The “D” word – debt! It strikes fear into the heart of most consumers and business owners. But all debt is not created equal. Taking on debt can help your small business grow.
If you’re pouring your heart and soul into your small business and are ready to expand, review our advice to prepare for getting your first business loan.
1. Ask yourself, why do I need this loan?
Lenders will ask your reason for seeking funding and you should have your answer nailed down. Answers likely fall into one of these categories:
- To start your business
- For cash flow to manage day-to-day expenses
- For business expansion
- To build savings
Your purpose for seeking a loan will help you identify whether you’re trying to fill a short-term or a long-term financial need. You’ll also need to determine when you would like to repay the loan. Long term loans generally have the lowest interest rates and 10 years or more to pay off resulting in low monthly payments. If you’re in it for the long haul, long term is best. If you plan on early payoff, check with your lender about penalties.
2. Prepare your business plan
According to the small business mentoring organization SCORE, a business plan has two primary purposes. First, it acts as an organized roadmap to help you analyze your plans for marketing, sales, production, distribution, etc.
The second purpose is the reason many entrepreneurs put together a plan-seeking funding from a bank, credit union, or other type of lender. Some financial institutions or other lenders will not invest in your company unless you present a business plan that demonstrates your steps to success.
SCORE reports that banks want to mitigate their risk of default and private investors, such as Angel investors, want a realistic forecast for when they will get a return on their capital. (NOTE: SmartBiz does not require a business plan when you apply for an SBA loan or a bank term loan through a bank in our network.)
Your business plan will also indicate when you need funding and help you determine the amount you can responsibly borrow to meet your short and long-term goals.
For more information, review Do I Need A Business Plan To Get A Small Business Loan?
3. Speak to a financial professional
It’s always a good idea to have a financial professional help you crunch the numbers before you seek financing. If you don’t have an accountant on your team, review our article to determine if you need to hire and in what capacity: How to Hire an Accountant for Your Small Business.
4. Decide which type of loan is right for you.
Your reasons for needing the loan will help you decide the type of loan you get. It’s important to note that If you’re starting a business, it’s almost impossible to get a loan in your first year of operation. Lenders require cash flow to support repayment of the loan, so startups are typically disqualified from financing. Instead, starting entrepreneurs can rely on business credit cards, borrowing from friends and family, crowdfunding, personal loans or a microloan from a nonprofit lender.
5. Determine the best small-business lender to work with
Unfortunately, not all small business lenders are on the up-and-up. Confusing language and calculations can result in paying much more than you think you signed up for. Make sure you work with a lending professional who is responsive and answers all questions clearly. Stellar customer service support is key.
6. Check your qualifications
Go into the loan application process with your eyes open about the financial situation of your business. Check the following details:
It’s important that every small business owners is aware of their business credit scores and actively monitor them so they can quickly address any errors on their credit reports. Both business and personal credit scores are important and will determine which loans you’ll qualify for.
Banks, which usually offer the least expensive small-business loans, want borrowers with credit scores at least above 680. If your credit score falls below that threshold, consider online small-business loans for borrowers with bad credit or loans from a nonprofit microlender.
The SmartBiz Small Business Blog has many informative articles about business credit, personal credit, and credit reports: What Is A Good Business Credit Score? Guide to Understanding Business Credit Score.
Don’t put in multiple applications with lenders as your credit could lower with each inquiry. Find a lender who does an initial “soft pull”, also called a “soft inquiry” of credit. Bad credit can sink your chances to qualify for low cost funding. For information on this, read Hard and Soft Pulls of Credit: What you Need to Know.
How long have you been in business?
In addition to your credit score, lenders consider how long you’ve been operating your business. You need to have been in business at least one year to qualify for most online small-business loans and at least two years to qualify for most bank loans and SBA loans.
Do you have enough income?
Many lenders require a minimum annual revenue, which can range anywhere from $50,000 to $150,000 annually.
Can you make the payments in full for the life of the loan?
Look carefully at your business’s financials — especially cash flow — and evaluate how much you can reasonably afford to apply toward loan repayments each month. Some online lenders require daily or twice-monthly repayments, so factor that into the equation if that’s the case.
To comfortably repay your loan each month, your total income should be at least 1.25 times your total expenses, including your new repayment amount.
7. Gather documents
Each lender will have slightly different paperwork requirements. In general, documents required include:
- Business tax returns
- Income statements (year-to-date)
- Balance sheets (year-to-date)
- Schedule of liabilities (list of all business debt)
- Personal tax returns
- Personal financial statement
If you took out a PPP loan, can you get another loan?
You can get a loan in addition to an EIDL or PPP loan. Generally, when you submit your application, banks want to see the amount of your EIDL loan payment included in your debt schedule and cashflow statement
The SmartBiz Small Business Blog was created to support entrepreneurs with up-to-date information about running a successful venture. From credit to marketing, we cover the important business topics to help you thrive. Visit the SmartBiz Small Business Blog.