Laying the Foundation for Your Business Loan
According to research from the Federal Reserve Bank, the average size of a business loan in the United States is $663,000. There’s a good chance that your business won’t need a loan this large, though small businesses in certain industries often seek loans that are easily double this amount.
What matters is that you crunch the numbers and figure out ahead of time how much cash you need. It’s hard enough to sift through the various options when you have details available… trying to find a loan when you don’t have a predetermined dollar amount only adds to the complexity.
For illustrative purposes, let’s assume that you decide to seek $663,000. You’ve carefully reviewed everything and can clearly articulate why that amount is ideal for your needs. Congratulations, you have now crossed the first hurdle of the hunt for business financing.
Next up is determining the timeline for your loan. This factor is crucial because there are several types of financing that can deliver money to your bank account in just a couple of days. On the other end of the spectrum, you might encounter loans that take as long as 3 months to fund.
If speed is of the essence, you’ll need to note that up front and focus your search on expedited forms of financing. When timing isn’t an issue, you’ll have more loans to choose from and they’ll often offer more generous terms.
Choosing the Right Business Loan
With the optimal dollar amount and timing for your loan locked down, it’s time to narrow your list of potential financing options. Business loans come in all shapes and sizes, so this can be an involved process. There are smallish loans that would barely pay the tab for a new Kia Soul. Others are large enough to purchase an entire fleet of Volvo vans.
“Getting a business loan sounds simple—until you realize how many types of loans exist and how many lenders offer those loans,” explains a financing report from Business.org. “Suddenly, you find yourself overwhelmed by choices that you didn’t even know existed.”
You can begin to sift through the available options based on criteria you’ve already outlined. For example, you may have a low credit score or be new to the business world and find that these factors eliminate your candidacy for certain financing products. No worries because there are plenty of fish in the sea. You’ll just need to do your due diligence to understand the best options available to your business.
Your business plan will be an essential part of this process, as it lays out the use for the money and your goals. Lenders scrutinize your plan to ensure that you have a firm grasp on your strategies and will make the most of any money they might lend you. A polished business plan is a great way to showcase your attention to detail and increase the lender’s confidence that they’ll ultimately be repaid.
The Most Common Business Loan Options
Let’s take a look at some of the popular financing products for small businesses. This list shouldn’t be considered comprehensive, but it offers a clear look at some of the best ways for you to secure the money you need to reach your business goals.
Business Line of Credit
Perhaps you aren’t looking for a traditional loan at all. Entrepreneurs often choose a business line of credit because of the flexibility and convenience. With amounts ranging from $1,000–$500,000, you can often get the money in just 1–2 weeks. And the money can be used for nearly all expenses related to your business.
The rates for business lines of credit start at 8% and can reach as high as 24%. You can anticipate the financing coming with a 1–2 year maturity period. Your business line of credit won’t come with a lump sum of money. Instead, it provides access to revolving credit, similar to a credit card. You’re under no obligation to use any of the money, but you can dip into the amount any time your business encounters a need.
A business line of credit is one of the easier forms of financing to qualify for. As long as your business has been up and running for at least 6 months and has annual revenue above $50,000, you’ll stand a good chance of getting approved.
Business Credit Card
Here’s another user-friendly financing option beloved by small business owners. If you have a mediocre credit score or haven’t been in business for an extended time, it could indeed be just what you’re looking for. Business credit cards connect you with working capital and also allow you to take advantage of a rewards program that will provide perks such as travel miles or gift cards.
A business credit card works almost exactly like the personal credit cards you’re likely familiar with. You can get approved for up to $50,000, which you can then access whenever you need it. The interest rates are similar to those you’ll find with a business line of credit, starting around 8%. Keep your eyes peeled for 0% introductory rates.
Compared to other forms of financing, applying for a business credit card is quite easy. There isn’t much paperwork required, and you can often get the money in just a week or 2.
Business Term Loan
Say hello to one of the most trusted and durable loans on the market. Business term loans have been around for decades and can provide amounts as small as $5,000 all the way up to $2,000,000. Surprisingly, the money can often become available to you in just 2–3 days.
You can use the money from a business term loan for a wide range of business needs. Examples include hiring staff, buying equipment, or boosting your inventory. This versatility, combined with the speed of funding, make this financing popular for small business owners.
Of course, even the most amazing loans need to eventually be paid back. Your interest rate could start in the neighborhood of 6%, which certainly helps to make it easier for you. The loans come with a fixed interest rate (or flat fee), so you can be confident that the payments won’t rise at some point. The repayment terms usually fall in the range of 1–5 years.
Short Term Loan
There are some scenarios where you’d need the functionality of a term loan but wouldn’t have the luxury of waiting 3 days for it. For example, you might need to replace a piece of crucial equipment or act on a new business opportunity. Short term loans offer a potential solution, often delivering funds in just 24 hours.
Of course, that ridiculously fast timeline comes with concessions. First, the amounts max out around $500,000. And you’ll need to pay it off in just 1–3 years. As for the interest rates, they tend to be higher than what you see for term loans but can still start as low as 8%.
If your credit score is healthy and you’ve been in business for 2 or more years, you should be a strong candidate for a short term loan. Be aware that lenders might require collateral before approving your loan, so you should think of what you could potentially offer up. Possible examples include real estate, homes, vehicles, or pieces of equipment.
Speaking of equipment, did you know that there’s a type of financing that’s dedicated to it? With equipment financing, you can qualify for as much as $5,000,000 to fuel your business. Many small business owners use the money to purchase prototypical equipment such as tractors, forklifts, trucks, refrigerators, ovens, or trash compactors.
But you should know that the term “equipment” is much broader than that. You could also use the funds for things like software products, payment processing solutions, or solar panels for your office. As long as the purchase equips your business in a meaningful way, there’s a good chance that it’ll qualify.
The interest rates for equipment financing are borrower-friendly, beginning in the neighborhood of 7.5%. And it’s usually easier to qualify than with other business loans. One reason for this is that the lender will use the equipment you’re purchasing as collateral. So if the equipment is a reliable investment and carries a solid lifetime value, you stand a good chance of getting approved.
Merchant Cash Advance
Most business loans are approved or denied based on your past business performance. But a merchant cash advance is based more on future earnings, providing a financing opportunity for those who might not qualify for more traditional products such as term loans or equipment financing.
Let’s look closer at how a merchant cash advance works. This financing allows you to borrow against the future earnings of your business. Once the funds hit your account, the repayment begins, with an agreed-upon percentage of credit card deposits will be withheld each day for the lender. It’s a turnkey process for you as the business owner, as you don’t have to worry about submitting monthly payments or handling any other billing details.
Merchant cash advances range in value from $5,000 up to $200,000, and the money can sometimes arrive within 24 hours of approval. Lenders make it easy to qualify for this type of financing since the payments will be coming directly from your credit card deposits. This means you will enjoy a streamlined application process, and your credit report might not even be pulled.
If you have your eye on a new business idea, startup loans can be a favorable option for financing. The main benefit is that you won’t be required to have the tenure that other loans often require for qualification. As long as you have a credit score above 679 and can demonstrate substantial experience in the industry your business will operate in, you will have a solid chance of getting approved.
Startup loans can provide you with as little as $500 but often have a ceiling of $750,000. It can take 2–3 weeks for the money to become available to you. As for the interest rate, it runs the gamut. You might be able to find a rate in the low-single digits, but it could also reach as high as 17%. Anticipate loan terms that can extend as long as 25 years.
Startup loans include a variety of products, including short term loans, SBA loans, lines of credit, equipment financing, and business credit cards. You can use the money for most of the expenses related to getting a business off the ground, including hiring staff, buying equipment, compiling inventory, and leasing office space.
Business Acquisition Loan
Maybe there’s an existing business that you want to take over. Business acquisition loans are intended for this very purpose, connecting you with up to $5,000,000. Given the size and complexity of this financing, the pace can be quite slow. You might not see the money for up to a month after getting approved.
A business acquisition loan can offer interest rates starting at 5.5%, making them one of the most favorable ways to obtain large amounts of capital. With a low rate, you’ll potentially save a lot of money over the course of the financing.
The qualification process for a business acquisition loan will take slightly different routes depending on whether you intend to buy an existing business or a franchise. But regardless of your plans, lenders will pay close attention to factors such as your business tenure, credit history, business plan, financial projections, and relevant industry experience.
Accounts Receivable Financing (aka Factoring)
Unpaid invoices are the bane of many entrepreneurs’ existence. It’s natural to have people owing money to your business, but problems arise when those payments consistently fail to materialize.
With accounts receivable financing, you can transform your unpaid invoices into working capital. How does it work? You sell your purchase orders and receivables to a lender, who then gives you as much as 80% of the value. So in just a few days, you’ll receive the money your business needs now, while the lender goes through the trouble of tracking down the debtors and collecting on the outstanding payments.
This type of financing is ideal for small business owners who have credit issues. Because the lender will be paid through collecting from your debtors, your financial situation isn’t very relevant. And you won’t be required to provide any collateral before receiving the financing.
SBA 7(a) Loans
The US Small Business Administration (SBA) is dedicated to helping small business owners acquire financing. In particular, the SBA works to help women, minorities, and other individuals who have been excluded from mainstream funding opportunities.
The 7(a) program is the most popular of the agency’s various financing products. It provides cash that can be used for a wide range of business-related expenses. One major catch is that the funding process can take up to 3 months.
Qualifying for these loans presents a unique set of hoops to jump through. Your business needs to be operating in the United States or its territories, you need to have equity to invest, and you must have already sought funding from other sources. Note that you will be immediately disqualified from consideration if your business relates to multi-sales distribution, speculation, gambling, loan packaging, investment or lending, rare coins, or stamps. The same outcome applies to government-owned corporations and charitable or religious nonprofits.
SBA Express Loans
When the glacial crawl of the 7(a) program is too slow for your needs, you might consider an SBA Express Loan. There is less paperwork involved in the application process, and you can often receive funding in just 4 weeks or so.
In many ways, SBA Express Loans are merely sleeker versions of the 7(a) loans discussed above. One feature to consider is that the money you obtain through an SBA Express Loan must be used for increasing your working capital, financing business equipment, or consolidating debt. So make sure your plans align with these limitations.
If your credit score is above 679 and you have gathered all the necessary documentation, you should be in a good position to be considered. Just remember that these loans are extremely popular, and it can be difficult to get your foot in the door.
SBA 504 Loans
If your business plans call for an expansion of operations, the SBA’s 504 program could be an ideal way to obtain financing. For example, you can use the cash from this program for parking lots, utilities, renovations, purchasing property, purchasing machinery, landscaping, or constructing a new facility.
To qualify for a 504 loan, your business must have a tangible net worth above $15 million and needs to have brought in a net income no higher than $5,000,000 for the past couple of years. These requirements obviously exclude a lot of deserving businesses, but the good news is that there are other programs available that would likely be available if the 504 program weren’t.
If your business meets the qualifications listed above, you should take the time to review the SBA’s size standards. Assuming you meet those standards, you’ll then be in a position to submit a strong application and see if you can qualify.
SBA Disaster Loans
While all years have their share of disasters, 2020 certainly delivered some crushingly difficult circumstances for America’s small businesses. The disaster loans provided by the SBA are intended to help soften the blow with low-interest financing that empowers you to recover economically and physically.
While the SBA loans listed above are known for strict requirements and sometimes quirky guidelines, the disaster loan program offers a much more welcoming approach. There are no size restrictions, so you can apply regardless of whether you match up with the SBA’s usual sizing guidelines. Also, private nonprofit organizations can qualify.
You can use a disaster loan for all manner of recovery efforts. For example, you could replace your business’s machinery and equipment or repair your personal property and real estate. Or maybe you have damaged inventory that needs to be replaced.
Just be sure to note that a disaster loan is only intended to help you get back to where you were before the disaster struck. This means that you can’t use the money to expand your operations or add new features to your business.
Putting a Price Tag on Your Business Loan
Once you’ve created a short list of optimal financing products, it’s time to crunch the numbers and find out which will deliver the most value for your business. This is an essential evaluation process, as it can help you weed out overpriced loans. You should be particularly vigilant when it comes to watching for obscure fees that might be buried in the small print. For example, you might discover processing fees, late payment fees, or early repayment fees that aren’t fair to you as the borrower.
“Financing is a crucial part of any successful business, providing much-needed capital for important investments like renovations, upgrades, expansions, and inventory,” says a small business loan analysis from Business.com. “But it’s not without their downsides. Many business loans come with obscure or hidden fees, which you may not know about until it’s too late to turn back.”
It’s unlikely that your favorite loan options will have identical rates and terms, so you won’t be able to get a perfect “apples to apples” comparison. But a few key metrics will help you get a firmer grasp on the price of a particular financing product.
- Cents on the Dollar: Everyone loves simple metrics, and this one is as simple as they come. It reveals the amount you’ll pay for interest and fees for every dollar that you borrow.
- Total Cost of Capital (TCC): If you prefer to view the fuller picture, this metric combines the overall cost of the loan’s interest, fees that don’t charge interest, and ancillary fees that might come into play.
- Average Monthly Payment: This popular metric is extremely budget-friendly, as it shows you how much your business loan will cost each month.
- Annual Percentage Rate (APR): It’s also helpful to forecast your expenses over a 12-month period. A loan’s APR provides clarity into just how much it would cost over the course of a year.
While these metrics can certainly help you get a better idea of loan pricing, it’s common for there still to be some degree of confusion. This stems from the fact that lenders often articulate their disclosures differently, and some of the most relevant metrics could be handled in disparate ways.
The experts from the Innovative Lending Platform Association (ILPA) joined forces with some of the nation’s most trusted lending platforms to create a tool that could help borrowers cut through pricing ambiguity. After months of tinkering and toiling, they released a comparison tool dubbed SMART Box (Straightforward Metrics Around Rate and Total cost).
Using SMART Box, you’re better able to bridge the gaps between loans and find more transparency in the disclosure standards. It’s almost like a Rosetta Stone for financing, as it provides you with a common language that empowers better decisions.
“It is important to note that the SMART Box is not intended to replace a lender’s existing disclosures or detract from the importance of providing clear and conspicuous information to a small business regarding the relevant finance product,” explains the ILPA’s website. “The SMART Box is instead intended to serve as a supplemental disclosure that presents key pricing information in a uniform fashion and helps to flag for the small business, in plain English, certain product features or policies. We ultimately believe that there are many responsible providers and products in the market, but these products often convey their pricing characteristics in different ways.”
The ILPA has thus far released 3 different versions of SMART Box, with each based on a different category of financing. So if you’re looking for a term loan, merchant cash advance, or line of credit, you’re in luck. Hopefully even more versions will be created in the future.
Moving Forward With Confidence
Armed with the data you’ve gathered through due diligence and SMART Boxing, you should be in a good place to make your final decision on a business loan. But you still might want to pump the brakes a bit before applying, as this is a prime opportunity to consult with an expert from outside your organization to get a fresh perspective.
If you have a business mentor, take the time to review your various options with them. With years of experience, a mentor can provide critical insights in a situation such as this.
Perhaps you haven’t been able to connect with a trusted business mentor yet. No worries. You can always reach out to business gurus from the nearest SCORE office. Or you could connect with an advisor from a Small Business Development Center in your region.
The point is that you have multiple resources when it comes to getting an expert opinion on your business financing. Just think how comforting it would be to receive an unbiased confirmation that you’re moving in the right direction. It’s almost like getting your passport stamped by a customs official, freeing you up to safely travel anywhere you like in the destination of your choice.