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The Ultimate Guide to Business Loans

Small businesses make up much of the American economy. The Small Business Administration (SBA) reports there were nearly 29 million small businesses, as of 2016. While the nature of the businesses varies, many hold one major thing in common – the need for business loans.

Business loans help provide much-needed cash flow to keep companies up and running. Getting a loan for your business isn’t as simple as walking into a bank and securing funds – there are a variety of loans to consider, each with its own requirements. If you need a business loan, keep the following in mind to ensure success.

Before You Apply

Determine your need for a business loan

Businesses today are at a unique advantage. The business funding landscape is now more varied and accessible than ever before. There are different types of business loans available to meet nearly every distinct need.

There are a few variables to consider when determining the right business loan for your company. Pursuing a loan should be a strategic part of your business plan. Think about whether a long-term or short-term loan option is best for your needs. If you just need funding to fulfill a large order or take advantage of a one-time opportunity, loans with shorter terms are probably best. If you need to purchase a piece of machinery that will last 20+ years, a long term loan is more cost effective. You don’t want to be paying back a business loan long past the investment’s useful life. Pursuing a long term business loan to purchase new software that will need to be replaced again in five years is probably not the best use for that type of business loan.

SBA Loan

A long term small business loan backed by the Small Business Administration. By guaranteeing the loan in case of default, the SBA takes the risk out, so banks can lend to small businesses, connecting these growing companies with the cash they need to thrive.

  • Longest loan terms (up to 20+ years)
  • Low down payment
  • Moderate interest rates (6-10%)
  • Suitable for a variety of business necessities

Short Term Loan

A traditional loan to fund timely business opportunities. Short term loans typically last from a few months to a year or more. This type of business loan is usually more accessible to small businesses than its long-term counterpart.

  • Fast approval process
  • Minimal paperwork
  • Applicants with bad credit are acceptable
  • Beneficial for short term business changes

Long Term Loan

A traditional loan to finance lasting business investments such as machinery, a manufacturing plant, or even acquiring another company. Terms can last up to 10 or 20 years depending on the business’ needs.

  • Fixed interest rates that are lower than other business loan rates (about 5%)
  • Fixed monthly payments
  • Flexible spending – there are no specifications on how to spend funds

Business Line of Credit

A set sum of cash for a business to draw upon as needed. Companies can choose to pull money out for long-term investments or for short-term needs. Whatever a business takes out is paid back on a set schedule with interest.

  • Funds are available as-needed
  • Suitable for a variety of business purposes
  • Interest is only applied to the drawn amount, not the full line of credit

Working Capital Loan

A short term loan for the purpose of funding a company’s day-to-day operations during a time of reduced activity. When the lull is over and business is booming again, the company can repay the business loan.

  • Available funds in case of emergency
  • Flexible spending options
  • Fast funding
  • Minimal paperwork

Equipment Financing

Enables businesses to pay for expensive equipment a little at a time; equipment is used as collateral. These loans are ideal for businesses that need hard assets like vehicles or commercial kitchen equipment, but can’t afford to purchase them outright.

  • Long business history not required
  • Equipment purchased with the money from the loan acts as collateral
  • Relatively low interest rate compared to alternatives (starting at 15%)

Accounts Receivable Financing

Gives a business immediate cash for existing invoices. These business loans are great for companies that are risk-averse or that don’t have good credit and a lengthy business history. AR financing can help businesses take advantage of timely opportunities or handle immediate needs.

  • Fast funding (within a day or two)
  • Invoices serve as collateral
  • Minimal paperwork
  • No pre-payment penalties

Find out which business loan is best for you

Calculate a desired business loan payment

One of the most important things to determine before applying for a business loan is how much you can afford to pay back on a monthly basis. Defaulting on a loan can cause irrevocable damage to a business and its credit history, which will impact its ability to get funding in the future. Don’t be too ambitious when making this calculation. Be realistic and err on the side of caution. Risk can be a good thing in business, but committing to a loan repayment schedule that’s too aggressive could ruin your company.

You should determine exactly how much your business needs to borrow to achieve its goals. This should be a precise figure, not a range. Lending companies want to see that you’ve done your research and that you will spend their money in a way that will help your business thrive. They want you to succeed so they’re sure to get paid back.

Our business loan calculator can help you see how altering certain variables can modify your monthly payment. Play around until you find the mix that’s right for you. Keep your desired loan amount with you throughout the application process so that you’ll know precisely what to ask for when engaging with funding partners.

Now that you know the types of business loans that are available, which one you might need, and your desired loan payment, the next step is to determine if you’re creditworthy.

Are you creditworthy of a business loan?

Lending companies expect to make money on business loans. To better their chances, they are scrupulous in determining the creditworthiness of loan applicants. To be considered creditworthy, borrowers must provide these funding partners with adequate financial data that underscores their ability to pay back the loan.

Check your credit history

Business funding partners will examine an applicant’s credit history, capital, collateral, debt-to-equity ratio, ability to manage resources, and other factors in evaluating if they are creditworthy. Banks also scrutinize economic conditions that might negatively impact the borrower’s ability to pay.

Borrowers should expect to have good credit to qualify for business loans. Funding partners build an assessment of the applicant’s character by evaluating how they handled debt in the past. Applicants can view their credit score at LendingTree.

FICO Scores are comprised of payment history (35 percent), types of credit (10 percent), debt (30 percent), new credit (10 percent), and length of credit history (15 percent). The history reveals the borrower’s ability to pay on time on their installment loans, credit cards, finance company accounts, and mortgages. Potential show stoppers include bankruptcies, excessive credit inquiries, liens, foreclosures, lawsuits, and judgements.

According to the SBA, loan officers are on the lookout for these “must haves” from potential borrowers:

  • The ability to pay back the loan based on collateral, financial reserves, and assets
  • The borrower’s successful past performance in business (for a new business)
  • The borrower’s existing cash flow (for an existing business)

Make sure you have the capacity to cover the loan

Capacity reflects the borrower’s earning potential to cover expenses to repay the amount of the loan requested and existing debt. In evaluating capacity, lending companies examine the resource management skills of applicants. To do so, they examine the:

  • Debt-to-equity ratio (D/E). The D/E ratio measures the proportion of the borrower’s debt divided by the business’ equity on a balance sheet.
  • Equity investment. Funding partners prefer to assist owners who invest their own resources into the enterprise. Banks especially want to know if the borrower is totally committed to the success of the business. To that end, borrowers starting a new business should compile start-up appraisals for their application, reflecting assets and cash, while existing business owners will need to provide financial statements.
  • Resource management. Business funding partners look over projected and historical financial statements in determining potential borrowers’ abilities to manage a business. Factors include the D/E ratio, amount of working capital, the rate of customer debt recovery on products or services, the borrower’s debt repayment history, and the rate for delivering products or services to customers.

The SBA warns that, “applications with high debt, low equity, and unsupported projections are prime candidates for loan denial.”

Calculate your working capital

Having sufficient capital is a key requirement for passing muster with a lending company. Factual assurance that there are sufficient assets to cover the debt in emergencies, such as collateral, offset potential risks to the funding partner.

The amount of working capital is calculated by subtracting all debt liabilities due within a year from the current assets that can be converted to cash to pay short-term creditors. The SBA alerts loan applicants that have seasonal or up/down cycles to build a larger buffer of working capital to counterbalance contingencies.

Prepare a cash flow projection

Borrowers should make sure that they have the ability to pay all debt – not just the projected loan payment – on a prudent and consistent basis. Applicants should prepare a Cash Flow Projection based on a monthly report that illustrates when money is collected, when cash goes out, and what’s left.

Funding partners typically like to see that the borrower has a thorough understanding of the financial operating cycle of the business, but not all have earnings requirements. Business owners looking to apply for an SBA loan will need to satisfy earnings requirements by having a cash flow projection report prepared. The SBA provides a guide on preparing cash flow projections.

Take inventory on assets that can be used as collateral

Collateral is an additional source of money that lending companies can legally seize if the borrower is unable to make payments on small business loans. Collateral amounts set by lending companies are not pegged to market value, but on potential lost value if the business is liquidated. Assets used for collateral on business loans can include company buildings, equipment, and accounts receivable. Business funding partners develop a collateral coverage ratio in assessing risk. All assets created through the loan are also subject to seizure in the event of delinquencies. Some business owners choose to use their personal assets – including their homes – as collateral on a loan.

Take character factors into consideration

Finally, lending companies can assess management aptitude and character by the way a potential borrower presents their explanation of financial needs. A half-hearted, slipshod business plan or inconsistent financials can say as much about an applicant’s worthiness as their credit history. Expect both types of criteria to factor heavily in the funding partner’s evaluation of an application for business loans.

Once you know if your credit will meet the minimum requirements, and you’ve assessed that your business can handle additional debt, you can move forward with getting your documents prepared to make the application process as seamless as possible.

Application Process

Prepare yourself for the application process

Once you determine that your business can handle taking on a loan, you should begin the process of rounding up the necessary documentation needed for your loan application.

The exact paperwork differs across business funding partners, but will most likely include the following documents:

  • Two years of personal and business tax returns
  • Legal Filings related to ownership
  • Recent profit and loss statement
  • Information on existing debts
  • Past bank statements
  • Recent balance sheet
  • Business license
  • Business plan

A common mistake made by failed applicants is the submission of inadequate or poorly planned financial documents and business plans. It’s imperative that you gather as much information as you can for the loan application.

Assembling the business loan application

Applications differ across various business loans. Short term loans typically have less paperwork than long term loans, and equipment financing usually doesn’t require as much documentation as a business line of credit. Borrowers, however, should be prepared to provide the most-extensive documentation package in order to increase their chances of receiving their desired business loan. Your documentation package should demonstrate the strength of your business based on profitability and sound business practices. Here’s how each type of document encourages funding partners to approve your loan.

Financial Statement

A financial statement shows net profit or loss over a specified time, which is typically each fiscal year and each quarter. You should review operating activities for your business to see how your business manages production costs and how it profits from goods produced. Non-operating activities cover profits and losses not directly connected with business operations, such as buying a building or selling business equipment you no longer use. Lending companies will use the net profit of your business to determine if you can afford to repay your small business loan.

Cash Flow Statement

A business cash flow statement tracks cash income and expenditures for your business. Funding partners review cash flow statements to see where income is being generated and how cash income is being spent. This provides an overall sense of how your business is run and the results of business decisions made concerning cash expenditures. A cash flow statement does not include profits realized from sales paid for with credit, nor does it show projections for future cash expenditures. Net cash profits will not be the same as net profits shown on your business financial statement.

Information reviewed for cash flow statements is typically split into three categories – including operations, investing, and financing. Operations includes cash income generated by services or products provided; adjustments made to cash income include depreciation, accounts payable, accounts receivable, and inventory. Changes in accounts receivable shown on the balance sheet from one reporting period to the next are also shown on the cash flow statement. The investing section of a cash flow statement documents cash expenditures for business related expenses, such as equipment or real estate. Financing tracks changes in debt, loans, and dividends paid out. A cash flow statement demonstrates the amount of cash income and outflow and indicates how decisions are made concerning cash transactions for your business.

Balance Sheet Accounts for Business Assets and Liabilities

Your business balance sheet shows funding partners the source of assets used to pay for business liabilities. In general, business assets come from income generated by business operations and by cash investments in the business made by you or partners/investors in your business. Examples of business assets include cash, inventory, and the value of business real estate. Liabilities include debt incurred against the business and accounts payable. There is no set format for balance sheets as the information reported varies by industry. Your balance sheet shows prospective business funding partners that your business has sufficient assets to repay loans and that it doesn’t have liabilities that can interfere with your ability to repay the loan.

Business Plan

Lending companies require business plans that include projections for financial statements, cash flow, and your balance sheet. The business plan describes the nature and scope of your operation, its projected income and expenses for a specified period, and lists operational activity and costs. Projections included in a business plan provide a pathway for making business decisions. Likewise, funding partners review your business plan to ensure that your decisions are consistent with your plan for a business loan and projected ability to repay it.

Business and Personal Tax Returns

Funding partners will also request your most recent two years of business tax returns and will usually want to see your personal income tax returns for the same period, especially if you’re just starting your business. Tax returns verify net income and are used to document that you and your business can afford to repay your loan. It’s important to establish a relationship with a Certified Public Accountant (CPA) familiar with your type of business. Your accountant can prepare the business and tax documents needed to support your application for business loans and guide you in accounting and tax matters related to your business.

Lending companies may also require business and personal credit reports, background checks and legal documents related to your business. The application process may seem eternal, but cooperating with your funding partner and providing requested business loan documents quickly will help move your application from pending to approved.

Apply for a business loan

Closing Your Loan

Final steps towards receiving a business loan

Receiving approval towards loans for your business is just the first step to obtaining the funds you need. There is a closing process that involves reviewing a ton of documentation that will dictate the terms of your selected loan. It’s important to understand what to expect when closing on your business loan to help the process go smoothly.

Review the business loan contract before closing

A business loan contract is a legally binding document that will dictate the terms of your loan. When you sign the contract, you’re completely agreeing to all of the lending company’s terms whether you understand them or not. Although reading the whole contract may take a significant amount of time, it’s important that you understand everything before signing to make sure you’re not getting a bad deal. After all, business funding partners expect to make money off of business loans.

Make sure you're comfortable with the contract's terms

When you’re reviewing the contract, make sure you have a thorough understanding of what they’re asking of you and the implications these terms have on your business’s financial future. Pay special attention to the following:

1

Monthly Payment

Make sure that the monthly payment is what you expected. This is where calculating your desired monthly payment before beginning the application process will be helpful. If the payment doesn’t match your calculations, ask the lending company to review how they came to that number. Make sure that there aren’t any hidden fees within the payment. Also, determine whether the payment will remain the same throughout the loan’s term or if it may change. If it’s likely to change, make sure you understand why the payment will change.

2

Loan Term

Next, make sure you understand how long you’ll have to repay the loan. Longer term business loans usually have lower monthly payments and lower interest costs over the life of the loan. The opposite is usually true of shorter term loans. Make sure your business has no issues and is comfortable repaying the funds during the entire term of the loan.

3

Interest Rate

Make sure you know the initial interest rate. Find out whether it is a promotional rate, a fixed rate, or a variable rate. If the rate is variable, ask how much it will change, how quickly it can change, and if there’s an interest rate cap. It’s important to know what an increase in the rate could do to your monthly payments.

4

Total Loan Amount

You should also be aware of how much you’ll owe the lending company throughout the duration of the business loan. The funding partner may give you the amount of money you requested, but you’ll likely owe more than the funds you receive. This could be due to fees you may have to pay, such as origination charges, which can be multiple percent of the cash you receive. Again, ask the funding partner to review how they arrived at the total loan amount.

5

Late Payment Penalties

You could face some harsh consequences including late fees, penalty interest rates or even repossession of collateral if you don’t make your payments on time. The specific consequences will be detailed in your closing paperwork, so make sure you read this section in detail prior to signing. The contract will also detail what happens if you default on your business loan. If your business survives the loan default, your business’s credit score could be damaged. If a funding partner required you to personally guarantee the business loan, your personal assets and credit score may be affected as well.

If any questions arise, or you don’t agree with a fee or penalty, the closing process is the time to stop and look for another funding partner. After you sign, you have agreed to everything in the contract – including what happens when you make late payments or default. Don’t allow the contract to come with surprises. Do your research before the closing process and compare business funding partners to ensure that you’re getting the most cost efficient terms.

Time to receive your funds

You’ve reviewed the contract and agreed to the terms set by the funding partner. Now it’s time to wait for the funds to hit your account. Here’s how quickly you can expect to receive the money based on the which of the following business loans you chose:

  • SBA Loans

    These take longer than many other types of business loans. While some SBA-approved funding partners claim they can fund a loan as quick as five days, if your business and lending needs meet a strict set of guidelines, typically SBA loans take anywhere from three to eight weeks or more to get funded.

  • Short Term Business Loans

    Short term loans are usually able to be funded pretty quickly. Many funding partners claim to be able to offer money in as little as 24 hours, but it may take a few days or weeks depending on the lending company and their processes.

  • Long Term Business Loans

    Long term loans usually involve larger amounts of money than shorter term business loans. While some business funding partners claim to be able to provide funding for long term loans in as little as two days, a more realistic time frame is as little as a week to as long as a few months.

  • Business Line of Credit

    A line of credit can be funded as fast as the next day, at best, or could take a few days or weeks to be funded.

  • Working Capital Loans

    These business loans are usually funded in a timely manner. Expect at least 24 hours to a week to receive funding.

  • Equipment Financing

    Equipment financing can be funded as soon as the same day the equipment is placed in service. Other lending companies may take a few days to arrange funding.

  • Accounts Receivable Financing

    AR financing can be funded quickly after a business becomes an established client with a funding partner, which may take about a week. Some will offer funding as soon as 24 hours while others take five to 10 days.

Keep in mind, the amount of time it takes to fund loans for small businesses depends on many factors. Each business funding partner may have their own processes to complete, which could differ greatly from partner to partner and result in different funding timelines. Funding partners may have to wait for third parties to submit documentation or your application may require clarification and additional support, both of which could delay funding. If your business finances are well organized, you should be able to quickly respond to any questions and keep the timeline as short as possible.

Getting down to business loans

Hopefully, by now you feel equipped with the knowledge to begin your journey to receiving a loan for your company. This process is important and shouldn’t be done impulsively. Compare lending companies so that you feel comfortable knowing that you’re getting the right rate, term, and payment option available. Follow your instincts. If you’re uncomfortable with any aspect of the process, get clarification from the funding partner you’re working with, or find another business funding partner. Finally, don’t be afraid to negotiate. You may not be able to negotiate every aspect of the contract for business loans, but there are certain areas where the funding partner can be flexible. Make sure that you’re getting the best option for your business.

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