Contributed by Jill Goodwin
Jill Goodwin is a content champion for a variety of online publications. She covers topics for business owners and entrepreneurs with a focus on finance, productivity, and management. To request a quote for content or articles, email jill@jgoodwin.me.
Applying for loans can be stressful, and when it comes to business loans, it’s no different.
You need to ensure that you have the relevant documentation on hand and be prepared to share all the details of your business with the financial institution. Once you’ve made it through this process, the waiting game begins.
Let’s take a step back.
How do you go about applying for a business loan, and how can you increase the odds of it being approved? There are plenty of mistakes entrepreneurs make, and failing to secure funding doesn’t have to be one of them.
Keep reading. Our guide will tell you everything you need to know about securing finance for your venture.
Table of Contents
What Is a Business Loan?
While a business loan can be made up of various components or products, it’s credit given to a business from a bank, credit union, or other financial institution.
A loan is often given over a specific term period with a set interest rate. And it’s an affordable funding option for most businesses, provided that you have the documentation available to convince the lender you’re not an unreasonable risk.
You are generally given the option to select your term, although the lender will have the final say. You need to know that your perceived risk will determine your interest rate.
Here’s an example of a typical business loan structure.
Amount needed: $100,000
Interest rate: 10%
Term: 1 year
Monthly repayments: $8800
Amount repaid: $100,000 plus $5500 in interest
Popular Lending Options for Businesses
U.S. Small Business Administration’s 7(a) Loan Program
To assist small business owners in establishing new businesses, the U.S. government has implemented a small business loan program. The U.S. Small Business Administration’s 7(a) Loan Program makes it easier for entrepreneurs to apply for a loan successfully that would’ve otherwise been declined.
This option takes longer to secure, and this needs to be factored into your finances, as it could delay your startup. These loans can range from $500 to $5.5 million.
In addition to the 7(a) Loan Program, the SBA previously ran a New Markets Capital Venture Program, but this is on hold because of COVID-19. However, you can approach private venture capitalist companies as an alternative.
Venture Capitalists
Venture capitalists (VCs) acquire part of your business in exchange for providing you with capital. VCs tend to focus on companies that have ground-breaking ideas or technologies, or long-term growth potential. These private equity investors are willing to invest in high-risk ventures, as their return can be extremely high if a company is successful.
This option is good for start-ups that don’t have collateral they can offer a bank. However, securing funding from a VC requires you to give up equity, and potentially relinquish control of your business.
Community Development Financial Institutions
CDFIs are private financial institutions that offer affordable ending options to ensure the injection of capital into low-income, low-wealth neighborhoods. If your business will aid the economic growth of a disadvantaged area, you can apply for a CDFI loan.
504 Loan Program
This program provides businesses with fixed-rate, long term financing that will fund expansion, modernization or the acquiring of fixed assets. They make these loans available through Certified Development Companies (CDCs).
Online Lenders
There are numerous online lenders that offer small business loans of varying sizes. These lenders complete the entire application process online, and their interest rates may be less than favorable, but they are not always as strict with their lending criteria. Several online funding options are available including Fundio, Kabbage, Accion and Fundera.
Alternative Funding Options
With so many loans available, it can take a while to identify which loans to pursue. Lars Lofgren, CEO of QuickSprout, offers a guide on the best business loans that QuickSprout has reviewed and that he personally believes and trusts in.
Sometimes, waiting weeks or months for your loan to be approved is not an option. If you find yourself in this position, there are options available that may pay out quicker. The downside is that their interest rates and fees may be higher. You’ll have a shorter repayment term too, and you may find the lending criteria is not as strict.
These options include peer-to-peer loans (P2P), invoice factoring, and cash advances.
P2P loans are often referred to as debt crowdfunding, marketplace lending, or crowd lending. They work on a similar principle to platforms like Indiegogo and GoFundMe. Borrowers are matched directly with lenders to secure funding. In return, investors receive their loan amount plus interest, and can charge a lending fee. P2P is also similar to Venture Capitalism, however, there’s no equity, shares, or signing over of control involved. P2Ps are ideal for businesses using credit card facilities. The terms will be determined on your daily sales, and the lender will receive daily payments in accordance with the agreement.
Cash advances are cash pay-outs released to the business with a repayment term of three months or less. These advances use invoice factoring, which looks at the business’s outstanding invoices, and then pays you upfront for these outstanding amounts. You’ll need to repay the lender as soon as the invoice has been paid in full. A merchant cash advance (MCA) is a popular type of cash advance where you agree to repay your loan with a percentage of your future sales. Sometimes, these loans can hold you back, in which case you could work with a debt resolution law firm to exit a merchant cash advance.
You can also reach out to friends or family, if you feel they may be able to assist. They may be more inclined to help, and their interest rate and fees may be a lot lower than that of conventional lenders. By approaching friends or family, you may find and receive the funding far sooner than you would through other lenders. If you choose this option, have a contract drawn up that outlines the agreement to ensure everyone involved is protected.
Qualifying for a Business Loan
The first step towards securing any loan is being able to qualify for what you need. This will quickly become apparent as you develop a business plan and add up the costs involved in the initial steps to start your business.
Most lenders will look at whether or not your business will be able to meet the loan repayment terms, and base their decision on that. This means you need to prove that you’re able to generate enough revenue and profits to pay off the loan and continue operating concurrently.
A steady cash flow or revenue model, or a well-written business plan will be able to support this. Your personal and business credit history will be examined too.
Please note that credit inquiries impact your credit score, so avoid applying for more than one loan at a time.
It should come as no surprise that your finances determine affordability, as they provide a realistic look into how you manage credit. For a new business, it can be tricky to secure a loan, as the business lacks a financial history to support its creditworthiness. This is where your personal finances come into play. If you can prove that you’re financially stable with a good credit score, it will improve the chances of your loan being approved.
A debt-to-income ratio is most commonly used to determine whether not you can afford the loan. Ideally, this ratio should be lower, indicating that you haven’t taken on more credit than you can afford.
Documents Needed to Apply for a Business Loan
The correct documentation is crucial when applying for a loan. These documents will be related to both your personal and business financial history. You’ll also need to show how much funding you need, and what exactly it will be used for.
Documents include, but are not limited to:
- Employer identification number
- Business licenses and permits
- Personal tax returns for the last three years
- Business tax returns for the last three years (For existing businesses looking for additional funding)
- Bankruptcies
- Bounced checks
- Personal credit scores
- Business credit scores
- Annual profit and revenue (For existing businesses looking for additional funding)
- Statement of disclosure of debt
- Copies of leases (If available)
- Personal bank statements
- Business bank statements (For existing businesses looking for additional funding)
What Is the Turnaround Time for a Business Loan Approval?
You may think that the initial application is the most stressful part of the journey, but waiting or loan approval can be even worse!
As with any investment—because that’s what you’re asking the lender for—the process requires thorough research and careful consideration.
All the documents will need to be vetted and deemed correct before being used to calculate your affordability, and determine a repayment option that suits both parties.
Most banks provide a turnaround time of two to four weeks. If you’re looking at applying for a loan from the U.S. Small Business Administration’s 7(a) loan program, it could take up to three months, sometimes even longer.
Determining if a Business Loan Is the Right Option
As one of the more obvious funding options, business loans are often the go-to when launching a start-up or seeking additional capital to scale up an existing venture. But before you start any credit processes, you need to determine if this is the most logical solution to your problem.
Determine why the loan is necessary, and what your goal amount is. You’ll need to consider the loan terms, as these can become a financial burden if not properly considered and planned. To help you determine if a loan is the best solution for your business needs, try an online loan calculator to get an estimate of the amount and repayment terms that would fit your budget.
If you need a loan to cover daily expenses, you may want to look into getting a smaller loan with longer repayment terms to prevent a knock to your cash flow. A larger loan with a shorter repayment term is more suited for expanding your business.
Something to consider is your ability to repay the loan, especially as a new business that’s yet to build a steady cash flow.
Being unable to pay back your loan will have serious consequences.
Budgeting will be the best tool to ensure that you’re able to meet all of your obligations. If you anticipate you may be late with a repayment, let the lender know as soon as possible so you can make a payment arrangement.
Support Your Cause
When it comes to loan applications, lenders need to know that you’ll be able to meet their repayment terms.
They’re investing in your business and are looking for a return as soon as possible. If the roles were reversed, wouldn’t you want to make an informed decision before giving your money to a stranger?
As a new business, there’s no separating your personal finances from your business finances. It’s therefore crucial that your financial history paints a positive picture. Ensure that you have the latest financial statements and documents available, as well as your business plan. Attach all these documents to your application to improve your chances of your loan being approved.
However, don’t rush into accepting the first approval that you get.
Take the time to review the offer and make sure you understand all the terms and conditions. By signing the loan contract, you’re agreeing to the terms. Should something happen that puts you in breach, pleading ignorance will not be a valid argument.
Conclusion
While there are various options available to entrepreneurs who need funding, securing a business loan generally follows the same path.
By having the correct documentation, a good business and personal financial standing, and a clear understanding of terms and interests, you can secure funding to take your business to the next level. And just in case a loan doesn’t work, you can always consider an SBA loan investor.
