how you’ve been financially responsible in the past.
Additionally, the bank will want to see paperwork of your business model, market research, tax returns, audits by certified public accountants (CPA), and any insurance documents. Disasters can happen, and the bank will want to make sure all your bases are covered.
Getting the Loan You Deserve
Small Business loans can be difficult to acquire, but they’re not completely out of reach. For brand new businesses, they can be extremely beneficial, but are also rare. However, that doesn’t mean you should avoid asking the bank. If you are thorough in your research and confident in your business plan, there’s a chance that the bank or lender will work for you.
However, it’s also important to make an informed decision about your loan options. Don’t agree to the first loan offer simply because it was a “yes.” Research your options and find the loan that works best for you. Additionally, be mindful of your personal credit, as it could come back to haunt you when you ask for a business loan.
If you’re careful, diligent, and do your research, you can find the right loan that works for you. Banks want to see you succeed, and small businesses are vital to our American economy. You just have to prove you can become successful, and the rest should fall into place.
For more tips and guides, visit our small business resource center.
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