Is your business growing faster than your cash flow can keep up? Or do you need funding to get your new venture up and running? If so, it may be time to think about getting your first business loan.
In 2018, 43% of small business owners sought a business loan, but less than half received the full amount they applied to borrow. You can improve your chances of getting approved for a loan–and avoiding any funding shortfalls–by laying the proper foundation beforehand. These tips can help you prepare to apply for (and hopefully, qualify for) your first business loan.
1. Get Clear on Why You Need a Loan
This important step is one you don’t want to skip.
Think about your purpose or goal for getting a business loan. You may be starting a new business or growing an existing one. Or you could be purchasing a key piece of equipment, refinancing existing business debt, or covering your day-to-day operating expenses.
Considering your reasons for seeking a business loan matters because it can give you clarity on how much you need to borrow, which type of loan may be best suited to your purposes, and whether a loan is the best financing option.
2. Figure out What You Can Reasonably Afford to Borrow
A business loan is debt financing, which means you’ll be paying it back over time and with interest. Your estimated loan payments need to be affordable for your business; otherwise, you could be putting an unnecessary strain on your cash flow.
Numerous business loan calculators allow you to run the numbers and estimate your payments. The key to getting an accurate idea of your payments is to know how much you truly need to borrow.
This amount goes back to understanding why you need the loan in the first place. For instance, if you’re interested in using a loan to expand into a new location, you’d want first to calculate all of the costs that might entail. Taking the time to realistically decide how much you need to borrow can help you avoid getting a loan that’s too big–or too small.
3. Compare Business Loan Options
Business loans aren’t all the same, and it’s important to understand your options. For instance, the most common types of business financing include:
- Short term loans
- Long term loans
- Equipment loans
- Purchase order financing
- Startup loans
- Small Business Administration (SBA) loans
- Merchant cash advances
- Inventory financing
- Invoice financing
Each one is designed with a different need in mind, and that’s reflected in their cost and repayment terms.
Short term loans, for instance, offer a lump sum of funding that you repay over a fixed term, typically 1 year or less. A long term loan may stretch repayment out over 5 years.
Equipment loans are used to buy equipment and can have repayment terms that last for the useful life of what you’re buying. The equipment itself serves as collateral for the loan. A merchant cash advance, on the other hand, is typically repaid in a matter of months and has no collateral requirement.
The other thing to consider is where you’ll get a business loan. Your bank or credit union may be your first choice, but online lenders are also an option. In comparing where to get a loan, consider:
- The interest rates individual lenders offer
- Any fees the lender charges, such as a loan origination fee or prepayment penalty
- Repayment terms and how long you’ll have to repay the loan
- Minimum and maximum borrowing amounts
- Funding speed
That last one may be especially important if you have a pressing financial need. A loan from a bank or credit union may mean waiting several weeks to receive funding whereas an online lender may be able to fund your loan in just a couple of business days.
4. Check Your Credit Reports and Scores
One of the most important criteria lenders consider for business loan approvals is your credit profile.
Generally, the stronger your credit scores, the more likely you are to be approved for a loan. A good credit score can also result in a lower interest rate on what you borrow.
As you prepare for your first business loan, check your personal and business credit reports and scores. If you’ve never checked your business credit scores before, this guide explains how to do that and how to improve your scores if they’re not as high as you’d like.
Compare your personal and business credit scores against the minimum scores various lenders look for from loan applicants. This information can help you narrow down the list of loans with your best chances of approval.
5. Consider Other Approval Requirements
Besides credit scores, lenders consider other factors, including:
- Your time in business
- Average annual revenues
- Assets and liabilities
When reviewing business loan options, look at the minimum requirements for each one. If you need to offer collateral for a loan, for instance, that’s something you’d want to know about ahead of time so you can decide which business assets you’ll use to secure the loan.
Also, consider whether the lender requires a personal guarantee alongside or in lieu of collateral. A personal guarantee is essentially a legally binding agreement in which you are held personally responsible for business debt.
6. Get Your Documents Ready
Finally, make sure you’ve got your paperwork in order before applying for your first business loan. Lenders will want to see key documents, such as:
- 2 to 3 months’ worth of business bank statements
- 2 years’ worth of personal and business tax returns
- Documentation for your collateral, if needed
- A recent balance sheet
- Profit and loss statement
- Cash flow statement
Having these documents on hand can help save time when applying for a business loan. The sooner you can get the approval and underwriting process underway, the sooner you can be on your way to getting the funding your business needs.