As much as we all love a good rags-to-riches success story, most entrepreneurs have had at least some help starting their businesses. Sure, having ambition and grit is crucial, but that won’t be enough to guarantee the kind of cash flow your business needs to get off the ground and grow.
What you need is financing, and business loans are among the most prevalent forms of financing. As an ambitious entrepreneur, there will come a time when you consider applying for a business loan. However, this is a major decision that you shouldn’t take lightly. Although it can help manage cash flow and expand, it’s often a time-consuming and overwhelming process.
One of the first things you’ll discover on your quest for financing is that banks don’t give out money in exchange for business plans. They’re working with their depositors’ money, and you wouldn’t want your bank to invest your money in a risky startup. Neither would banking regulators.
What you need is financing, and business and personal loans are among the most prevalent forms of financing. As an ambitious entrepreneur, there will come a time when you consider applying for a business loan. However, this is a major decision that you shouldn’t take lightly. Although it can help manage cash flow and expand, it’s often a time-consuming and overwhelming process
Luckily, technology has made it a lot easier to apply for an online business loan. At the same time, you should keep in mind that this doesn’t mean it’s easier to get approved. The vast majority of applicants get rejected. But there are some things you can do to increase your chances of success.
Every business owner has to adapt to their unique position. Maybe your credit score is less than ideal, or maybe you have other loans to pay off while seeking a business loan.
In this article, we’ll take a closer look at some of the things you need to know before applying for a business loan so you can learn what the process entails and what it takes to get approved.
Terms You Should Know
Before you apply and meet with your bank, there are two terms you need to understand: collateral and equity.
Collateral refers to something tangible like real estate or equipment that you offer the lender as security for the loan. If you default on your loan payments, the lender can seize the collateral and recover their losses.
Equity can also serve as collateral, but it’s not something you can see and touch. It refers to what your business is worth. Let’s say you have a business that’s worth $800,000, but you have $300,000 debt. That means your business has $500,000 in equity.
Documents You’ll Need
When you do meet with a commercial banker, there are usually four documents that you’ll need to bring with you:
- Tax returns – usually for the past 3 or 4 yours
- Personal financial statements
- Your business plan
- Financial projections
They’ll need access to the documents so they can get a clearer view of your company’s assets and liabilities. The information in these documents will also guide the conversation, and they’ll want to discuss the type of loan you’re interested in and what repayment plan you can afford.
How Much Do You Need to Borrow?
Before you apply, you can use a business loan calculator to figure out how much funding you need and how much you can realistically afford to borrow. The amount will typically depend on what you plan to do with the money.
Let’s say you’re currently running a small catering business from your home selling various baked goods. You want to get a loan so you can open a single brick-and-mortar location. The kitchen equipment alone should cost on average $100,000, and you have to also think about maintenance, insurance and utilities.
At first, you’ll be tempted to think only about the price of the equipment, but you have to give yourself some leeway. This is especially valid in businesses with tight margins, such as food service. You need to calculate the amount you borrow so you can maintain or increase profitability in order to meet your repayment obligations.
What Kind of Business Loan Should I Apply For?
The next step is to think about what kind of business loan would suit your needs and goals.
Term loans or installment loans are the most common type of business loans. You borrow a fixed amount, which you have to pay back through a series of installments over a fixed time-frame. You’re probably already familiar with the term loans offered by banks. Nowadays, you can also research alternative lenders that offer loans with shorter terms, which you can use as working capital loans.
The amount you can borrow varies quite a lot – from $5,000 to millions. It all depends on how much you qualify for and the purpose of the loan.
The period of repayment also varies. If you get a business loan from a bank, you’ll usually be given 2 to 7 years for working capital. For real estate, the duration is up to 25 years. Alternative lenders typically offer shorter terms starting from 3 months.
In terms of security, banks will usually require collateral, but alternative lenders don’t.
Term loans are a good option for established businesses with good credit and positive cash flow since the criteria can be quite stringent.
Line of Credit
With a line of credit, you can get access to a pool of funds whenever you need them. If you use the funds, you will be charged interest on the outstanding balance, and once that balance is repaid, your line of credit goes back to the original balance.
Your credit limit will depend on factors that influence your ability to pay back your debts, such as your credit score, revenue and other debt obligations. The draw period for these funds depends on the agreement your reach with the lender, but it’s usually several years.
In terms of security, a line of credit can be secured with collateral or unsecured. If you want to get an unsecured line of credit, you’ll need a stronger credit profile.
This type of business loan is usually ideal for companies with seasonal revenue and fluctuating cash flow.
Invoice factoring refers to selling your invoices or accounts payable to a lender in exchange for a service fee. The lender will give you an advance rate of typically 80% and collect payment from the invoiced client. They will then deduct their fee, usually between 0.5% and 5% per month, and give you the rest.
The amount you can borrow depends on the amount of your invoices, and you can borrow for a duration of 90 to 120 days. The application is usually done online, and you can get approved in as little as 24 hours. Invoice factoring is usually used by companies that aren’t able to collect their invoices before the due date on their expenses, so this way, they can fix temporary cash flow problems.