Are you considering applying for a small business loan? It’s a major milestone for any business, but it can also be a daunting process if you haven’t properly prepared and gathered the right info. Here’s everything you need to know from understanding your options and deciding to seek financing to actually applying and understanding the terms of your lender’s offer.
What To Do Prior To Applying For A Small Business Loan
• Don’t Set Yourself Up For Unnecessary Stress
Understand that you’re learning and growing as a business during this entire process. If you take the time to understand all your options and the intricacies of your business and personal finances, then the small business loan process can be all but painless. Without this prep, however, you’re setting yourself up for a lot of stress and possible failure. Begin with getting familiar with your options.
• Ask Yourself If You Really Need Financing
If the answer is yes, then decide if a term loan is best for your business’s niche and growth stage? You have other options, such as a business credit card, angel investment, and invoice financing, to consider. Each option has pros and cons that you’ll need to weigh against your business model and growth to determine which is the best financing fit.
Once you’ve decided on a financing route, you’ll need to understand your credit and use case in order to successfully complete the financing applications.
• Get Up Close And Personal With Your Credit
When it comes to the loan application process, your credit is like the main course of a meal. It’s basically a numerical value assigned to your reputation, and lenders use that number to determine how comfortable they are trusting you with their money. Would you loan a friend, much less a stranger, money if their history of repaying debt was lackluster? Probably not, right? Well, lenders feel the same way about you, the borrower, when it comes to your reputation and their money.
It’s important to remember that the lender will analyze both your business and personal credit scores in both accepting or denying your loan and in what terms you’ll get with any loan offer.
Understanding Your Business Credit Score
Particularly in the beginning, small business owners have a tendency to intermix their business and personal finances. This can become a huge burden when applying for a small business loan. It can also be a nightmare during tax season.
It’s important to separate these out as soon as possible so that your personal finances don’t impact your business’s credit potential and so that your business accounts can start to build a solid credit history of their own standing.
Business credit scores work similarly to personal credit scores. Healthy ones are based on a record of timely bill payments. Different scales are used by the three main scoring systems for business credit reports. While Experian and Equifax consider collection agency data, legal filings, and public records, PAYDEX’s score looks at nothing but account payment histories. In any case, each scoring system spits out a three digit credit score based on the information they collect. The higher the score, the more likely you are to get approved for a loan and approved with favorable terms.
Understanding Your Personal Credit Score
While it’s extremely beneficial to separate your business finances from your personal finances, lenders are still going to look at your personal credit score in determining loan approval and terms. Why?
Let’s say you’ve hired a chauffeur with a stellar professional history, but then you find out he’s had multiple accidents and moving violations during his personal time. That professional history doesn’t look quite so stellar now, right? Lenders view personal verses business credit history the same way. Both matter when it comes to vetting you for a loan.
The most important factor in your personal credit history is the same as it is in business – a history of timely bill payments. Your FICO score and VantageScore are based on a range of 300 to 850, with higher scores going to those that pay creditors the required amount at the required time.
Common Mistakes That Can Negatively Impact Your Personal And Business Credit Scores
There’s quite a few mistakes that can lower your credit scores, including these two biggies:
1. Carrying too much debt through outstanding balances, even if you meet minimum payments on time; it’s best to keep your balances low so that your line of credit margin is larger.
2. Not keeping a high utilization rate, which is your credit balance divided by the credit limit and then multiplied by 100. Credit utilization is basically the measurement of your revolving debts in relation to your credit limits. FICO scores don’t penalize you as much as the VantageScore does, but it’s a negative on both fronts. It’s best to keep utilization under 10 percent.
Is It Possible To Improve These Credit Scores Before Applying For A SBL?
Yes. You’ll first need to access the personal and business credit info the credit agencies use to tally your scores. Thanks to the Fair Credit Reporting Act, this is all free info and not too complicated to gather. Sites like Credit Karma and AnnualCreditReport.com will give you free access to personal credit reports, and sites like CreditSignal will give you access to business credit reports.
Once you have the info, you can work on some quick fixes to raise your credit score, including:
• Checking for errors, negative activity that’s already been addressed, unreported positives, banking errors, activity that doesn’t belong to you, and so forth.
• Report any errors you find. If successfully disputed, then they’ll be removed.
• Get with creditors on any past due debts to negotiate a settlement in exchange for goodwill adjustments.
• Contact any government entity holding you to a tax lien. Pay it or negotiate for a payment plan.
• Contact any entity posting late payments, errors, or not reporting good standing credit history.
• Keep your utilization rate low.
• Don’t close accounts as you pay them off as this ultimately lowers your credit accessibility and therefore your score.
• Keep your balances under the 30 percent threshold of your total credit to show that you aren’t relying on credit as a 24/7 flotation device, and it’s even better if you can aim for a 10 percent threshold.
• Look at credit monitoring services, which typically cost around $20 per month, to help you stay abreast on any changes to your credit.
• Look at where you can improve your payment amount and schedule to boost your credit over the long-term and get better loan offers and rates in the distant future as your business continues to grow.
• Diversify with various types of credit accounts, but do this sporadically so that it doesn’t appear as if you’re on some desperate mission for quick funds.
Improve Your Chances Of Loan Acceptance With Justification And Being Specific
What are you asking for? Why are you asking for it? What will it accomplish? Knowing the specific answers to just these three questions can help improve your business loan application’s forecast significantly.
Composing a budget for the funding you’re seeking is a superb way to demonstrate that you truly understand your own business. Let’s say you’re expanding your boutique to include monogramming and need several key pieces of equipment. Knowing the market price of the equipment, if there are any associative or operational costs, and how much revenue it will add helps to backup the merit, value of, and repay ability of your loan request.
Know Your Financial Statements
If your credit is the main course, then your financial statements are the finishing course of creme brûlée. Ask your accountant or bookkeeper for your business’s profit and loss statement, balance sheet, and cash flow statement for at least the last few years. These will help you outline your overall revenue verses profit and breakdown where you’re making your money at, your primary costs, and if you’re profitable enough to repay a loan.
Keep in mind that if the answer is no concerning profit and being able to pay a loan, then you have to come up with a viable plan to get there if you want a small business loan. Maybe you need to secure better rates from your suppliers or determine where the operating leverage is going to derive? In any event, you’ll have a stronger case if you can show profits and a margin to improve said profits.
How To Prepare Your Documents For A SBL
With all the analysis above complete, you’re ready to apply for a small business loan, and now you’ll find it much simpler to get the paperwork completed. You’ll need to have the following documents on-hand to help you complete the application:
• Tax Returns for one to two years
• Accounts payable and receivable
• Financials like your income statement and balance sheet for one to two years
Understanding Your Offers
You’ve dotted every i and crossed every t for your SBL application. The lender has considered it and put an offer on the table for you. How’d they come up with the offer, though?
Aside from the actual loan and repayment breakdown, a big facet will be the APR (annual percentage rate) and interest rate, which are largely based off your credit score (how big or small of a risk you are.) Interest rates are percentage marks from the principle loan amount. It’s what the lender charges to take out the loan. APR is the yearly average of the interest, service charges and fees you’ll pay. Compare the big picture of what you’ll pay bottom line because a SBL with big fees and low interest rates may end up costing you more than a high interest rate with lower fees.