When prepping to grow your already-successful small business, there are several things to take into account. Financing the expansion is definitely on the list. Which leads us to this article’s topic: small business loans.
Trite though it may sound, it takes money to make money.
Your small business could all too easily stall out without the funds to get things going. Of course, the goal is to make more than you spend. But when starting a new phase of growth, you need to have some capital behind you to get your business plan off the ground.
Many small business owners find the idea of applying for a small business loan intimidating. What’s required? What are the benefits? How likely is approval? Are there other options? What about acquiring a business line of credit or a merchant cash advance instead?
The answers to these questions are fairly straightforward and not all that complicated.
What is a small business loan?
A small business loan is just what it sounds like—a business engaging with a lending institution to borrow money.
While the details may vary, there are some defining principles you can use to guide you toward finding the best small business loan for you and your business. We recommend that your first course of action be getting familiar with some of the most basic terms, qualifications, and types of small business loans out there.
Basic terms to know
It’s always best to approach the process knowing, at the very least, the basic terms that are going to be thrown around. Here is a quick rundown of the most basic terms used for small business loans.
- Borrower: The business that borrows money and agrees to terms that result in repaying the full amount plus interest.
- Lender: The bank or similar institution that offers funds to the Borrower, expecting repayment according to the agreed upon terms.
- Principal: The amount of funds provided by the lender to the borrower.
- Interest: The amount added to the initial loan based on the amount of money borrowed and the time it takes to make repayment.
- APR or Annual Percentage Rate: The yearly rate of interest—expressed as a percentage—charged by the lender to the borrower.
- Term or Period: The total amount of time between when the loan is made and when the principal and interest has been fully repaid.
- Payments: Scheduled repayments made by the Borrower to the Lender of the principal amount borrowed along with interest agreed upon.
- Collateral: An asset or piece of property offered by the borrower to guarantee repayment of the loan. Should the loan not be repaid in full, the lender can seize the collateral as payment.
How to qualify for a small business loan
Depending on the type of loan and the lender, there are three qualification standards that most small business lenders look at when determining whether or not to approve a loan.
Potential lenders look at personal credit scores, annual earnings, and time in business.
Personal credit score
This is often the first in line when evaluating a loan application—especially if you are running a new business and this is your first small business loan application. Potential lenders can’t get an accurate sense of how well your business manages debt, so looking at how you manage your personal finances gives them a better overall picture of what kind of risk you represent.
You hear a lot about credit scores on TV and the radio. There are a number of online services available to help you keep track of your credit score. Here’s a broad overview to give you an idea of how strong your personal credit score is.
- Excellent: 750-850
- Good: 700-749
- Fair: 650-699
- Poor: 550-649
- Bad: 300-549
Time in business
A little over 20% of businesses flounder and fail within their first year. The longer you’ve been in business, the more the numbers are in your favor. Surviving one year is good. Surpassing two years is even better and may offer a greater advantage in getting your loan approved.
You could have an excellent credit score and a number of years in business behind you, but if you’re not bringing in enough revenue to meet repayment obligations, that doesn’t look good. Your small business loan could be sunk before it leaves port.
The amount of annual earnings you need to have on the books is going to vary depending on the amount you’re trying to borrow. The greater the revenue, the better your loan chances.
Even very small businesses have options in the form of microloans or a merchant cash advance (MCA).
Types of small business loans
There are a number of options when considering a small business loan—from working with a traditional lender to a merchant cash advance.
This is what most people think of when they hear “small business loan.” It’s the standard arrangement of borrowing a lump sum of money for a set term of generally one to five years, with interest accrued over that time at a fixed rate. The borrower makes monthly payments on both the principal and interest until the loan is repaid.
Term loans are popular because they are fairly straightforward. They offer a significant sum of money over a long period of time, and generally offer low interest rates.
The downside is that they rely on higher qualification standards than other loans.
This is very similar to a standard term loan, but the amount available to the borrower is less—often between $2,500 and $250,000—and the loan period for repayment is considerably shorter. Usually between three and 18 months.
The most significant difference, however, appears in the repayment schedule agreement.
A short-term loan is a good option for businesses who need some quick cash or for those with a poor credit rating. Unfortunately, the interest rates tend to be higher and the weekly or daily payment schedule can be problematic for some.
Business line of credit
This is essentially a credit card for your business. You are provided with an amount available, and you take what you need and pay interest based only on what is drawn from the line of credit.
Terms, interest rates, and qualifications tend to be more flexible. The biggest advantages in using a business line of credit are in building a good credit history and having quick access to cash for emergencies.
Merchant cash advance
While not technically a loan, an MCA is the most flexible, simple, and fast option for many businesses. It has a lot in common with the business line of credit, but no banks are involved and approval can often be had within a day or two.
Collateral is not an issue, and there’s no repayment schedule at all. Instead, a very small percentage of your revenue goes toward repayment until the full amount is paid off. If your business has a slow month, you pay less toward the MCA.
This is a popular option for businesses who need to arrange funds for a variety of reasons, including inventory stock, advertising, loan consolidation, equipment upgrades, or even payroll and tax needs.
Choosing a small business loan
Armed with some basic knowledge of your options, you should take some time to examine your needs.
What qualifications do you bring? What terms work best for you? What are the advantages for each type of loan for your business?
A traditional term loan might be your best option. Or you might find that a merchant cash advance or business line of credit works better for you.
Whatever your choice, you’re on your way to building a bigger, better, stronger business.