Running a small business is like maneuvering a ship through an unpredictable sea. It’s smooth sailing when everything falls in place, but it can quickly turn into a rough ride if your business runs into troubled waters.
As a small business owner, you need to be prepared to face financial challenges caused by an unexpected loss in business, inconsistent cash flow, inflation in operating costs, competing against big brands, etc. But not every business manages to survive financial hardships. According to Statista, 14,347 U.S. businesses filed for bankruptcy in 2021.
Many entrepreneurs turn to small business funding options like capital investments, crowdfunding, and small business loans to ride out the financial storms.
Options to fund your business
As the name suggests, self-funding requires the small business owner to tap into their personal wealth and assets or take a loan/gift from friends and family to fund the company. Unfortunately, only a few entrepreneurs have the luxury of self-funding their businesses.
Small businesses can also take the investment route where they seek funding from venture capitalists and other investment firms to pour capital into their business operations. Getting this type of small business financing can be challenging as the competition for investments is usually cut-throat. According to Corporate Finance Institute, you have only a 0.7% chance of getting capital from VC firm Andreessen Horowitz.
Small Business Loans
A relatively popular choice among business owners, a small business loan offers the monetary help necessary to sustain and grow your business at times of financial uncertainty. From large banks to online lending platforms, there are plenty of options to get small business loans for your company.
A left-field choice for small business financing, crowdfunding utilizes the power of the internet to sell your company’s vision and receive small donations from a large number of people.
What are small business loans?
A small business loan provides you with funds necessary to carry out your business smoothly. It offers a source of capital that can be used to cover a wide range of business activities such as expansion, renovation, relocation, payroll, day-to-day operations, buying inventory and equipment, etc. Government organizations, banks, and alternative lending options like online lending platforms offer small business loans to a multitude of US-based small businesses. To learn more, read our article, “What are Small Business Loans?”
Why should you get a small business loan?
If you are a business owner, your need for funding doesn’t end at mitigating losses or staying afloat during financial crunches. There are a lot of reasons why small businesses opt for a loan. According to a 2021 report by Annual Business Survey, in 2020, 56% of small businesses required funding to cover operating costs while 30.9% businesses sought financing for expansion.
Some common reasons for getting a business loan:
● Expand Your Business
● Manage Hiring & Payroll
● Manage Operating Costs
● Consolidate Business Debt
● Buy or Lease Equipment
● Stock Inventory
● Mitigate Losses in Business
How do small business loans work?
There are different types of small business loans depending on the usage and terms of the loan. For example, working capital loans are used to resolve inconsistent cash flow issues and are usually short-term loans. On the other hand, equipment financing loans are used to purchase or lease critical equipment to keep the business operations running.
Having said that, any type of small business loan would more or less follow the same process of application, approval, disbursal, and repayment of loans. Here’s a step-by-step rundown of how small business loans work:
1. Borrower reviews lender’s loan qualification criteria
2. The borrower applies for a business loan
3. The lender conducts a thorough credit check
4. The lender finalizes the loan amount, interest rate, loan term, and repayment structure.
5. Once the borrower accepts the terms and conditions of the loan, the loan amount is disbursed to the borrower’s bank account.
6. The borrower utilizes the loan amount to grow their business.
7. The borrower repays the loan as per the loan agreement.
How to get a small business loan
1. Select the right type of loan you need to fund your business
The first step towards getting a business loan is to understand how you want to use the loan and then select the type of small business loan that would suit your needs.
Short-term loans are business loans that need to be repaid within six to eighteen months depending on the loan amount and the lender. This type of small business loan is a perfect alternative to a line of credit and can be used to cover any emergency expenses or to avoid defaulting on bill payments.
Equipment Loans & Financing
If you need money to buy or lease equipment for your business, then equipment loans are just the right financing option for you. Depending on the cost of the equipment, its depreciation rate, and several other factors, this type of small business loan can last for years if you choose to buy the equipment or it could have a shorter term if you decide to lease it.
Working Capital Loans
If your business needs better cash flow, you can opt for working capital loans to cover the day-to-day operational costs. Be it hiring, payroll, or managing bill payments, this small business loan can ensure your business enjoys a steady cash flow over a short period.
Inventory Financing Loans
For a product-based company, inventory is essential to make sales and earn profits. But what if you are short of money to stock up your inventory? If you need capital to restock your product supply, then inventory financing loans are what you need.
2. Explore Multiple Small Business Lenders
These days, there are multiple lenders in the market offering financing solutions to small businesses. However, a wide range of lending options has made it difficult for small businesses to choose the best lender for their needs. As a rule of thumb, you should look into more than one lender who offers the type of loan your business needs.
3. Learn how lenders review credit reports, financial history, and debt risks
If you want to improve your chances of loan approval, you must understand what lenders look for in a loan application. Ranging from capital to credit score, lenders evaluate borrowers based on 6C’s. Before you apply, have answers to the following questions that your lender will ask:
What’s your credit score?
Most lenders check your personal credit score before approving your business loan. If you are not sure about your credit score, check with credit bureaus such as Equifax and Experian .
What’s your debt-to-income ratio?
The debt-to-income ratio, also known as the credit utilization rate, is the total credit that you have used compared to the maximum credit limit available to you. It indicates how much debt you have undertaken. Anything below 30% is considered to be a decent credit utilization ratio.
How long have you been in business?
Believe it or not, the age of your business has a role to play in your business loan approval. If you have been in business for 6 months or longer, your chances of getting a small business loan increase compared to a startup that is just setting up the business.
What are your annual sales figures?
Lenders extend loans to businesses that are profitable in the long run. This is where your annual sales figures come into the picture. The more money your business makes annually out of sales, the better your chances of getting that small business loan.
How much loan amount do you need?
Last, but not least, lenders look into the loan amount that you have requested and compare it with your business’ stability, sales figures, and personal credit score to decide whether or not to offer a loan.
4. Gather your financial records
Every lender will request you provide the necessary financial information along with your loan application. If you are applying for a small business loan, you may need the following financial documents:
● Your business bank statements
● Your personal bank statement
● Declaration of existing debts
● Business income-tax returns
● Declaration of major shareholders in your business
● Personal income-tax returns of every major shareholder of your business
● Income Statement that declares the revenue of your company
Compared to conventional lending options, some alternative lenders require less documentation, making the application process faster and easier.
5. Know everything about your small business loan application
Every lender might have different prerequisites for approving a business loan application. Talk to a funding advisor for an in-depth understanding of your small business loan application. Ask them about interest rates, repayment process, prepayment options, hidden fees, etc. Your lender might also need your EIN, and proof of business ownership among other documents.
6. Be transparent about the usage of the business loan
Just like the way you want your lender to be transparent with you, as a business owner, you also need to be honest about your loan usage with your lender. If there are restrictions on how you can use the small business loan, make sure that you are not flouting them once you receive the loan. For example, using business loans for personal benefits or using inventory financing for paying off debts should be avoided at all costs.
7. Figure out an affordable repayment plan
Before the lender lays down the terms and conditions of the loan such as interest rate and repayment process, be sure to do your own calculations to determine how much you can repay in a single payment along with the frequency of payments.
8. Understand the benefits and risks of collaterals or liens on your business
Collateral in small business loans is defined as an asset used as a security against the loan that the lender can sell if the borrower defaults on the loan. A lien on your business allows the lender to stake a claim on a part of your business if you fail to repay the loan.
While some lenders require businesses to put down collateral for loans as security, one must understand its benefits and risks. Collaterals may get a borrower a better interest rate on the loan, but there are risks it is fraught with danger as you might lose control over your business assets if you fail to pay back the lender.
9. Analyze the key terms of the proposed business loan
Once you have applied for a business loan, the lender may accept or reject your application. If the lender accepts your loan application, they will share the terms and conditions of the loan. Review all aspects of the loan proposed by the lender. Check interest rate, loan amount, loan disbursal process, repayment amount and frequency, repayment process, any collaterals required, early payment conditions, etc.
10. Compare quotes of loan options from various lenders
To get the best interest rates and terms of a business loan, compare loan quotes offered by two or more lenders.
11. Make an informed decision
Now you can see the light at the end of the tunnel. You are about to get the small business funding that you need. All you need to do is choose the type of loan and lender that perfectly fits your business needs with the help of all the knowledge you gained from the previous steps.
Small business loan application checklist
Here’s a quick recap of all the details and documents that you may need to complete your small business loan application:
1. Loan amount
2. Usage of Loan
3. Type of Business Loan
4. Annual Sales Revenue
5. Years of Business
6. Declaration of existing debts
7. Declaration of major shareholders
8. Credit Reports of all major shareholders
9. Business Income Tax Returns
10. Personal Income Tax Returns of all major shareholders
11. EIN Number
12. Proof of business ownership
13. Collateral or Personal Guarantee if needed
While filling out the loan application, keep in mind to be as transparent and accurate as possible. Falsifying documents or information on your application might lead to the instant rejection of your small business loan.
Pros and Cons of Small Business Loans
● Due to a plethora of lending options in the form of SBA loans, banks, and online lending platforms, getting a small business loan has never been this easy.
● Compared to the line of credit, small business financing offers a larger capital for businesses in need.
● With different types of business loans available, it is easy to choose the loan that is geared toward your specific needs.
● Many lenders offer flexible repayment terms.
● Interest rates may vary depending on your credit score and credit history. If you have poor credit, you might have to pay higher interest on your small business loan.
● Some lenders may require you to put down collateral for loan security. If you default on loan payments, you would run the risk of losing your collateral.
Frequently Asked Questions about Small Business Loans
How much income do you need to get a business loan
Your annual sales revenue plays a critical role in getting a business loan. Having said that, it is difficult to predict the income you might require for loan approval as the number varies from lender to lender. Some lenders might need monthly revenue of $10,000 while others might require an income of over $30,000 per month.
Can I get a business loan with no money down
Some lending platforms offer small business financing with no money down. However, such loans are often accompanied by high-interest rates, collaterals, and substantial processing fees.
Can I get a loan if I just started a business
Finding small business funding for your startup business can be challenging as most online lending platforms require companies to be actively operational for at least 6 months.
How hard is it to get a small business loan
If you have a good credit score, decent credit history, and your business generates an annual revenue that meets the income requirements of most lenders, getting a small business loan might be fairly easy. Some online lenders process business loans within days.
The information provided is not tax advice. All loans are subject to approval from the lender. Please consult your tax advisor or other professional for more information.