Entrepreneurs who are ready to expand their small business, but who don’t have the capital to do so, are prime candidates for small business loans.
Nowadays, applying for a small business loan can be done either through a traditional bank or via alternative lenders. Financing the expansion of a company this way could be a game-changer for many business owners, but even after determining what kind of lender to seek financing from, the process of putting together a solid loan application still ends up being a stumbling block for many.
What are some of the best ways to clear the hurdle of submitting a loan application that’s likely to get approval for small business funding?
Start by getting organized. Being a model of efficiency can be a big help in the loan application process and making a list of what should be included as part of your application is one small step toward achieving the ultimate mission of approval.
Your checklist should include:
- A borrower information form can be downloaded from the U.S. Small Business Administration. This form, also known as SBA Form 1919, is used to profile the applicant seeking a term loan. The form will have the applicant’s contact information, identifying company qualities, the intention of the loan you are seeking, business principles, as well as a record of any previous loans or loans that still are not paid off.
Some of the documents you will need to fill out SBA Form 1919 are:
- Contact information (for all business owners and equity owners)
- Ownership percentages
- Total number of employees
- Loan amount and purpose of the loan
- Business licenses and agreement
- Business tax returns
- List of business affiliates
- Organize the information you will need for a personal background and financial statement. Delivering this statement will be required of any loan applicant who is a partial owner, general partner, proprietor, guarantor or managing member of a company. The lender needs to know that the loan applicant is a good risk, and that his or her credit score is solid. In addition to rudimentary information such as phone number, address and any other contact info, the statement requires the applicant to declare his current financial assets, as well as liabilities.
- Create a formal business financial statement. These statements will itemize the small business owner’s income, expenses and his plan for managing funds. Is your revenue balancing the way you intend for it to? A financial statement can help not only the lender, but the loan applicant/business owner to see things laid out in simple form. For any small business owner who creates balance sheets, a formal business financial statement for the bank should not be difficult to come up with. The “sub-statements” you will need to assemble this formal business financial statement include:
- A startup budget or cash flow statement
- A startup costs worksheet
- A pro forma (projected) profit and loss statement
- A pro forma (projected) balance sheet
- Sources and uses of funds statement
- Break-even analysis
- Register your small business with a business license or certificate. Neglecting to do so will preclude the lender from viewing your company as a legitimate entity.
Registering a company is a vital element in the journey to receiving approval for a small business loan. A business can be registered as a sole proprietorship, a partnership, a limited liability corporation (LLC) or a C-Corp, which makes your business a separate entity from the owners.
An LLC is a legal entity that can be formed to own and operate a business. An advantage of registering as an LLC is that it provides the same limited liability as a corporation, but it is easier to form and less expensive to operate.
A C-Corp is a legal structure in which the owners, or shareholders, are taxed separately from the entity. C-Corps, which are very common, are subject to corporate income taxes. The taxing of profits from the business is at both corporate and personal levels, so C-Corps incur double taxes. A C-Corp is legally viewed as an individual entity, separate from its owners, who are now shareholders.
- Any lender will need and want to know whether an applicant is a reliable candidate to pay off a loan, so it’s imperative that you are able to present the prospective lender your loan application history. Did you pay all your installments on time? How many times did you try to access credit? Were you approved or denied prior loan requests? In either case, a statement itemizing your previous loan applications can help the lender determine whether you are a good risk (i.e., a viable applicant for credit).
- Gather your business and personal income tax returns for the last three years. This is information that a lender must see before considering whether to approve your loan request. Make sure the tax returns are signed and feature the correct information before submitting to your lender.
- Present the lender with your resume and the resumes of any small business partners who are part of the application. Do not confuse this resume with the kind that you would be submitting if you were interviewing for a job. According to the SBA, some lenders require evidence of management or businessexperience, particularly for loans that are intended to be used to start a new business.
- Put together a business history with an overview to present to the lender. Include a short history of your small business and the challenges you have faced in operating the company. Explain in the business history/overview why you need an SBA loan for your business. Also communicate what your intentions are: How are you planning to use the money you are seeking to be lent?
- Does your business have a brick-and-mortar presence? An office or a storefront? If so, give the lender a copy of your lease, or a note from your landlord, so the lender is able to see what the rental agreement is. If your company is one that operates exclusively online, this is not a step you need to include.
- Lenders commonly expect to see one year of personal and business bank statements from the applicant before completing the loan process. The last 12 months of your bank statements are a way for the lender to verify the other financial information that you have provided on this checklist. They also are a window into an applicant’s spending patterns.
Presenting a business plan
A small business owner who is preparing to apply for a loan will need to prepare and present a business plan to the lender. Anyone who owns a company and has come this far is probably already well-acquainted with the concept of a business plan, but it will behoove you to craft the presentation in this particular business plan to suit what the lender is looking for.
A business plan should include an executive summary, description, opportunities and competition analysis, marketing and contingency plans. You should also include in the business plan your intentions for using the money you are lent, your vision for how that loan will enhance the company’s growth prospects, and projections for future profits. If the loan applicant believes there will be a subsequent need for additional financing, it’s better to be frank about your business needs rather than concealing that intention.
Types of Loans to Consider
Which financing options should a small business owner seek for his or her company?
Some types of small business financing include:
The U.S. Small Business Administration (SBA) offers commercial financing backed by the SBA through its SBA 7(a) loan program. The most common type of SBA loans, an SBA 7(a) loan assists businesses in the purchase or refinance of owner-occupied commercial properties up to $5 million. This loan also gives the business owner a chance to borrow funds for working capital.
These loans are suited to assist businesses that are unable to secure credit anywhere else. With an SBA (7a) loan, the borrower can purchase land or buildings, build on new property or renovate existing property as long as the real estate will be occupied by the owner. Through an SBA (7a) loan, an entrepreneur can borrow up to $5 million through an SBA-affiliated lender. The maximum allowed interest rates for the program are based on the Wall Street Journal Prime Rate plus a margin of a few percentage points. Interest rates can be fixed, variable or a combination of the two. Loan terms for 7(a) loans that are used for commercial real estate may be as long as 25 years for repayment. Each monthly payment would be the same until the loan is fully repaid.
Merchant Cash Advance
Another way to facilitate access to money needed to finance one’s business expenses is a merchant cash advance. In this instance, a company grants the borrower access to cash. The borrower is then required to pay a portion of his or her sales made with credit and debit cards, as well as an additional fee.
A merchant cash advance does not require collateral or a minimum credit score. However, merchant cash advances to business owners involve higher costs than most other forms of borrowing.
A merchant cash advance is an expedient way for a business owner to get his hands on capital when the need for cash becomes extremely pressing. A business owner might be slammed with a bill he or she did not expect, or the owner might need the cash fast in order to consummate a time-sensitive deal that must be decided upon sooner rather than later.
With a merchant cash advance, a business owner can potentially get hold of a large sum of funding in a hurry. The turnaround actually could be realized in as little as 24 to 48 hours in some cases. A merchant cash advance could be for a sum of a few thousand dollars up to as much as $200,000 with a minimal of paperwork.
A P2P Loan
Business owners with good credit who need a small amount of working capital quickly may be able to meet small, short-term working capital needs with a peer-to-peer loan. This type of loan must be repaid with interest in a period of one to five years. If your credit is good enough to command better rates than you’d get with a short-term loan online but is not quite good enough to qualify for an SBA loan, you might have eligibility for a peer-to-peer loan.
Peer to peer personal loans are offered directly to individuals without the intermediation of a bank or traditional financial institution. Online lending platforms fund borrowers via institutional lending partners. Also referred to as marketplace lending, peer-to-peer (p2p) lending is an increasingly popular alternative to traditional lending. Borrowers and lenders can both benefit from this more-direct lending system.
In p2p lending, one party lends money to a business, with the promise of receiving a sizable return for doing so.
For companies that have unpaid invoices. Invoice factoring is a financing method where you sell your accounts receivable at a discount for a lump sum cash amount.
A method of securing working capital that is a little different than applying for a loan, invoice factoring is the process of selling invoices at a discounted rate to a factoring company and receiving in return a lump sum of cash that can be used as working capital.
After assessing the risk of financing the business owner’s invoice, the factoring company collects payments from the business’ customers over a span of between one and three months. If a company sells something to a customer, but that customer cannot pay off the invoice right away, there’s a gap of time that could create a shortfall for the business owner. The lump sum that the business would receive by undertaking the process of invoice factoring would cover the shortfall and solve the problem of cash on hand.
Short-term loans from online lenders may be easier to get approval than some other types of loans.
Choosing to apply for a short-term loan comes with the expectation that you might have to repay it over just a couple of weeks. If you have an installment loan, you have up to six months to pay it off. A short-term loan application is completed online and normally takes a matter of minutes to be approved.
Rapid processing is one of the main attractions of a short-term online loan. Sometimes approval could even come the same day the application is placed. In addition to fast approval, other advantages of short-term online loans for working capital include paying less interest, the chance to improve a bad credit rating, and flexibility.
Business Line of Credit
When a lender provides pre-approved funding with a maximum credit limit, that is known as a business line of credit. If the borrower is approved for this line of credit, funds can be accessed whenever they are needed until the established credit limit has been reached.
Because the borrower is only paying interest on the amount that he or she withdraws, a business line of credit can be advantageous for business owners who are uncertain of the amount of funding they will actually require, or when they might need it.
The drawback to a business line of credit is that the loan will be at a rate that might be considerably higher than other types of loans. How costly that would be is heavily dependent on the amount of funds the entrepreneur ends up using.
Sometimes a business line of credit can be approved in as little as 24 hours or less. Depending on the lender, you might only need a credit score of 500 to qualify for a business line of credit.
A loan with a fairly short repayment period, a short term loan is one in which the borrower receives his cash in a lump sum up front, then repays the loan, often with some pretty sizable financing rates. Some short term loans allow the borrower to make extra payments to pay it off sooner. However, some short term loans actually come with penalties for early repayment. Short-term loans generally have a term of 12 months or less.
Payments on short-term loans are required frequently — sometimes once a week, or, in some cases, every day.
Although the business credit requirements are not as strict for short-term loans as they are for regular term loans, the frequent payment schedule may be burdensome for someone in a new business without a lot of cash flow at that moment. But a businessperson who needs a loan in a hurry still might opt for a short-term loan because it may be easier to secure than other forms of financing.