Small Business Loans: Everything You Will Need to Be Prepared

By Myles Leva

-

Last Updated: October 10, 2022

Share

123
1

When you’re applying for a small business loan, there are several things you need to be aware of.

Business loans differ from the personal loans you’ve experienced before in a few ways. However, the same logic applies when it comes to the key questions for anyone considering borrowing money:

  • What precisely do I need the money for?
  • How much money do I need?
  • Will I be able to make the scheduled repayments?
  • Will I be able to handle the repayments for the entirety of the repayment schedule?
  • Am I willing to risk the collateral I’ve put up?
  • How precisely will this impact all my other financial responsibilities?

Responsible borrowing as a business owner comes with very similar considerations.

In a recent article, we covered what you should be paying attention to when starting a small business. Here, we want to follow up with the broader world of small business loans. We will go over:

  • How lenders assess business borrowers
  • The types of business lenders
  • Red flags to look out for

 

 

Business Credit

Business creditworthiness is based on several factors.

In order of importance, those factors are:

  • Personal credit score
  • Business credit score
  • Time in business
  • Revenue
  • Financial statements
  • Collateral

In addition to this, lenders will also base their decisions on the type of loan you’re applying for and the purpose of the loan.

1. Business Credit

Your business has its own “Corporate Credit Score”. This score, reported by credit bureaus, monitors the credit history of businesses as individual entities. If you’re applying for a loan for your business, they will look at your personal credit. Then, they will consider the history of your business itself.

Unlike personal credit scores (ranging from 300-850), corporate credit scores range from 0 to 100.

Business credit is monitored by a couple of familiar agencies, and one more that only monitors businesses:

  • Experian
  • Equifax
  • Dun & Bradstreet

All three of these agencies produce business credit reports and a FICO score specifically for businesses, known as “FICO SBSS”. Business credit reports are available for free from over 100 sources, while it’s harder to pull your score alone.

From here, however, business credit scores differ greatly from personal credit scores and can be confusing. There are the familiar factors:

  • Debt payment history
  • Age of credit accounts
  • Debt ratio

However, business lenders also use some other factors:

  • The level of risk in your industry
  • The size of your company

Remember that each scoring model is different, so some of the factors we’ve discussed will be irrelevant or weighed differently depending on the business credit reporting agency.

2. Time in Business

Business lenders are more comfortable lending to business owners with more experience and with tested business models. This is why business financing is harder to acquire for startups.

The requirements will differ by lender, but there are more significant differences between the different types of lenders (more on that soon). A typical bank is willing to lend money to a business that’s been operating for 2 years or more. But requirements change based on factors like loan size, loan type, and more.

3. Revenue

Personal lenders consider your income, but debt-to-income ratio and credit scores are far more important. In business, however, your revenue is far more important and is a key part of the lender’s risk assessment. Most business loans with such a requirement come with a clearly stated minimum revenue.

4. Financial Statements

Business lenders also base their decision on what they see on your key financial statements:

  • Income statement
  • Balance sheet
  • Cash flow statement

5. Collateral

If your borrowing qualifications are strong, you may not need to provide collateral for some business loans.

This means your personal credit score is over 680 and you have a long history of stable business management and responsible borrowing.

In many cases, you will need to provide some collateral for the business loan you want. This can include assets and properties of enough value. Many business loans, such as vehicle or equipment loans, use the item you financed as collateral for the loan.

 

 

3 Types of Lenders

There are a few types of lenders you can go to. This is an area that deserves more attention, as there are plenty of unscrupulous business lenders.

Banks

A bank is normally the first place business owners look for financing. Most banks offer business loans to borrowers in good standing. Loan types include standard term loans, lines of credit, and business credit cards.

With a bank, you can expect more reasonable APRs and repayment terms. You can also expect a higher standard of customer service than you could with alternative lenders. But for a loan of any significance, it can take some time to go through the process.

Credit Unions

The other type of traditional lender.

Credit unions are exclusive organizations, often accepting those in specific industries or operating in specific locations. While it’s a harder source of financing to access, credit unions normally offer the best rates you’ll find on a business loan.

Alternative Lenders

Alternative lenders fall into a few categories, but most are simply private businesses largely operating online. They are not banks, but they operate largely like the lending arms of banks.

Alternative lenders have a newfound popularity, as they’ve been growing quickly.

There are several reasons, but the ease of access and fast service seem to be key components. Alternative lenders are more likely to approve loan requests than small banks are. They have lower requirements across the board, especially when it comes to credit scores.

While loans from alternative lenders are easier to qualify for, they normally come with higher APRs. Depending on the lender, this includes higher interest rates, but may also include additional (and even sneaky) fees.

 

 

3 Warnings on Predatory Lending

There are a few mistakes business lenders should actively avoid when looking for financing.

1. Avoid Payday Loans

Yes, there are also “business payday loans” on the market. If you’re familiar with their counterpart which is marketed as a loan for someone waiting for their next paycheck, you know where this is going. You can expect:

  • Loan balances far lower than those offered by regular business loans
  • Interest rates many times higher than the maximum charged by any bank

In some cases, this means a loan of less than $1,000 at an interest rate of well over 300%.

 

2. Merchant Cash Advances (MCAs)

Oftentimes, “business payday loans” really means merchant cash advances.

An MCA has its name for a reason: it’s not a conventional loan, and isn’t regulated as such.

Rather than lending money in the conventional sense, an MCA is when another business purchases your future receivables. That means they buy your future transactions, in exchange for a lump sum (thus the “cash advance” part).

As compensation, the MCA provider takes a fixed percentage of your daily sales until they have been fully repaid. These repayments are automatically deducted from each of your transactions, before you even see the money. They get the same portion of each sale, regardless of your sales.

This has a few effects, some of which seem preferable:

  • You’re not obligated to repay the loan such as you would be with a promissory note in a typical loan agreement
  • You simply continue having portions of your transactions taken to repay the MCA provider, with no time limits
  • No liens
  • Factor rates instead of interest rates

Of course, the negative side of all the above is:

  • A long-term, high-cost drain on your working capital
  • Very high costs

Perhaps because of the lax regulations in the MCA space, there are unfortunately many horror stories. Sneaky clauses and unscrupulous behavior have been reported. Bloomberg’s excellent series on these issues explain these problems in detail.

 

3. Regular Considerations

Of course, many of the problems borrowers of any kind of loan can face can only be avoided by the borrower themselves. As such, consider those same questions we listed above:

  • What precisely do I need the money for?
  • How much money do I need?
  • Will I be able to make the scheduled repayments?
  • Will I be able to handle the repayments for the entirety of the repayment schedule?
  • Am I willing to risk the collateral I’ve put up?
  • How precisely will this impact all my other financial responsibilities?

In the context of running a business, these questions can be harder to answer. But responsible and well-audited choices are important if you want to avoid financial rough spots, or worse.

 

 

Pro Tips

Mistakes on Reports

Credit reporting bureaus make mistakes, too.

There are varying reports every year, but the Wall Street Journal reported that 25% of small business owners who checked their business credit reports found errors.

There are several reasons, but if you can find any errors and report them to the reporting bureau, they will be corrected free of charge and your credit score will be re-evaluated.

 

SBA

The Small Business Administration backs loans that meet certain qualifications.

They have higher creditworthiness requirements but come with highly favorable rates and terms.

Photo by Tim Douglas

YOU MIGHT ALSO LIKE

One comment on “Small Business Loans: Everything You Will Need to Be Prepared”

Leave a Reply

Your email address will not be published. Required fields are marked *

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.

LATEST

Subscribe for daily financial content

Daily articles, financial messages and affirmations to best help you navigate your financial future.