Small Business Loans
A Practical Guide to Business Credit
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Choosing the right loan for your small business is vitally important. Learn more about the options for business loans using our guide below
Small Business Loan Guide
With so many options to choose from, how do you decide which loan program is right for your small business? Our simple guide will help you decide which programs will be best for your business needs, just follow these steps to get started:
Browse the Most Popular Types of Small Business Loans
The U.S. Small Business Administration, or SBA, is a federal agency that provides loan guarantee programs to businesses that may not be able to get traditional bank loans and receive long-term, low interest rate funding. The SBA has a number of loan programs designed specifically for small and medium sized businesses, including microloans, SBA 7(a) loans, and CDC/504 loan program.
Business Line of Credit
With a business line of credit, lenders will establish a credit limit for a maximum amount of money they will lend you. You can draw as much as you need up to your limit and like a credit card; you pay interest only on the amount you borrow. Business Lines of Credit can help bridge the gap during seasonal lulls and other lean periods. A business line of credit can ensure that you always have the capital you need, when you need it.
Equipment financing allows you to borrow money to purchase necessary business equipment outright. The borrower will pay back the total amount borrowed, plus interest and fees over a pre arranged period of time.
Merchant Cash Advance
As the name implies, a merchant cash advance grants a lump-sum amount to the business owner and that amount is paid back (in addition to any fees charged) directly from a portion of future daily or weekly credit card sales.
Unsecured Business Loan
An unsecured business loan is a loan that does not require the borrower to pledge assets of the company to borrow funds. However, in most cases an unsecured loan requires a personal guarantee of repayment and will generally have a higher interest rate and fees.
Business Acquisition Loans
A business acquisition loan allows you to purchase an existing business, buy-out a partner or purchase/expand a franchise.
How important is your credit profile when applying for a small business loan?
The quick answer is "Very important". When it comes to small business lending, owners and their companies are seen as one-and- the- same. Small business owners generally exert a lot of influence over their company so lenders put a heavy emphasis on the owner's credit profile. The better your credit history and credit score (FICO), the better the chances you will get a loan; and, likely on better terms. Your personal FICO score is also a component of the BizAnalyzerTM.
Once again, it's important not to leave this issue to chance. Pull your own credit report; know what it says about you. Free services like freecreditreport.com will allow you to run your credit score without harmful credit "inquires" (which lower your score) appearing on your report. Also, many credit card companies offer free credit reports with their online accounts.
Do not stop at the FICO score. Examine your credit report closely. If you see an item that does not belong or may be outdated, file a request to have the item removed from your report. Inaccurate and outdated entries in credit reports are more common than most people realize.
The image below shows how your FICO score is created and what importance is placed on each issue. If you think you can improve on any of these areas in a few months, you may even consider delaying your loan application until your score improves.
What is your ability to repay a small business loan?
Whether a business loan, a car loan or a mortgage, the first question a lender will ask you is "how much do you want?" As a business owner you should ask yourself "how much can I afford to repay, and on what terms", then work back from there.
Business Loan Tip 1
Calculate Your Debt Service Coverage Ratio (DSCR). Understand how much you should borrow based on an objective analysis of your business situation.
Lenders will focus on this metric as well. The amount you can afford to repay can usually be determined by knowing and understanding you Debt Service Coverage Ratio. This is the standard practice lenders use to calculate how much free cash you have to repay debt. Your debt service coverage ratio is a simple equation:
Debt Service Coverage Ratio (DSCR) =
Net Operating Income
Total Debt Service
DSCR can be calculated on a monthly or annual basis.
Let's examine a hypothetical example. Let's take an average month of operations sales and expenses. Let's assume the cash flow of your small business is $6,000 (gross sales minus expenses). Now let's assume that your loan payments will total $1,500 per month. That makes your DSCR a 4, which is pretty strong. Most lenders will look for a score of at least 1.5 and definitely above a score of 1. A DSCR of less than 1 means you don't have enough free cash flow to repay your loan from business operations.
Business Loan Tip 2
Perform a Small Business Loan Performance Analysis with BizAnalyzerTM
TIME IN BUSINESS (MONTHS)
Comparison with your peers!
FICO Percentile in US Full-Service RestaurantsFICO 737 beats 68% of Businesses in Full Service Restaurants Industry
Age in Business (Months) Percentile in US Full-Service Restaurants62 Months in Business beats 72% of Businesses in Full Service Restaurants Industry
Annual Revenue($) Percentile in US Full-Service RestaurantsAnnual Revenue of $800,000 beats 59% of Businesses in Full Service Restaurants Industry
What a FICO score is to personal credit, BizAnalyzerTM is to business credit. Understanding how lenders will evaluate your risk as a borrower will empower you to get the best loan and terms available. Taking a small business loan is an important step in your business operations. Understanding why you are borrowing money and determining the value it brings to your business is a complex and often, an uncertain event.
Business Loan Tip 3
Know your target monthly repayment amount and choose the best available loan type. Armed with some basic knowledge and you BizAnalyzerTM Score you are ready to begin the process of applying for your loan. Determine your monthly repayment amount, then choose the loan type that fits your business needs.
Choosing a small business loan product and submitting an application
Many business owners report feeling stressed when applying for a small business loan. It seems that lenders are asking for more and more documentation with each passing day. In reality, most lenders have a standard discovery list of documents that are required to apply for and process a loan. Knowing which documents will be required and getting that documentation in order before you apply for your business loan can reduce your stress and speed-up approval of your loan.
Typical documents required to initiate your loan application include:
- Several months of bank statements
- Outstanding credit account statements (if hard credit report not pulled)
- Corporate tax returns for multiple years
- Balance sheet and/or statement of profit/loss
- Individual tax returns
Lenders vary in the amount and history length of the documents they need to process your loan application. Be prepared to provide up to 2 years of history. Not all lenders will require two years on all documents, but many will not require more than that. In any case, be prepared to furnish all requested documentation.
The Cost of Credit
After you have gone through the application process and you are approved, you need to still make some important decisions. Understanding the true cost of credit can be confusing. Choosing between the available loan products can greatly affect the amount of the total or true cost of your business loan.
Start by asking your lender about Annual Percentage Rate or APR. APR takes into account all fees and interest rates so you have a standard measure of the cost of credit across different type loan products. Ask the lender to explain any and all fees associated with your small business loan. Typical fees associated with loans may include: