As experts in accounting for small businesses, we understand that the application and approval process for obtaining a small-business loan can be overwhelming. To help make things easier, we’re sharing these 5 steps to obtaining a business loan.
Step 1: Determine why you need the loan.
Lenders will definitely ask your reason for the loan. Generally speaking, your answer will fall into one of the following categories:
- Start-up costs
- Day-to-day expense management
- Business growth
- Emergency or reserve fund
Step 2: Decide which type of loan is right for you.
The reasons you need the loan will dictate which type of loan you get. If you’re looking to cover start-up costs, then it’s highly unlikely you’ll get a loan from a bank or other lender. That means, you’ll need to find other ways to cover start-up costs, which may include:
- Business credit cards
- Loans from friends, family, and associates
- Personal loans
If your business has a year or more of revenue history, you have more financing options, including:
- SBA loans: Small Business Administration (SBA) loans are guaranteed by the federal agency of the same name. This allows lenders to offer loans with flexible terms and low interest rates. They are difficult, but not impossible to obtain and can help with the purchase of fixed assets like buildings, equipment, vehicles, etc.
- Term loans: Offered by traditional banks, credit unions, and online lenders, term loans range from $2,000 to $5 million. Borrowers agree to make fixed monthly payments for a set term usually no more than 10 years, until the loan is repaid.
- Business lines of credit: A line of credit doesn’t provide a large injection of funds like a traditional loan. Instead, you draw on the creditas you need it, similar to a credit card.
- Invoice factoring: This is a type of accounts receivable financing that converts outstanding invoices due from other businesses or government offices within 90 days into immediate cash for your small business. The factoring company (a third-party vendor) will pay you the amount due, minus their fee, in two installments—80% up front, and the remaining when they receive payment on the invoice.
Step 3: Determine the best type of small-business lender.
You can get small-business loans from a variety of sources that may offer some or all of the financing options listed above.
Traditional bank options include term loans, lines of credit, and commercial mortgages to buy properties or refinance. Getting approved takes longer than other options, typically 2 to 6 months, but banks usually provide your lowest-APR option.
Use banks when:
- You can provide collateral.
- You have good credit.
- You don’t need cash fast.
Microlenders are nonprofits that typically lend short-term loans of less than $35,000. The application may require a detailed business plan, financial statements, and other documentation, making it a lengthy process. But these loans may work well for smaller companies or startups.
Use a microlender when:
- You need funds for start-up costs.
- Your company is too small to qualify for a traditional loan.
- You can’t get a traditional loan due to a limited operating history, poor personal credit, or a lack of collateral.
Online lenders provide small-business loans and lines of credit from $500 to $500,000. Interest rates are higher than traditional banks, but the approval process is fast, sometimes within 24 hours.
Use online lenders when:
- You are in business for less than a year.
- You lack collateral.
- You need funds quickly.
Once you know which loans you qualify for, choose the one that has the lowest interest rate and affordable repayment terms.
Step 4: Find out if you qualify.
To determine which types of loans you’ll qualify for, you’ll need to consider 4 questions:
- What’s your credit score? Your credit score is the first thing most lenders will look at. Banks usually require a score above 680. You can get your credit report for free from each of the three major credit bureaus—Equifax, Experian and TransUnion—once a year. You can get your FICO score for free from several credit card issuers as well as personal finance websites.
- How long have you been in business? You need to have been in business at least one year to qualify for most online small-business loans and at least two years to qualify for most bank loans.
- Do you make enough money? Many lenders require minimum annual revenue, which can range anywhere from $50,000 to $150,000.
- Can you afford the payments? Look carefully at your business’s financials—especially cash flow—and evaluate how much you can afford to apply toward loan repayments each month. As a rule of thumb, your total income should be 1.25 times your total expenses including your new repayment amount to comfortably afford the loan.
Step 5: Gather Your Documents.
Once you’ve compared your options, it’s time to apply for the loans that fit your needs. Most lenders will require you to submit a combination of the following documents with your application:
- Business and personal tax returns
- Business and personal bank statements
- Business financial statements
- Business legal documents (e.g., articles of incorporation, commercial lease, franchise agreement)
If you have questions or need guidance as you navigate the small business loan process, then contact the financial experts at Tobin & Collins. For more than 50 years, Tobin & Collins has provided certified public accounting services to clients in the New Jersey and New York metropolitan area. Our exceptional team of professionals provides personal service and sound financial strategies to put our clients on the path to future success.