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5 Tips for Negotiating a Business Loan

image for goodlu/Shutterstock
goodlu/Shutterstock

You can't start or grow your business without funding. Unfortunately, applying for and getting a business loan isn't a fast or stress-free experience.

Applying for a loan is one of the most crucial steps for a small business owner. To give yourself the best chance of getting approved, follow these tips for negotiating and ultimately getting a business loan.

Alex Espinosa, SBA lending consultant and founder of BOLD Lender, recommends researching banks before applying for a loan. Like doctors, banks have specialties. You should find banks that are able to help you – don't waste your time applying to banks that can't.

"Some banks are good at restaurant loans and some are good at gas station loans, but many lenders reject those categories," said Espinosa. “I would start by looking up every bank headquartered in my county and begin investigating them, starting with the smallest. A good place to start is on the FDIC website." 

BJ Lackland, CEO of Lighter Capital, suggests trying to seek capital from multiple sources. "In any negotiation, it helps to have options," he told Business News Daily.

Editor's note: If you're looking for information to help you find a business loan, use the questionnaire below to have our vendor partners contact you with free information.

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Bankers and lenders won't take you seriously if it seems like you're unprepared or unsure of what you're talking about.

"Speaking the same language as your lender demonstrates that you understand the process and your responsibilities, increasing your lender's confidence in you," said Paola Garcia, a small business advisor at Excelsior Growth Fund. "This can also help you spot warning signs that a potential lender may not have the experience you need or may demonstrate predatory lending behaviors – either of which can result in a loan that's poorly structured, with repayment terms that jeopardize your business's cash flow."

Before you apply for a loan, here are some terms you should familiarize yourself with.

Balloon payment: "[This is] the unpaid balance due at the end of a term loan for loan types that don't fully amortize over the term of the loan," said Gennady Litvin, associate at Moshes Law. "The balloon payment is due at the end of the loan to pay the balance in full."

Default: Litvin defined this as "failure to make the agreed-upon periodic payments on a loan."

Financial covenants: "These are financial guardrails within which you need to operate your business," Lackland said. "If you go outside these, you'll be in default under the loan and the lender can demand immediate repayment." Financial covenants may include a minimum cash balance in your bank account, a minimum level of profitability and asset coverage of cash-flow ratios.

Loan-to-value ratio: "[This is] the ratio of a loan to the value of the purchased asset," Litvin said. "It's one of the metrics used to evaluate the risk on a potential loan."

Personal guarantee: "If you personally guarantee a loan, that means not only is your business on the line, your personal assets are also at risk," said Lackland. "The capital source could come after your house … Try to avoid a PG as much as possible."

"Preparing for a business loan is like dressing for your wedding," said Espinosa. "You want to look as attractive as possible and present yourself like a good risk."

While you need to speak the part, so does your paperwork. Espinosa recommends getting copies of your credit report to identify any negative items and try to repair or remove them. "Have a letter of explanation prepared for any negative items that remain."

You should also have your tax returns for the past three years, three years of fiscal year-end financial statements and year-to-date financial statements.

"You should prepare a personal financial statement listing your income, assets and liabilities," Espinosa said. "Have copies of up to six months of bank statements, recent broker and retirement account statements, copies of your life insurance policy and statement, any trust information, and any recent appraisals you have had done."

Before you arrive at the bank, make sure you and your paperwork are organized and neat. "Neatness, grammar, spelling and organization counts," said Espinosa. "Sloppy requests don't even get read and are often rejected immediately."

Walter Gumersell, an attorney with Rivkin Radler who specializes in business negotiation, said small business owners should be wary of the personal guarantee. Many small business loans, especially those from online alternative lenders, require a personal guarantee to serve as collateral for your loan. A personal guarantee may make sense in some instances, but it's a tool you should be aware of before signing a loan agreement.

Instead of taking business property as collateral (which the lender may already be doing), the lender may also ask for a personal guarantee, which means that in the event of default, your personal assets can be seized to reconcile the debt. If your lender requires a personal guarantee, try to limit it to certain assets. Don't ever sign a loan agreement that you feel will put your personal financial situation in jeopardy.

While it may seem counterintuitive, many lenders charge you a fee if you pay off your loan in one lump-sum payment. This is because, depending on your loan agreement, if you pay off your loan upfront, the lender collects less total interest. Variable interest rates can fluctuate, and even fixed interest rates are charged on the remaining principal. As your loan matures and amortizes, the amount of interest you pay each month will be a result of the remaining principal. If you pay off the total principal and interest upfront, you're not making future interest payments to the lender, which affects its balance sheets and total interest collected. You could also be paying less interest overall.

Gumersell recommends negotiating a prepayment option so you can pay off your loan immediately if you have the opportunity. This tip comes down to flexibility: You want to be able to be as financially nimble as possible. The option to pay off a loan in one lump sum means you can quickly attain financial freedom if you have the opportunity.

For more information on what you need for a small business loan application, read this Business News Daily guide.

Additional reporting by Matt D'Angelo.

Saige Driver

Saige received her Bachelor’s degree in Journalism and Telecommunications from Ball State University. She is the social media strategist for Business.com and Business News Daily. She also writes reviews and articles about social media. She loves reading and her beagle mix, Millie.