July 12, 2018 | Last Updated on: April 3, 2023
A professional service business like a physician, accountant or attorney present a unique challenge when applying for a business loan.
Loans are an integral part of any small business growth plans, and play an important role in helping them expand, hire new employees, and build new facilities. Traditionally, businesses are required to go through a fairly rigorous application process involving credit and background checks and some sort of collateral.
For many businesses, this process is straightforward and does not present many surprises. The applications are submitted to a lender, credit and collateral is processed, and a loan decision is made. These businesses have physical assets or are applying for a loan to purchase one, making the loan somewhat less risky for a lender, as they can recoup some of their funds if the business goes south by repossessing the assets.
Since there is not necessarily a tangible product being sold, banks and other lenders may have a difficult time determining how much revenue a professional services business can actually generate. Contracts and patents are not as easily appraised as something like a bulldozer or dump truck. Lenders may also have an aversion to these businesses because they aren’t sure they’ll be able to find a market or a buyer for the collateral they hold for loans.
A professional services business – which include legal firms, consulting businesses, accounting and financial services firms are not always in this position. These businesses face stiff competition and a constant requirement to continue innovating and growing to stay relevant. There can sometimes be several businesses that pop up in short periods of time, because the barrier to entry may be smaller. No equipment to purchase or large numbers of employees to hire can mean that the costs of starting a business are much lower. This can cheapen the value of professional services businesses overall, as many people view the lack of scarcity as an indication that the services themselves are not important or worthy of being paid for.
The first thing to remember when applying for a business loan is that the process is very similar to the one that borrowers go through when obtaining a consumer loan and many business loans also include personal credit. Having a handle on your personal finances is key to a successful business loan application.
Business credit, financial statements, tax records, and a business plan will also be required to apply for a loan. Since revenues are generated through contracts or hours billed, there may not be an ability to generate a forecast as would be done during a traditional application process. In these cases, it is important to be able to present detailed records of billed hours and show the contracts that are responsible for generating revenue over time.
Service-based businesses are a different animal altogether when it comes to valuation. It’s relatively easy to determine the value of a piece of equipment or a building but placing a value on intellectual property or coming up with a revenue forecast may be quite a bit more difficult. You may hold patents or trademarks that, because of the innovative nature of your service, are valuable. You may also have an experienced ownership team or staff that bring a unique and proprietary way of doing business to the table. These things are every bit as valuable as tangible equipment or property and are key to both determining and communicating the value of your business.
The questions that lenders will ask to determine your businesses value and earning potential will basically boil down to: how much revenue have your services generated in the past, and how likely are they to continue generating revenue going forward. Patents prove that you have a product or service that is yours, is original, and cannot be duplicated for the foreseeable future. The patents add value because they show that your business has access to knowledge or technology that others don’t. They are also valuable on their own as an asset that can be sold, sometimes for great sums of money.
These are the most common and, in many cases, the most straightforward financing option for businesses. Banks and other lenders issue funds to pay for business expansion, build new facilities, and purchase new equipment. Based on the purpose of the loan and the quality of the applicant, traditional loans can be priced very competitively and offer favorable terms and payment options. In some cases, these types of loans can put funding out of reach for businesses, especially those in the professional services sector, as they may require collateral or a well-defined revenue forecast.
With a function much like a credit card, lines of credit provide buffer funds to help businesses bridge short term gaps in revenue. The interest rate and credit limit are determined in much the same way that a traditional loan is processed, with creditworthiness and business operations playing a large role. Payment amounts vary as funds are drawn against the line, and interest rates may be variable over time as the line is renewed.
Small Business Administration (SBA) loans aren’t provided by the government but are instead secured by the government’s SBA offices. These loans function very similarly to traditional loans and can be used for the same purposes. The major difference is that approval is sometimes easier, which means that SBA loans may be more accessible to owners of professional services businesses. Where banks are not on the hook for the entirety of a loan balance should the business or loan go awry, they are more inclined to view borrowers and applications through a value lens rather than purely from a risk perspective.
These lenders are not always tied to the same strict regulation and requirements that banks and credit unions are. This means that they are able to set their own terms and determine their criteria for loan approval. These lenders are sometimes backed by investment groups or by private investors whose main interest may be in specific types of businesses. This means that the approval process may be shorter and the application requirements less strict. It may also mean more favorable terms for the loan itself, since some alternative lenders specialize in loans for professional services businesses and other industries that may be considered difficult to lend to.
