The Guide to
Getting Started with Business Loans in 2020
If current trends continue, 2020 will prove to be a strong and exciting time to get a business loan and build your own company. There will continue to be unique challenges for every business owner, but with an improving national economy and the emergence of alternative lenders, entrepreneurs looking to start or build small businesses have a wide variety of available loans and fewer, lower bars to clear to get them.
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Why Are So Many People Starting Their Own Businesses?
Today's workforce is surrounded by nearly unlimited options in every aspect of their lives. They can have food from around the world delivered to their doorsteps in a matter of minutes, watch movies from a hundred years ago with just a few clicks, and complete a doctor's appointment using only their cell phones. In almost every case, if someone's situation doesn't feel completely perfect, technology and changing values have led to a near-universal ability to simply find a new situation.
And that goes for work as well. Gone are the days of decades-long tenure at a single corporation and a comfy retirement with a pension plan guaranteeing workers a predetermined monthly cash benefit. As we enter this new decade, those pension plans are more rare than ever.
Hand in hand with the loss of guaranteed benefit pension plans comes a change in motivation for many members of America's workforce. If workers aren't guaranteed a monthly benefit with a company, they're now motivated to move from job to job based on factors like pay, benefits packages, working conditions, and location.
In fact, according to a 2018 study from the Bureau of Labor Statistics, American workers are only staying with an employer for an average of 4.2 years. The erosion of tenure and longevity benefits, along with the instability of many of today's companies, has led many workers to believe that they are better off as an independent business owner.
Every business begins with a dream, desire, or necessity.
Every company advertised on TV, on the posters drivers pass in their cars, or shining on billboards in Times Square was started because an entrepreneur had a spark of an idea based on something they loved. Cooking. Flowers. Carpentry. Fitness. Cars. Photography. No matter where a person's interests and passions lie, there are businesses there just waiting to be built from the ground up.
Or when they're comfortable trading a head start for some flexibility, many entrepreneurs look to buy into a franchise, which brings with it an established brand and proven operational systems. From bicycles to hospitality to coffee, there are countless diverse franchise opportunities to cater to a wide range of personal interests.
More and more new companies are also being launched out of necessity. It's uncommon for someone who's lost a job to seize an opportunity to start a business. In fact, they may have always dreamed about being the boss, but were unwilling or unable to take the risks associated with starting a business while still toiling at their old gig.
Often, this type of entrepreneur launches an enterprise in the same field they have always worked in and vows to do it better.
Once you've committed to starting a company, it's time to get serious about financing
Too many entrepreneurs start their business without an adequate plan in place to secure the cash they'll need to keep the business running smoothly day to day, week to week, and month to month. Being prepared starts with having a clear idea of how much funding you'll need to see your company thrive.
The good news is that entrepreneurs aren't the only ones taking advantage of an on-demand world full of new and exciting technologies. Lenders are too. In years past, business owners may very well have been limited to the lenders in their immediate geographical area. But now, there are innumerable lenders ready to hear from potential borrowers at the click of a mouse. These new and alternative lenders can be incredibly specialized for a particular industry and move incredibly quickly.
If you're starting to consider which lender to work with, it's likely time to write a business plan. Your business plan will be the first thing reviewed by the lenders you might approach for capital. Think of your business plan as a brief preview of your company. It should explain what the business is, who its customers will be, where the business will be located, and when it will operate, and why it'll be successful.
Remember: for lenders, approving a business loan means effectively placing a bet on your company's ability to pay them back in full and on time. Your business plan is your opening statement in the process of proving you're a safe bet.
Many entrepreneurs look at their lenders or investors from an adversarial perspective. That's a mistake. They're not your adversary at all. In fact, it behooves your lender for you to build a successful company able to pay back your loan with interest. A good lender is also a valuable ally in establishing budgets and financial projections. The right match of lender and borrower benefits everyone involved.
Potential lenders and investors will base their decision on the vision you outline in the business plan, the expertise of those involved in running the company, and the financial data you'll provide. There's no doubt that business owners looking for financing in 2020 need to start with a solid business plan.
Deciding how much to borrow
- Drawing the right amount isn't easy. Asking for too much or too little capital to finance your business can have disastrous consequences. While there is no single formula, you may wish to ask your lender if they have experience lending in your field or industry. Do extensive research and, if possible, speak with entrepreneurs who've been successful in the industry.
- To start, have a well-researched and justifiable estimation of the amount of money you will need and include it in your business plan. Draw upon your expertise in the industry to determine a budget that outlines how much money will be required to start. Including that estimation in the business plan also gives you an opportunity to document how the funds will be used and why.
- A rule of thumb is to ask for more than you have estimated. Inevitably, surprises and setbacks will occur during your company's pre-launch phase. Request an amount that provides cushion in case of cost overruns. After all, most companies lose money during their first year of operation. Estimate the firm's burn rate (the amount of money spent each month on costs) and determine how long you can realistically afford to stay in business before turning a profit.
Identify sources of small business funding
Some entrepreneurs are fortunate enough to have enough money that they can self-fund a new business effort. In such cases, these business owners are able to cover startup costs without getting money from outside sources. There are two main types of financing from outside sources.
- Debt financing means that the company borrows money and then must repay the lenders with interest over a specified period of time.
- Equity financing means that investors put up money to launch a business and receive a percentage of its ownership.
Best Types of Small Business Financing in 2020
Funding through Friends and Family
Many business owners start by asking family and friends to put up money to fund a new business venture. Many times the lenders are willing to provide the money with little or no interest. However, borrowing from your family and friends brings with it the very real risk of strained family relationships and loss of friendship if the company's finances go sideways.
Entrepreneurs who do not have a network of family and friends willing to put up capital often look to venture capitalists who will put up the cash in exchange for a percentage of the company. The hit TV series Shark Tank has widened the understanding of this type of small business financing.
Term Loans are traditional bank loans to small businesses in which the borrower requests an amount of money and then agrees to repay the loan, with interest, over a specified period of time. In this way, securing a small business loan is similar to getting a mortgage to buy a house, right down to the typically monthly payments.
Term loans can be risky for lenders, so they're often stringent about which companies receive them. Borrowers must meet certain lending criteria, including having a personal credit score above the parameters set by underwriters. Individuals with little or no credit repayment history often find it difficult to secure funding. They may also require your company to have been in business for a particular length of time, or be generating a certain amount of money each month.
SBA Loans are term loans that are guaranteed by the United States Small Business Administration (SBA). The agency itself does not provide funding. Instead, the loan comes from an authorized lending partner - usually a bank -- at rates and terms determined by the lender. But they're different from term loans in one very important way: while term loans are risks taken by the lender, SBA loans are partially - often up to 75% - guaranteed by the SSBA. The SBA's guarantee greatly minimizes risk for the lender and provides incentive for banks and lenders to make capital available to entrepreneurs at attractive interest rates.
The downside of SBA loan applications is that they require a lot of documentation, which slows the process and lengthens the amount of time it takes to finalize the deal. Decisions hinge upon the borrower's credit score, which is a reflection of his or her payment history. However, borrowers with a sufficient level of creditworthiness will find an SBA loan a really attractive option because the interest loans they offer are tough to beat.
Business Credit Cards
Who among us has not received a business credit card mailer in the past few months? Business credit cards work just like personal credit cards, except that their use and repayment affects a company's credit report instead of an individual's. They typically come with credit limits that range from $3,000 to $20,000. Often, they are easy to apply for and secure, and many of the companies that issue business credit cards make an initial offer with a low annual percentage rate (APR) for a certain period of time.
However, after the introductory period has passed, the interest on credit card purchases can be quite high. Using credit cards to launch a business can mean high repayment costs if it takes a while to repay the debt. Further, if you need to borrow a large sum of money for purchases of property, building renovations, equipment purchases, and inventory, a credit card's borrowing limit may be too low.
Business Line of Credit
A business line of credit is a form of small business financing in which an entrepreneur has cash available to draw upon when needed. When cash is needed, the business owner withdraws the money from the credit line and interest is paid only on the amount of money that has been borrowed. Business owners like this type of small business financing because of its flexibility and because the interest rates charged are much lower than the rates of business credit cards, which can approach 19% APR.
Equipment financing is exactly what it sounds like. With this type of funding, the equipment is put up as collateral. In case of default, the lender can take possession of the equipment and sell it to recoup the loss. That inherent collateral makes these loans relatively low-risk for the lender, often leading to competitive interest rates. So if your primary up-front cost is going to be a piece of equipment, an equipment loan may be the smartest choice.
Accounts Receivable Financing
Accounts Receivable Financing is an option that established business owners use when they are caught in a cash crunch. If unanticipated costs or slow-paying customers are impacting cash flow, this type of financing can provide a quick infusion of capital. However, the money usually comes at a steep cost. Essentially, you are selling your future earnings at a discounted price to the funder.
Merchant Cash Advance (MCA)
Merchant Cash Advance (MCA) is a similar form of small business financing. MCAs provide a lump sum of cash that if paid back by providing authorization for the lender to skim your daily credit card receipts until the amount of the loan is repaid. Borrowers are able to pay based on the company's sales. The amount of repayment during a period of time is related to the fortunes of the borrower. During good weeks, they pay more, during slower weeks, they pay less. For instance, if you need to borrow $10,000, the repayment amount frequently is $12,000, which is repaid as a percentage of credit card receipts for the length of time it takes to repay the agreed upon amount.