Introduction
Starting and growing a business often requires financial investment beyond what your savings or credit card can handle. This is where business loans come in to provide a significant help to the business owner. Business loans can provide the necessary funds to start your business, buy inventory, expand your business, hire employees, purchase equipment, and so much more. However, applying for a business loan can be complicated and confusing, so it’s important to understand how business loans work before you dive in. In this article, we will guide you through the process, explain the different types of loans available, compare traditional and alternative lenders, discuss the potential risks and benefits of debt, provide interview insights from successful entrepreneurs and guide you on how to build a strong business credit score.
Step-by-step guide to applying for a business loan
Applying for a business loan can be a complex process, but it is not impossible to understand if you follow the steps closely. To apply for a business loan, follow these steps:
- Evaluate your business needs: The loan type and amount that you need to apply for greatly depends on why you need the loan and what the amount will be spent on.
- Shop around for lenders: Consider traditional lenders such as banks, credit unions, as well as alternative lenders like online lenders, or peer-to-peer lending platforms to find one that fits your business need.
- Review loan terms: Amongst the lenders you are considering, compare their interest rates, fees, terms, repayment policies and decide which is most profitable for your business.
- Apply: Once you decide the lender you want to use, submit your loan application. This process differs between lenders. You may be asked to submit several documents including financial statements, tax returns, business plan, and other documentation that may be relevant to your business.
- Wait for approval: Lenders usually require at least a few days to few weeks to review your application and respond with a decision.
- Receive the funds: Once approved, you will receive the funds in your account. The waiting time to receive the funds might differ amongst lenders.
Preparing to apply ahead of time increases your chances of approval and makes the procedure smooth.
Comparing traditional vs. alternative lenders
When seeking external funding, it’s important to consider both traditional and alternative lending options. Understanding the differences between traditional and alternative lenders can help you make an informed decision when choosing a lender.
Traditional Lenders:
Traditional lenders, such as banks and credit unions, have been the go-to source for business loans for years. Interest rates for traditional lenders tend to be low, but they may have more strict requirements that might be more strenuous to meet than alternative lenders. These traditional lenders require a good business credit score, financial records, and the reason for borrowing. Additionally, it takes a longer time to be approved, a few weeks and sometimes months, more documentation and processing.
Alternative Lenders:
Alternative lenders, such as online lenders or crowdfunding platforms, have grown in popularity over the years. These lenders tend to have fewer requirements than traditional lenders and that increases its accessibility. They have minimal requirements for the lender, so they’ve been easier to get loans from but also could come with higher interest rates. Loans can be approved within hours to days and the requirements are usually self-evident, the intention of the loan and the purpose of the business.
Understanding the different types of business loans
Business loans come in different types, and the type of loan that is most suitable for you will depend on your business needs. Below are the different types of loans:
Term Loans:
Term loans come with a fixed rate and maturity date, for both principal and interest. Payments are often structured without intermediaries and are paid monthly or biweekly. Depending on the type of loan, they can be secured or unsecured. Repayment period varies from a few months to over 20 years, depending on the purpose and the amount borrowed.
Lines of Credit:
Lines of Credit works more like a credit card. A lender approves you for a ‘line of credit’ which works as a maximum amount that you are allowed to borrow at any given time, only paying interest on the amount borrowed. They are highly flexible and popularly used for short-term financing.
Equipment Financing:
Equipment Financing is for purchasing equipment or machinery for business operations. Loan term and interest rate vary depending on the equipment’s lifespan, and ultimately the lender will want to ensure the equipment acts as collateral. If the borrower is unable to repay, the equipment is taken by the lender.
SBA Loans:
SBA loans come from the Small Business Administration in America and are government-backed loans designed only for small businesses. While the lender is usually a bank, it mitigates the lender’s risk while giving your business the required funds. Terms for these loans vary and are issued through an SBA-approved intermediary, unlike a traditional financial institution having to check the borrower’s credit eligibility.
Risks and benefits of taking on debt for your business
Leveraging debt is a common method many business owners use to grow their businesses. However, taking on debt does come with potential risks and rewards.
Benefits:
- The interest paid on a business loan can help lower taxable income at the end of the financial year, reducing your tax obligation.
- The loan allows businesses to expand and, as a result, increases its revenue streams.
- A Seed Capital for modern businesses with i.e., operations costs less than revenue, which is a significant setback from gaining profits in the first quarter of operation.
Risks:
- There is always a risk of defaulting on loan repayments, which can lead to bankruptcy for the business and the downfall of the entrepreneur’s credit score.
- High-interest rates can make it challenging for businesses to make regular payments and still have funds available.
- New or smaller businesses might find it difficult to secure loans due to limited cash flow, creditworthiness, and track record.
Interviewing successful entrepreneurs who have used business loans
Successful entrepreneurs that have used business loans have invaluable insights and tips to give. Based on experience and observation, some of the successful entrepreneurs that spoke with us about their opinion follows
Anne Gherini, co-founder & CEO of Affinity:
“When it comes to funding, timing is everything. Knowing when you need to raise money, the type of money you need, and the investors and lenders you want to attract are critical to your company’s success.”
Daniel Wesley, CEO of CreditLoan.com:
“Avoid taking out too much debt. The less debt a company has, the more funds it can direct towards revenue-producing initiatives. Additionally, lenders prefer to see that companies can still operate within healthy financial metrics even with outstanding debt.”
Economic and political factors affecting the availability and terms of business loans
Political and economic factors often impact loan availability and conditions. Some factors available as a general overview that can affect this include: inflation, government regulations, economic downturns, and interest rates.
Building your business credit score
Your credit score for a business, also known as a business credit score is a metric that takes into account your payment history, company size, and financial history. While personal credit scores are important, business credit scores allow lenders to understand your business’s creditworthiness and determine your loan eligibility and interest rate. To build your business credit score, follow these steps:
- Establish your business: Incorporate or form an LLC to give you the legal business structure you need to do business.
- Obtain an EIN: Applying and obtaining an EIN, or Employer Identification Number, from the IRS will help create a clear separation between personal finances and business expenses.
- Open a business bank account: A business bank account separates your personal finances from business finances, thus forming a clear trail for your transactions.
- Apply for trade credit: Trade credit will help you build a good credit score from day one by creating credit structures with other businesses.
- Stay on top of payments: Regulate timely payments to creditors and stay up to date on your account balances. This sends out good signals to your credit score and lenders.
Conclusion
Business loans are an essential aid for most business operations and come in various shapes and sizes – traditional, alternative, and intermediate – each having its benefits and risks. Understanding the different types of loans available, the application process, as well as the reasons why you need the loan, are critical to making the right decisions. As a wrap, build a strong credit score, weigh pros and cons, educate yourself from successful entrepreneurs, and consider your business needs before choosing a lender.
