Applying for your first small business loan can be a stressful process. Here is how to ensure the process goes smoothly.
- For your first small business loan, consider traditional bank loans, government loans, merchant cash advances, business lines of credit, business credit cards and other short- and medium-term loans.
- When applying for your first small business loan, you should also create a budget, compare lenders, check your credit score and determine how much funding you need.
- You should also consider working with your accountant to ensure all of the proper paperwork, such as tax return and financial statements, are in order.
- This article is for small business owners considering taking out their first small business loan.
Is this your first time venturing into the small business loan frontier? Obtaining a small business loan is just one of the first steps to launching your business. Proper financial planning, however, is critical to your success.
There are two key things to keep in mind as a small business loan first-timer. If you're seeking a small business loan, the way you present your business idea, business plan and financial forecasts can be the difference between gaining or not gaining investors' or a bank's approval. But once you do get a business loan, how you manage your operations and where those funds go can make or break your entire business.
Types of loans to consider
Among the types of loans – also known as debt financing – you should consider for your first small business loan are:
Traditional bank loans. These are harder to secure, but generally offer more favorable terms.
Government loans. This includes loans from the Small Business Administration (SBA), which may have more favorable rates than bank term loans.
Merchant cash advances. You repay these loans with a portion of your debit and credit card sales. These are paid in daily, weekly or monthly installments and typically have a high APR.
Business lines of credit. You can use lines of credit repeatedly until they run out or you no longer need the funds.
Business credit cards. You repay these just as you do a personal credit card.
- Long-term loans. Typically offer larger funding amounts that you can repay over longer periods.
Key takeaway: Types of first small business loans you should consider are traditional bank loans, SBA loans, merchant cash advances, business lines of credit, business credit cards and long-term loans.
The do's and don'ts of your first small business loan
From creating a budget to managing costs, there are several steps you can take to make the most out of obtaining and managing small business loans. Holly Nicholas Signorelli, a certified financial planner and CPA, advises aspiring entrepreneurs and small business owners to maintain realistic expectations. Based on more than 20 years' experience, Signorelli shared the following do's and don'ts of first-time small business loans. [Read related article: Applying for a Small Business Loan? Here's What You'll Need]
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1. Do create a real budget.
About 90% of the time, clients come in with a huge budget made up of millions of dollars in profits, Signorelli said. But when you start to go through the line items, there isn't any real backup to substantiate the numbers. Instead, there is always some hype about the product, the market in general and, most of all, "the potential." Banks and investors don't want to buy your idea; they want to make a profit, Signorelli stressed. For them to believe in your idea, they have to believe there is a profit. With very few exceptions, they are not going to invest in your idea if it doesn't make sense, or if it feels too good to be true, Signorelli said.
2. Do have budget references.
Make sure that every single line item has a reference behind it, Signorelli said.
"Real figures, real research – get down and dirty on it," she said. "For example, if you are providing a service and your budget states that you can sustain XX amount of customers per month at XX amount of dollars, then the price of the service will be easy to show, given the average price of that service in your geographic area."
However, you need to back up why the customers would come to you versus the competition.
"That's 'down and dirty,' and you can't get too detailed; keep it short and to the point with backup," Signorelli said. "Think about it: When you are reading a budget, you don't want someone rambling about their pipe dream. You want to know that the person understands what it's going to take to make a profit and has a clear plan to bring in business."
In other words, you want details, but you want them to be short and concise.
3. Don't overestimate your income.
"In 20 years, I have never seen a budget where the income was as high as predicted in the first year," Signorelli said.
This is critical, because the lack of income in the first year is what causes 80% of small businesses to go out of business, she said.
"Once your budget is done, go back to it and reduce your income 25 to 50% less than what your due diligence led you to put on the report," Signorelli advised.
4. Don't underestimate your expenses.
"There are things that you underestimated, no matter how meticulous you were, and there are things that you forgot altogether," Signorelli said. "Just like income, you need to go back to your budget and take your expenses and increase them by 25 to 50%."
5. Do have extra funds.
As a small business owner, you must have enough savings, to make sure you can pay your bills during the first year, Signorelli said.
"It was hard enough to get your loan, but I promise you that six months into when you are not profitable, no one will want to loan you more money to get you through the next six months," she said.
6. Don't stress about finances.
To make it through the first year and build a profit, you want to focus on marketing and bringing business in, so you don't need to stress about finances, Signorelli said. Manifesting and building a business requires you, the owner, to believe in yourself and your new small business.
With the right budget, you will get the right amount of money from the right investor, giving you the freedom and confidence to focus on your dream and make it happen, Signorelli said.
7. Do compare lenders.
No two lenders – not even lenders that offer the same type of loan – have quite the same terms. If you find two lenders willing to offer you a loan amount favorable for your budget, one of these loans is likely to have a higher APR than the other. The high-APR loan, though, might have a shorter term, meaning that the burden of repaying your debt lasts longer with the other lender. You should also consider the lender itself – browse its customer reviews and determine the level of customer support you'll receive. A trusted lender willing to assist you may be better than a less-reputable lender with more favorable loan terms.
8. Do check your credit score.
With a low credit score, your chances of being approved for a loan decrease substantially. The minimum credit score needed varies by loan type. This can range from as low as 550 for most merchant credit advances to as high as 680 for traditional bank or SBA loans. If your credit score is too low for the small business loan you desire, there are actions you can take to potentially raise your credit score.
9. Do decide how much funding you need.
It's important to know how much funding you need so you don't get charged prepayment fees when you repay your loans. Some lenders charge prepayment fees if you pay part or all of your loan before your loan term ends. For example, if you take out a $20,000 loan when you only need $5,000 and then attempt to pay back the extra $15,000 after realizing you only needed $5,000, you'll be charged fees you could have easily avoided.
10. Do gather your paperwork early.
Applying for a loan is rarely as simple as filling out an application. It usually requires you to file large amounts of paperwork as well. As such, it's never too early to get all your documents in order. These documents can include tax returns and financial statements. You may want to speak with your accountant to determine what you'll need based on the loan for which you choose to apply, but it never hurts to compile everything possible so you’re ready no matter what.
11. Do learn from your mistakes.
Yes, it's OK that you made mistakes, as long as you learned lessons from them.
"I worked for a great CPA right out of college for five years to learn all I needed to know to run a business," Signorelli said. "I still made mistakes in the first few years, but the foundation had been set and above all else, it was not an option for it not to succeed. It was my life, and whatever you are taking on must be your dream that you will move heaven and earth to make happen."
Key takeaway: When applying for your first small business loan, create a budget, compare lenders, check your credit score, determine the funding amount you need and more.