Unless your small business is completely self-funded or backed by investors, you’re likely going to need a small business loan to help you start or grow your business. Commonly offered by banks, business loans offer a much-needed infusion of cash to help cover most costs, though many small business owners find it hard to be approved. When seeking a business loan from a bank, it’s important to keep the following information and tips in mind so you can get approved more quickly and easily.
When looking at potential financing options, here are some of the more common types of business loans to consider.
This loan is your traditional bank term loan option, provided by a financial institution, and it operates similarly to a personal loan in some aspects. Businesses often seek this type of loan when they need funds for major investments, business upgrades, acquisitions or other major needs.
Depending on the agreement, these loans tend to feature a fixed interest rate, with the lender requiring a monthly payment or quarterly payment schedule. These loans also have a fixed end date, with intermediate-term loans running for three years or less and long-term loans running for 10 years or possibly longer.
When considering a business line of credit, think of it like a credit card. If approved, your small business is able to borrow up to a certain amount of money from the bank. As you accrue debt, you pay interest only on the amount you’ve used so far.
As long as you stay within the credit limit, this option provides much more flexibility in how the money is used. This option is great for small businesses that have a steady flow of income, a decent credit history and, in some cases, are willing to put assets up as collateral. [Read related article: What Is a Revolving Line of Credit?]
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If your business is looking to acquire a location to expand, a commercial mortgage is the type of loan you need. A commercial mortgage is secured through a lien on a commercial property and acts similarly to a home mortgage.
Suppose your credit history is nonexistent or unflattering. In that case, a bank can require that the business owner or any principals personally guarantee the loan, promising to pick up the tab in the event the business goes under. While most residential mortgages typically last for 30 years, commercial mortgages are significantly shorter.
Not unlike leasing a car, an equipment lease spreads out the cost of a major equipment purchase over a set amount of time. Most lessors don’t need a large down payment on a lease.
Once the lease has run its course, you can opt to return the equipment. Alternatively, you can pay the rest of the equipment’s value based on the life of the lease and the appreciation of the item in question. Though the monthly payments will be lower than the upfront cost of just purchasing a piece of equipment, it’s important to note that interest will add to the price tag.
A letter of credit is a guarantee from a bank that a seller will receive the correct payment owed on time. The guarantee comes in two different flavors: seller protection or buyer protection. In the former, the bank agrees to pay the seller if the buyer fails to make their payments; this is generally offered for international transactions.
Funds for this type of letter are sometimes collected from the buyer upfront in a sort of escrow. Buyer protection is offered in the form of a penalty to the seller, like a refund. Banks provide these letters to businesses that apply for one and have the credit history or collateral required.
An unsecured business loan doesn’t require the borrower to provide any collateral against the amount they’re borrowing. Since it’s friendlier to the borrower than the bank, the lender charges a significantly higher interest rate than it would for a loan backed by collateral. This kind of loan is most commonly provided through an online lender or alternative lender, though traditional banks have been known to offer unsecured loans to customers with an existing relationship with the institution.
Without any assurances in the form of collateral, unsecured business loans are often much harder to obtain than other loans. The inherent risk involved in an unsecured loan naturally means it will generally be offered as a short-term loan to alleviate the lender’s risk.
Follow these steps to get the funding your business needs.
Evaluate the best business loans side by side across several factors to determine which loan fits your needs. Key factors include:
Ask the bank what information it will need when going through the application process relative to the type of loan you’re seeking and the size of the request. To this end, you should generally try to have three years’ worth of business and personal tax returns on hand as well as year-to-date profit and loss figures, balance sheets, accounts receivable aging reports, and inventory breakdowns, if possible.
If you have a CPA or bookkeeper, you can usually get all of that information from them. However, the best accounting software [See our QuickBooks review or Xero review] can just as easily generate most of that information as well.
If you’re seeking a loan as a startup, it’s imperative that you also have your business plan drawn up. If you don’t have that laid out in writing just yet, there are plenty of free resources that you can use, including local Small Business Development Centers, SCORE and Economic Development Centers.
If you need a loan for a one-time purchase or another financing option, it’s also important to have estimates for the work or purchase ready to show the loan officer.
“Lenders want to see that you’ve carefully thought through your business goals, know how much you need to achieve them and have a specific plan to use the money wisely,” said small business content writer Karen Axelton. “Whether your goal is to open a second location or buy new machinery, run the numbers to see how much it will cost. Also calculate how loan repayments will affect your business budget going forward.”
Your final step is to complete the loan application. This process will look different for each loan. For example, some banks tout their quick applications as a selling point, whereas SBA loans are known for their tedious, lengthy applications.
Once you’ve filed your application, you’ll get an answer within a period that the bank has likely stated outright. Typically, this period is at least one week and is often much longer. The good news is that, since many bank loan applications are submitted online, your completed application should give you access to an online portal. You can usually track your application’s status and follow up with your contact at the bank to request updates.
At the end of a successful loan application, the bank will draw up a loan contract specific to your business. You should go through this final loan offer carefully to make sure that everything looks right. All collateral, interest rate, term length and fee provisions in the contract should align with what you and the bank have previously discussed. If everything checks out, you’re all set to sign on the dotted line.
Carefully consider the type of loan your business will need and the type of agreement you will have to enter once approved.
When applying for a business loan, it’s imperative that you keep a bank’s requirements in mind. Each bank has its own loan application forms. Many institutions offer their applications online, though some still require you to fill out a paper form. The bank may have a preferred method of applying based on the loan amount and the kind of loan you’re seeking.
In addition to how a bank prefers to receive a loan application, you should also pay attention to the prerequisites that a bank needs in order to be considered for approval. Many factors go into a potential approval, so prior to applying, be sure to check on the following:
Only you know your business’s financial situation. Gathering the appropriate information can assuage a lender’s concerns about your business’s ability to repay financing.
The below pros and cons of small business bank loans are worth considering as you decide whether to apply.
As a small business owner, you have many loan options to choose from for financing. Each type of loan comes with its own set of stipulations, requirements and other criteria that may make one a better fit for your financial situation and repayment abilities than others.
Bank loans are not your only option. You can work with alternative lenders to secure the funding you need. Alternative lenders are an option to consider if your business doesn’t qualify for a traditional loan. Here are three alternative lending options to consider:
Besides the type of loan you apply for, consider the details of the loan. Each loan comes with its own interest rate and loan term, among other points of consideration that are as equally important as the type of loan you take on. It’s important to read the contract in full to make sure there aren’t hidden terms or fees.
When applying for a bank loan, check the following:
Small business bank loans can help you fund your boldest business goals if you qualify for them. Of course, the idea of taking on a substantial amount of debt to fuel your growth might seem intimidating. However, countless small business owners have successfully used loans to take their operations to the next level without incurring financial danger – and so can you.
Max Freedman contributed to this article. Source interviews were conducted for a previous version of this article.