How To Get a Business Loan – Important Tips To Keep In Mind
Having enough funds to run a business is one key element to succeeding. Running a business has its ups and downs. When you’re in a downward cycle and funds are low, it spells trouble ahead. With the right financial backing, you’ll keep your business up and running during the rollercoaster ride.
Many business owners dread the process of applying for funds. I’m one of those people, but there is good news. Knowing the loan process and spending some time to prepare will give you more confidence and a good idea of the amount you can borrow.
This post covers many options related to business loans. Have a look at each section to gain a broad understanding of the process.
Many sections contain hand-picked resources that go into depth and offer tips you can use when you’re ready to apply.
Let’s get started!
How To Get a Business Loan
The process of getting a business loan takes time and effort to prepare. You don’t just walk into a bank and ask for a business loan without having all your records and plans available.
In most cases, you will be asked for the following:
You need financial statements, which include profit and loss statements. It would be good to speak with your accountant or bookkeeper to create a report with the financial documents. They can have them ready in a format familiar to the lender.
You’ll need to have your business plan ready and up to date. Most banks and conventional lending institutions won’t even consider your application without a business plan.
You will need your official business registration documentation such as incorporation documents, partnerships, etc. If you have partners, you will need to submit the share structure and responsibilities as well.
You’ll find more about the documentation in the articles at the end of this section.
Determine How Much Funding You Need
You need to figure out how much finding you’ll need for your business. If you ask for too much, you may not get approved. If you ask for too much and you do get approved, you’ll end up paying interest on the money you’re not using unless, of course, you get a line of credit instead of a loan.
From personal experience, I’ll try and get more than I need. Not a lot, but anywhere from 5 to 15%. My reasoning is there are always unseen expenses, and I like to have a little extra on hand because it’s more difficult to get another loan when you already have debt than to get the money the first time around.
Business Loan Documents
When applying for a business loan, you don’t just walk into the bank and say, “Hey, I need a business loan,” It doesn’t work that way. You need documentation that the bank will use to determine if you qualify for a loan.
Banks are in the business of lending money, but they’re not in the business of losing money.
The documentation you have will allow them to assess if your business is high or low risk and if you can afford to pay the loan back. Your potential lender will need a copy of your business plan, income statements, profit and loss sheets, etc.
Have a look at the articles below that outline the documentation you need to apply for a business loan.
Take Your Time
Before jumping in too fast and applying for any loan opportunity, it’s easier to be prepared, organized, and have everything ready before approaching a lender.
Suppose you approach many lenders, and you’re denied because you don’t have everything ready; it will show up in the credit file. Many loan inquiries hurt your credit rating. You’re better to have to build a rock-solid portfolio before applying.
Identifying The Right Business Loan
There are many types of business loans on the market. It’s essential to find a loan that works for your situation. There are many ways to get funding, using conventional as well as high-risk lenders.
With high-risk lenders, the interest rate could put you out of business, and that defeats the purpose of getting a loan in the first place. Have a look at the summaries below for more on the popular types of business loans.
A term loan is one of the loans that are faster to process. The payments are on a fixed repayment plan and a fixed interest rate. These types of loans are reported as the fastest to process.
See, What Is a Business Term Loan? for More
Business Line of Credit
A line of credit for your business allows you to use funds as needed. You have a limit, and you can use as much as you need, and you only pay for the interest on the funds you use.
A line of credit allows flexibility and can act as an emergency fund. Whether you need it or not, it’s something you should have in case of a need for cash at any time, to make payroll, or use it instead of overdraft.
For More about a Line of credit for a business, see, What is a Business Line of Credit & How Does it Work?
Equipment financing is for businesses looking to update or purchase equipment for their operation.
One of the benefits of applying for an equipment loan is that the lender knows exactly where the money is used and can easily assess its value in case of loan default.
You still need to present your financial documents to the lender and go through the loan approval process.
Invoice financing is for business owners that offer credit for their customers to pay their invoices.
These funds are short-term financing options, and costs can vary. For example, there could be a 3% admin fee and 1% interest on the balance for each week.
Suppose a customer owes $500 for four weeks. Your cost would be $500 x 3% equaling $15 for the admin fee. Financing would be $500 x 1% equaling $5.00 per week. Multiply that by four weeks would equal a total of $20. In this example, your total fees would be $35 for the four weeks or 7% of the loan amount.
For more on invoice financing, see Invoice Financing: What It Is and How to Get It
Commercial Real Estate Loans
Commercial real estate loans are a similar process to purchasing your home. A commercial loan has a stricter process because there is more risk involved with commercial real estate.
One of the advantages of a commercial real estate loan is the property value secures the loan. With a strong revenue stream, a strong business, and a good plan, loan approvals are highly likely.
For more on Commercial Real Estate Loans, see the following articles:
Microloans are small loans and are popular in less developed countries. As the name suggests, they are micro. They can go anywhere from a few hundred dollars to a few thousand dollars.
Microloans in North America offer a much higher value and can reach approximately $50,000
Have a look at the articles I have selected for more information on microloans.
Personal Loans for Business Use
For a new startup, some people will take out a personal loan for business use, which could be the case for some sole proprietorships.
Legally a sole proprietorship and the business owner are one entity. If you start a business full-time, the lender may see your personal loan application for business purposes as high risk because most businesses fail in the first few years.
For more on personal loans for business use, see the following articles.
Merchant Cash Advances
A merchant cash advance (MCA) is an advance based on future revenue. It’s an alternative for businesses that can’t get a business loan. The fees are expensive for this type of advance.
You need to have strong revenue through credit cards. Be sure to go over the fine details to ensure it’s worth it. For more on merchant cash advances, see the articles below.
SBA loans are government-backed loans. The government guarantees these loans and makes it easier for businesses to qualify.
The government backs small business loans because it benefits the economy. When a small business succeeds, it creates job opportunities and contributes to the amount of money flowing through the economy.
Multiply this process by hundreds of thousands of businesses, and you have an opportunity to stimulate the economy.
For more, see the articles included below to identify the types of business loans available in today’s market.
Questions To Ask Before Applying for a Loan
Below you’ll find a few questions people may ask when considering a business loan. You’ll also find some questions that may come up during the application process.
What Is the Purpose of the Loan?
Identifying the purpose of your loan is important for you to understand. Write out your reasons and the benefits you will receive. Also, note how the repayment will affect your finances. When you write your plan out, you’ll have practiced for your application.
If you have more revenue than your expenses, you have a positive cash flow, which helps with the approval process. Lenders like a solid deal and want to lend money to stable businesses. If your business is operating with a negative cash flow, it will be harder to get approved.
How Much Debt Do I Currently Have?
You must figure out how much debt your business already has. With a lot of debt, you will have a harder time finding a lender because the higher your debt, the higher the risk.
A formula will allow you to identify the risk called a DSRC (Debt Service Ratio Coverage.) Your business is okay with a 1% rating. A 2% and higher rating indicates your business could handle more debt. For details on this formula, see, Debt Service Coverage Ratio – Guide on How to Calculate DSCR
What Does My Credit Profile Look Like?
Have a look at your credit report. Many people never look at these credit reports unless they apply for a loan. It’s good to know your business’s credit rating to gain an overview and determine if you are eligible for financing. Another important point to bring up about looking at your credit rating is to make sure there are no errors, and if there are, you need to get those correct before applying for a loan.
What Is My Payment History?
Have you ever missed any payments? If you have, then that’s a red flag. Lenders become very nervous when a client misses a payment or is constantly late on payments. It shows that trouble is brewing. Your credit report will reflect your payment history.
Are Business Loan Payments Tax-Deductible?
Business loan payments are not tax-deductible. Repaying the Principal part of the loan is not a business expense. However, the interest you pay on your business loan is a tax deduction.
How Much Can I Borrow For A Business Loan
Another question commonly asked is how much can I borrow. Many factors come into play. It’s like when you apply for a mortgage. How much do you make, how much do you spend, and what collateral do you have?
Once those are factored in, you’ll know how much you can borrow. If what you owe and how much you spend every month is more than what you make, that’s not a good sign unless you have assets and a financial plan that can be put together to make everything work, or in other words, a refinance. For more see How Much Capital Can You Get With a Business Loan?
Find Out if You Qualify For A Business Loan
One of the most common reasons small business owners avoid seeking financing is they don’t know if they can qualify for a loan.
No one wants to get rejected for financing. By putting together all your financial statements, and looking at your credit history, you can ask your accountant or talk to your banker to get an idea about how much you can qualify for without applying. If everything looks good, then you can apply.
For more, see the articles included below:
Business Loan Interest Rates
As a new business owner, you may pray that you get approved for any loan, but as an established business owner with good credit, you have options to choose and pick which loan suits your business.
When you’re in this situation, you want to choose the best rate and loan terms. When you’re borrowing a large sum of money, a small variation in the interest rate makes a difference in your payments.
In this section of the post, you’ll be able to access resources that offer business loan rate comparisons.
Small Business Loans Alternatives
As a new business owner, you may not get approved for a business loan. There are alternative ways of getting funding. A few conventional business loan alternatives that come to mind are borrowing from friends, family, using credit cards, mortgaging your house, selling some of your assets, etc.
Please note all the above alternatives I have mentioned have pros and cons to them, you may lose friends or family, you may lose your house, you may end up with a huge list of high-interest credit card loans you can’t pay back, etc. They’re not the best way to get funding for your business, but maybe the only choice you have during the startup phase.
The articles below outline the options available for funding your business.
The government offers grants to boost certain industries. It’s an incentive to get people interested in starting or upgrading a business. If your business falls into eligible categories, you can apply for a grant.
Have a look at the articles below that specialize in information about business grants. If you’re starting a business, it’s important to look at these options. You may need to tweak your business to qualify, but it’s worth considering.
Business Loan Brokers
Business loan brokers work with businesses to help them get a loan. Some work off of commission, while others charge you a fee whether you get the loan or not.
If I’m looking for a business loan and don’t have a good relationship with a banker, I would definitely consider using a broker.
An experienced broker will know what lenders are looking for, how to present your applications, and identify any red flags a lender may see. Most importantly, brokers have a list of lenders to send in your application.
For more on business loan brokers, see the articles I have included below.