Business Loans: What You Need to Know
It’s not unusual to need a business loan to cover expenses that exceed your current budget. Seasons and circumstances change, impacting daily cash flow and your ability to support continued growth. Before approaching a lender, educate yourself on the types of loans available, the terms you can expect, and what documentation will be required to determine eligibility.
What Are the Types of Business Loans?
Companies with property to put up as collateral
Ongoing working capital expenses
Outstanding invoices, short term debts
Necessary equipment to grow business
Expansion or new facility
Lenders offer a variety of loans for businesses depending on the intent of the financing and how companies are able to guarantee payment.
- Secured loans require collateral to back up the amount of the loan, meaning you could lose what you put up if you fail to pay in full.
- Unsecured loans are granted to companies with solid credit ratings and may offer lower interest rates than secured loans.
- Lines of credit work like a credit card, allowing you to borrow against a set amount as needed and only requiring interest payments on the money you use.
- Merchant cash advances are based on your volume of monthly credit card sales and are paid back using a percentage of each future sale.
- Accounts receivable loans use outstanding invoices as collateral to help pay off short-term debts.
- Equipment loans are granted specifically for the purchase of new equipment, using what you purchase as collateral.
- Construction loans provide funding to expand your existing location or build a new facility, and the building is considered collateral.
- Invoice factoring lets businesses with rigid cash flow constraints operate more flexibly by providing them with access to the funds they require until invoices are paid in full.
Each loan type has a specific payment structure, term length, and interest rate. Some are more difficult to qualify for than others, and most require you to present detailed paperwork when applying.
How to Apply for a Small Business Loan
When you’re ready to apply for financing, find out what documentation your lender requires. The following is a list of things lenders may take into consideration:
- Personal background, including criminal record. Anyone owning more than 20% or more of the business must fill out a form with their personal information and sign a personal guarantee.
- Business background. Members of the company management team should be prepared to provide a resume outlining their business and work experience.
- Business plan. This should include a value proposition, financial statements and projections, details of any existing debts, and a clear outline of how the SBA loan funds will be used.
- Personal and business financial statements, tax returns, and bank statements.
- Business credit report. As with a personal credit report, the lender will need you to provide details so it can access this report.
Benefits of An Online Small Business Loan
A business loan is an expensive growth opportunity that, if used wisely, will pay off for your small business in the long term. Whether you borrow money to expand to new premises, hire new employees, or finance the purchase of new equipment, there is a common thread: your loan is an investment to help your business grow.
One of the reasons that people seek out online lenders is the greater ease at securing a loan. Banks and other financial institutions view many small businesses as too risky to finance, and if you’re running an online business with no brick and mortar storefront or more traditional revenue stream, you may find yourself out of luck. Not only are the loans easier to secure, they tend to come through quicker. Applying can often be as simple as a series of online questionnaires that don’t require meeting with a loan representative or anyone who can hold your hand and walk you through it. Once approved, the loans tend to be issued in a matter of days, not weeks or months like with banks.
Below are 5 reasons you could use your business loan to grow your business.
1) To Expand Your Location or Open a New One
If your small business operates out of a physical location such as a storefront or office, at some stage you’ll want to expand or move to new premises in order to grow and attract more business. The same can be said for an online business: your website might have done of a good job of attracting new customers, but sooner or later you’ll have to add more features, upgrade servers, or open multiple URLs to keep your business going.
2) To Build Credit for Future Loans
Your personal credit can affect the terms of your business loan, as many small business owners discover the first time they talk to a lender. If you have good personal credit, lenders will be willing to offer you favorable terms for your business loan. If your personal credit is poor, you could treat your new business like a blank slate. Taking a business loan or business credit card presents you with an opportunity to build business credit. Even if you only take out a $1,000 loan (the minimum amount offered by most lenders), every payment you make on time helps build your credit and strengthen your case for a better loan the next time around.
3) To Finance Equipment
A common purpose of business loans is funding the purchase of fixed assets, meaning property or equipment used to generate income. Equipment loans differ from general business loans in that they’re made by a lender or equipment-financing company and are designed specifically for buying expensive equipment. An equipment loan allows you to spread the cost of the purchase over several months or years. The equipment is put up as collateral, meaning the lender can seize the equipment if you default on payments. Equipment loans are offered for things like:
- Commercial printers
- Computer servers
- Manufacturing equipment
- Specialized machinery
- Kitchenware or kitchen equipment
4) To Fund New Inventory
Inventory refers to your business’s products and the raw materials that go into manufacturing the products. Because inventory is different from equipment, it has its own special type of financing called inventory financing. This can take the shape of an inventory loan or inventory line of credit. Inventory loans are good for making a one-off purchase of a large amount of inventory. A line of credit offers flexibility to make regular, unscheduled inventory purchases.
5) To Recruit New Talent
Many businesses start off as one-person or two-person operations, but if your business expands you’ll eventually reach a point where you need assistance. Payroll can be the largest and simultaneously most necessary expense for small businesses. Unless you operate the type of business where you can attract interns or pay employees in equity, you’ll need to have cash on hand from the moment your employees walk in the door. A business loan can help cover payroll until you generate enough cash flow to pay employees from your earnings. Payroll loans could also be suitable for businesses that employ seasonal workforces. If you need extra help to meet the Xmas or Black Friday rush, then a one-off loan might be the best solution for your small business.
Line of Credit vs. Business Loan: Which Is Best for You?
- Business loans work best for long-term capital costs, such as buying equipment for the business. Since the equipment will last a number of years, the loan term can be roughly matched to the number of years that the asset is expected to be productive. This will not only avoid the need for a large out-of-pocket outlay for the equipment, but it will also spread the purchase price out over several years.
- A line of credit is better used as a source of working capital, to pay short-term operating expenses, such as the acquisition of inventory, the payment of payroll, or a surge of expenses that is expected to take place within the next few months. Lines of credit act as an additional source of cash to cover these needs, and you don't need to access it until the expenses are actually due and payable. As income catches up with expenses, you can repay the line.
A business loan should be taken when a specific capital expenditure is necessary, while a line of credit should be taken before it's even needed. The difference being that the loan has a very specific purpose, while the line mostly acts as a reserve to even out cash flow disruptions. Decide what it is you want the financing to do for you, and you will know whether to take a business loan or line of credit.