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.
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.
Online Business Loans vs. Traditional Bank Loans: Which is Better for Your Small Business?
Getting a loan from a traditional bank generally takes a long time. You'll need to visit your branch in person, provide a lot of documentation and wait while the bank considers your application. It can take several weeks for the capital to come through from a regular bank. Online loan providers are able to use financial technology (FinTech) to somewhat automate the process.
Simple online application process
Regulated by independent authority
Government assisted loans
Available from some providers
How Much Can I Borrow?
If a company is looking to borrow a large amount, banks are a better address than online loan providers. Banks are generally able to offer much larger maximum loan amounts than online providers – as long as your business is able to qualify for the loan, that is. Many online loan providers offer maximum loan amounts in only six digits. It's not just about the maximum amount. Businesses often find it difficult to borrow small amounts from traditional banks, such as enough to cover extra merchandise for the holiday season. Online lenders have far greater flexibility to offer small loans of just a few hundred dollars.
What are the Loan Requirements?
When it comes to the loan requirements, banks are far more stringent than online lenders. They generally ask applicants to prove several years of business operations, making it very difficult for newer businesses and startups to secure a line of credit or a vital small business loan to get things started. Small businesses that have only been in business for six months can find favorable terms with online providers, but would struggle to qualify for a bank loan.
How Much Credit Do I Need?
Small businesses applying for a bank loan are unlikely to get one without near-perfect credit ratings, usually around 700-800. After the 2008 financial crisis, banks are wary of accepting anything lower than that and will usually require years of successful business dealings and collateral in order to lend to businesses with lower credit ratings. However, online loan providers look at a number of other factors when assessing business reliability and are far more likely to overlook a poor credit rating. Many online loan marketplaces offer loans for small business with no minimum credit score.
How Easy is the Application Process?
The application process for a traditional bank loan is long and often complicated. One usually has to apply in person and defend his/her reasons for the loan to a bank manager. Banks require more documentation than online lenders before they will consider your loan application, including business plans, collateral agreements that could go as high as 100% of the loan amount, and demanding cash-flow projections. In contrast, small businesses can prequalify for a loan from an alternative lender in just a few minutes through a process which is entirely online.
How Secure is the Process?
Security is traditionally high when you go through an established bank. As well as their own security requirements, banks are regulated by one or more federal or state regulatory bodies which demand certain security measures to protect the privacy of customers as well as the safety of their collateral and money. Online loan aggregators aren’t subject to the same requisites, which makes them potentially risky. Small businesses need to look for a TrustE or similar certificate that guarantees that the loan provider is compliant with security protocols, check that the loan provider uses a high level of encryption when storing sensitive details, and see that there is transparency about the way in which the company uses their data. Without these assurances, there is a risk that your business details and financial information could be traded or hacked without your knowledge.
Your Business, Your Way
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.