Several years ago, business owners did not have the same available options for small business loans today. With numerous choices available, it can become confusing for the entrepreneur. It is significant to be savvy enough to determine how to borrow and the whole application process. It can take a couple of weeks at least, but there are also options that let you get the approval within minutes.
Learning about the terminologies, conditions, and requirements involved in a small business loan can help you figure out if it is an investment and risk worth taking.
What is a Small Business Loan?
As the name suggests, a small business loan is a type of funding provided to small business. The borrower can have one or more reasons for obtaining the loan. To apply for the loan, an entrepreneur has to talk to the lender and meet the requirements to get the funds.
Some creditors don’t have very restrictive requirements while others are a bit firm with their demands. Often, it is also known as small business financing.
Line of Credit vs. Term Loan
A small business line of credit is not the same as loans and works almost the same as credit cards. It can come in handy if you need extra cash quickly. A line of credit makes sense for short-term financing and can be helpful if you have a shortage of cash flow and payroll. The interest rates are often high, and the credit limit is not huge compared to loans. However, if you’re in a pinch, a line of credit can be useful.
On the other hand, a term loan refers to a lump sum you borrow from a creditor, and you pay it off at specific intervals, usually monthly or bi-weekly. If you have bought a house or car, you may be familiar with term loans.
More often than not, term loans are stricter with the repayment schedule and other requirements. Additionally, you have to pay the term loan as soon you receive the funds. You will benefit from a term loan if you are in any of the following situations or something similar:
You are opening a new storefront
You need to expand your space
You have to hire new employees
You plan to revamp your site, or you will build a new one
You are refinancing debt with a high interest
You will purchase a new piece of equipment or technology to help your business
Lenders search for documents before they approve your application. You also need to meet certain requirements including the following:
A high credit score
Your credit score can either be business or personal, and lenders look at both of them. You need to increase these two scores so you can apply and get approved easily. What’s more, you will be granted with a lower interest rate than those with bad credit rating.
You build your business credit score when you purchase items from some merchants and pay your business bills. You can check which stores report to the three agencies namely Dunn & Bradstreet, Equifax, and Experian.
Meanwhile, your personal credit score shows your reliability as a borrower. Banks and lending institutions have their own numbers and methodologies in measuring the scores. Some may require the consumer to have at least 600 while others need at least 700 to approve a small business loan application.
While you can apply at online lenders that usually accept people with bad credit rating, you can plan your course of action before you submit the required documents to a lender. One way to increase your score is to settle all your dues and ensure that you don’t miss a payment after that.
Business earnings and profits
The lender knows that you can repay the loan if your business has income, which means that you can pay the loan back. Other than your revenue, the bank or lending institution will also look at your current bank balance and cash flow.
The amount you have in your bank account will help the lenders evaluate your cash flow. Having enough revenue doesn’t always mean that you have the money to cover emergency expenses. Typically businesses only focus on their operating costs, so they don’t leave any wiggle room in case of emergencies.
Most lenders like knowing the purpose for applying for the loan. The most obvious reason is that it helps them identify which loan type would fit the needs of the applicant. For instance, some small business loans are better suited for buying a franchise, while others are for purchasing pieces of equipment or real estate.
The purpose of the loan also helps in determining whether the business owner should choose a short-term or long-term loan. Additionally, some loans eliminate some options, such as the inability to pay off an existing loan or consolidate some debts.
Some lenders require insurance to mitigate risk and cover the losses if the borrower defaults on the payment. Banks, for instance, secure the small business with real estate or equipment.
APR vs. Interest Rate
Two of the most common terminologies you will encounter are the interest rate and annual percentage rate. Many entrepreneurs confuse these two, but they are entirely dissimilar. The loan’s interest rate refers to the percentage of the amount the lender requires you to pay when you take out the loan. The higher the interest rate, the riskier the borrower is to the lender. You can have low interest rates if you can prove to the creditor you can repay the loan.
Meanwhile, the APR gives a holistic view of the complete cost of the loan since it tallies up the average of the interest rate, fees, and other charges.
Business and legal documents are often necessary for the application process to push through. Some of the documentation you will need to present may include:
Articles of incorporation
Business permits and licenses
Title deeds if the business owns any real estate
Trademarks, copyrights, and patents
Other documents that lenders require may be payroll records, bank statements, and business income tax returns. The current balance sheet, accounts receivable, and profit and loss statements are often needed as well. Personal documents, such as individual tax returns and title deeds may be required.