If you’re like most small business owners, you will need a small business loan to start/grow your business. Small business loans are commonly offered by banks and offer small businesses the cash to cover most costs. Unfortunately, many small business owners do not qualify for this type of funding. If you are interested in a traditional small business loan, keep the following things in mind to increase your chances of approval and to make the process go much smoother.
Things to Consider
Traditional bank loans are some of the most common types of small business funding because of the safety nets that come with them. Since these loans are backed by the federal government, they have assurances that most non-traditional lenders do not. In addition, these funds generally have lower interest rates than alternative options.
As a small business owner, you have many options for funding, each with its own set of criteria that may make one option better than another for your personal situation. Once you’ve decided that you need funding, you must determine which type of funding you are interested in. One of the biggest mistakes people make is choosing the wrong type of funding.
Top 6 Most Common Traditional Small Business Loans
Below, we’ll look over the top 6 most common traditional small business loans:
Business Term Loan
A traditional bank loan, offered by a traditional financial institution, is similar to a personal loan. When businesses need funding for major investments, acquisitions, upgrades, or other needs, this is often their first choice. Depending on the agreement, there is typically a fixed interest rate and payments are required monthly or quarterly. These loans also have an end-date, which typically runs 3 to 10 years, sometimes longer.
Line of Credit
A line of credit is similar to a credit card. If your business is approved, you can borrow up to a set amount of money. You only pay interest on what you actually use. As long as you stay under the maximum limit, this option is flexible in how the money is used. This is ideal for small businesses that have a steady income, a decent credit history, and who are willing to use their assets as collateral.
Commercial Mortgage
If you are interested in acquiring a physical location, a commercial mortgage may be your best option. This type of funding is secured with a lien on the commercial property and is similar to a home mortgage. If your credit history is unflattering or non-existent, the bank may require you, as well as other principals, to personally guarantee the loan. This means that you must promise to pay the loan if the business cannot. Most residential mortgages last for 30 years, but commercial mortgages are much shorter.
Equipment Lease
An equipment lease is similar to leasing a car- it spreads out the cost of the equipment over a period of time. In most cases, a large down payment is not required and when the lease is over, you can either renew the lease, return the equipment, or pay the equipment’s value based on the lease and the appreciation of the equipment. While the monthly payments are lower, the interest will add to the total cost.
Letter of Credit
A letter of credit is a guarantee that the seller will receive payment on time and comes with protections for the seller or the buyer. If the seller is protected, the bank agrees to pay the seller if the buyer does not make payments and is typically included with international transactions. Funds are sometimes collected from the buyer and placed in an escrow account. If the buyer is protected, the seller is penalized, often in the form of a refund. These letters are provided for businesses that apply for it and have a decent credit history and/or collateral.
Unsecured Business Loan
An unsecured business loan doesn’t require collateral. The interest rate is typically higher since it’s not backed by collateral. This type of funding is often provided through an alternative/online lender, though in some cases may be offered by a traditional bank if they have an existing relationship with the borrower. Since there is no collateral involved, this type of funding is difficult to obtain and if you do qualify, the terms are shorter to alleviate risk to the lender.
Top 2 Alternatives to Traditional Small Business Funding
As a business owner, it’s important to note that traditional funding is not the only choice you have. You can work with an alternative lender to get the funding you need, especially if you don’t qualify for traditional funding. The top 2 alternatives include:
Online Loans
Online lenders are usually more flexible and turnaround time is quicker. However, rates are usually higher.
Microloans
A microloan is a small amount of money that helps cover certain costs within the company and usually comes with a lower interest rate. unfortunately, they also have shorter terms and often have stipulations on how the money can be spent.
Terms to Keep in Mind When Applying for Business Funding
In addition to the loan you choose, you must consider the details. Each loan has an interest rate and terms, as well as other things to consider. Make sure that you carefully read the contract to ensure there are no hidden terms/fees.
Closely review the following when applying for funding:
Rates
In addition to the amount of money you’re borrowing, you need to check the loan/interest rate, which differs based on several factors including:
- Type of loan you’re seeking
- Financial institution
- Personal credit score
When you are seeking a business loan, make sure the interest rate is low. Depending on the loan, rates vary from around 3% to 80%+.
Terms
The term is the amount of time you have to pay the loan off. If you can afford the payments, you want shorter terms because the longer the term, the more interest will accrue, increasing your total cost.
Banking Relationship
In order to be considered for a traditional loan, you may be required to have an existing relationship with the bank. If you don’t already have an account, consider opening one to establish a relationship so that you can apply for funding in the future.
What do banks look for in your application?
Each financial institution has its own requirements and application forms- many are offered online, but some still require you to fill out a physical form. They may have a preference based on the type of loan and the amount you’re seeking.
You must also consider the criteria for approval. There are several factors involved, so make sure to check on the following:
Credit Score
A high credit score proves that you’re reliable for paying your debt. Your credit score can make or break your approval, but it will also affect the terms and interest rate if you are granted a loan offer.
Loan Purpose
Some loans have stipulations on use. For example, an equipment loan must be used for equipment, while a mortgage loan must be used to obtain property.
Collateral
If your credit score is low, you may be required to put up collateral. If you don’t meet the guidelines for repayment, you may lose that collateral, which will sell it to recoup the loss.
Cash Flow
Many traditional lenders will not approve your loan application if you cannot prove that you have a steady cash flow. In some cases, they require a certain amount of revenue before the will consider your application.
Financials
One document that the institution will want to see prior to approving your loan is your cash flow history. You’ll also need to provide financial projections for your business.
Business Plan
Most lenders, whether traditional or alternative, will require you to submit a business plan.
Working Capital
This refers to the money you have available to cover your operating costs. If you don’t have working capital, you’re considered high-risk.
How to Get Started with Applying for a Business Loan
Once you’ve decided which type of funding will meet your needs and what the lender needs to determine whether you qualify, it’s time to apply. Keep the following in mind to make the process easier:
Get financials in order
When you apply for a business loan, you need to have your financials ready. Ask the loan officer what they need ahead of time. Typically, you’ll need 3 years’ worth of business expenses and personal tax returns, as well as YTD P&L statements, balance sheets, inventory breakdowns, and accounts receivable aging reports.
Create business plan
If you are just starting a business, you need to have a business plan. There are several options to choose from if you need help.
Estimate how much you need
If you need a loan for a single purchase, make sure that you have estimates for the work or the purchase to show the loan officer. Lenders want to know that you’ve given thought to your needs/goals and have a plan to use the money wisely.
Conclusion
A business loan can be beneficial for your small business in many ways. If you need help with getting the funding you need, contact Commercial One Group today. We can help you with alternative financing.