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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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:
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.
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.
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.
Collateral: An unsecured loan does not require collateral but rather is based on a borrower’s good credit.
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.
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.
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.
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.
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.
When a business is trying to raise funds, the SBA can help with:
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:
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.
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.
Lenders write loans under a variety of names. These include:
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 acts as a cash management tool that delivers cash fast without strict credit or collateral requirements.
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:
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.
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.
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.
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:
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.
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.