A loan at the right time can allow your small business to weather the storm, leverage growth opportunities, or scale to new locations. Loans are, ultimately, tools. If you use them correctly, they can be an invaluable part of how you grow your small business. If you don’t know how to use them, however, they are of little help, and very costly.
The key to your success with small business loans is therefore understanding what you need, and what you are getting. In this article, we discuss everything you need to know and think about before applying for your small business loan.
Types of Loans Available to Small Businesses
Broadly, you will have access to three types of loans when you are looking for small business financing:
A Term Loan: These are traditional bank loans, usually applied to the purchase of a long-term asset.
An Alternative Loan: Alternative loans are offered as easier, more accessible options than term loans. Almost all banks and lenders offer these loans, and they are usually associated with flexible and negotiable repayment terms and interests rates.
A Small Business Administration (SBA) Loan: These are loans offered by traditional banks, but applied for through the U.S. Small Business Administration, and therefore backed by government.
Term loans and alternative loans are not necessarily structured in a way that caters for small businesses – they form part of the large body of credit options that most banks offer. Sometimes they are advertised as small business loans specifically, but what that means will differ between banks and providers. For several reasons, an SBA loan should be your plan A when you are looking for a small business loan.
Why SBA Loans Are Your Best Bet
Some of the most effective SBA loans are guaranteed by the federal agency. This allows lenders to offer SBA loans at lower rates than would otherwise be possible. It also allows them to offer more flexible terms than typically available outside of the SBA loan ecosystem.
The low annual interest rates make SBA loans the cheapest option for small business financing. There is a caveat, however: it can be quite difficult to get an SBA loan. The best course of action is therefore to start by applying for an SBA loan, and explore other options later if that turns out not to be feasible.
SBA Loan Requirements and Types
The 7(a) loan program is SBA’s flagship loan program, and by far the most popular. Loans in this program are federally guaranteed and amount up to $5 million. 7(a) loans are granted for the purpose of providing funds for working capital, expansion, and/or equipment purchases. These loans are processed through banks, credit unions and specialized lenders.
The 504 loan program also allows for federally guaranteed loans of up to $5 million, to be used for the purchase of land, machinery and/or facilities. These loans are processed through private-sector lenders and nonprofits.
The SBA also offers microloans of up to $50,000, processed through community-based non-profits and available for the purchase or maintenance of working capital, inventory, equipment, or starting a business. Finally, SBA itself offers loans of up to $2 million for small business owners affected by natural disasters or other emergencies.
The SBA loan rates are almost definitely the lowest that small business owners have access to. The application process is long and arduous, however. It therefore helps to determine beforehand whether or not you are likely to qualify.
SBA loans have the following general eligibility requirements:
Your business must be a for-profit enterprise
Your business must be conducted in the U.S.
You must have invested equity in your small business
You must not have sufficient liquid assets or other resources to finance yourself for the project at hand
You (and all other owners with a more than 20% stake in the business) will have to offer personal assets as security.
If you think you might qualify, it is worth the time and effort to further explore your options with regard to SBA loans. Regardless of whether you qualify for an SBA loan, however, there are some general requirements that applies across the board, for most loan application processes.
General Business Loan Requirements
When you are getting ready to apply for a small business loan, you should have the following at hand:
Credit Reports. This is how lenders know whether or not you are a “safe bet”, so to speak. If your business is incorporated as a separate legal entity, you will most likely need to provide a business credit report. Additionally, if you intend to use personal collateral for the loan, you will also have to provide your personal credit report.
Financial History. Every lender will want to know your small business’s financial history. This should ideally be presented as the complete financial statements of the previous one or two financial terms, but some lenders do accept more informal records.
Business Plan. This serves to indicate how you plan to use the funds that the loan provides, and why that will make your business feasible (and, when all is said and done, able to repay the loan). Most loan applications will require that you state the loan amount and loan purpose elsewhere in the application – but be sure that the amount and purpose of the loan forms a part of your overall business plan.
Regulatory Compliance. You will have to prove that your business is duly registered an operating within all regulatory requirements. This will usually mean that you need to provide your business licenses and permits, your employer identification number (EIN), and your personal and business tax returns.
Financial obligations. Be prepared to disclose all financial obligations that affect the business’s liquidity. This will includes major contractual obligations, commercial leases, accounts payable, and a disclosure of other debt.
The Most Important Rule For Small Business Loans: Plan
As a small business owner, you often have to jump through so many hoops to satisfy potential lenders that you forget to set our own stringent criteria for your loan: how much do you really need? How much growth/value will this loan realize? Is there no other way to realize that growth/value? And is it worth it, given the total cost of the loan?
Never loan more than you need, and perhaps more importantly: know exactly what you need before applying.
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