If you own a small business, the chances are high that eventually you’ll need financing. When considering your options for a small business loan, it is important to determine exactly what your requirements for the loan will be and how likely your business will be to qualify for the individual loan type. It is, of course, also important to understand all of the available options and loan types that exist. This can be a process that involves understanding a fairly wide range of different financing types.
The many different types of financing available to small businesses
Because businesses often require large amounts of capital for a huge variety of different needs, small business financing contains a considerably broader range of options than simple consumer financing. While most small business owners will look for financing from a bank, getting a bank-financed small business loan is far from the only option available.
Although this article will primarily focus on what is needed to secure a small business loan from a traditional lending institution, it is important to understand the multitude of alternate financing options that exist.
Small business credit cards
One of the most popular ways that small business owners finance their operations is through the use of a business credit card. The pros of going with a business credit card are the same as they are for a personal credit card. The approval process can often be nearly instantaneous. And small business owners can often find enticing introductory offers, including sign-up bonuses and balance transfer incentives. What’s more, it may be possible to find cards that come with essentially no interest payments so long as the balance is always paid off in full.
Business credit cards also come with far higher spending limits. This can make them a viable option for small business owners who need small-to-medium standby credit facilities. However, there are downsides with business credit cards as well. First, they usually require strong to excellent credit for approval. It turns out that the same kind of personal credit rating that can get you a business credit card with a $25,000 limit is likely to also get you a small business line of credit that can easily be 10 or more times that amount.
But most importantly, business credit cards can end up costing huge amounts of money if the balance is not paid off in full every month. And unlike other forms of financing, negotiating with credit card companies can prove to be almost impossible.
Mezzanine financing simply refers to loans that are backed by equity shares in the company. This can be a strong backup option for those businesses that may not have adequate collateral available for the loan amounts they need or that suffer from poor credit. Mezzanine capital also typically comes with considerably higher interest rates.
Asset-based and invoice financing
For businesses with valuable assets, like real estate or capital equipment, asset-based financing can be one option for securing high-dollar-amount financing. Another type of financing that depends on the business’ assets is invoice financing or factoring. In this case, money is loaned against future payments from invoices that have already been created, that is, against future cashflows.
The benefit of both of these types of asset-based loans are that they typically do not require the business owners or the business itself to have excellent credit or an impeccable track record of repayment of loans. This type of financing can also result in high-value loans in a relatively short timeframe, sometimes within just a few minutes.
Angel investors are a good option for businesses that are newly formed or otherwise plying a risky trade or unproven business plan. The upside with angel investors is that they can provide risky startup ventures that those companies would be unlikely to secure from more traditional lenders, sometimes in amounts up to millions of dollars. The downside of angel investors is that they often require huge returns on capital and are frequently primarily interested in payment through equity stakes in the company.
While turning to angel investors can be a viable means of last-resort financing, it is generally recommended that those business owners who can go with more traditional lending sources do so.
Bank financing and other traditional small business loans
For the lender who qualifies for bank loans or loans from other traditional lending institutions, these forms of finance can often be the best option. However, small business owners should realize that there is an often-lengthy process that one must go through in order to obtain this kind of financing. Much like applying for a mortgage, obtaining bank financing for a small business can be a labor-intensive and challenging process. But there are a few things that you can do to maximize your chances of securing bank financing.
Know your personal and business credit score
One of the best things you can do to ensure that your business will qualify for a bank loan is to maintain both an excellent business and personal credit score. In order to do this, it is of course necessary to use a wide variety of credit types and make sure that you make timely and full payments on them. However, one point that is often overlooked by new business owners is that completely separating business and personal funds is an important step in making sure that your business also maintains a solid credit score. Intermingled personal and business funds can quickly lead to credit problems for your business, including an inability of the business to establish any kind of independent credit history.
Formulate a coherent proposal
As a general rule, you can never be too detailed about how the funds that you are requesting from the bank will be used. Having a detailed budget that lays out in great detail how each dollar of the loan will be used and what future budget, revenue and profit projects look like will greatly increase your business’ chances of being approved for a loan.