Every business needs financing of one kind or another, either as part of their initial formation, or in the form of a cash infusion after the business is operating, and often both. Financing for a business can come from the sale of stock or equity in the operation, from personal savings, from investors, from grants (although the TV commercials about “free money from the government” are at best wildly exaggerated), or from loans. Debt financing, or the taking out a loan for business purposes, is one of the most common forms of funding a small business. But how do you get a small business loan?
The first step is to identify what you need the money for. In the earliest stages of starting a business, when you don’t yet know what you don’t know, you may have ot be general with your business and marketing costs. However, as you grow, you should strive to get more and more specific about exactly what you’re going to do with the money. “We’re going to get new equipment for the factory” is okay, but “We’re going to buy a T-291A index collimator for $4,999 to increase our factory output by 37 percent” is better.
This article is primarily about how to get a loan, not about the dangers of falling into debt, but it is still a good idea to have some concept of how your business is going to repay the loan before you go into debt. Understanding the total cost of the loan (the principal plus the total interest you will play) as well as understanding the opportunity cost of the loan repayment (the other things your business would have done with the cash flow that goes to repay the loan) is an important part of making a repayment plan. “Hopeful loans” —loans in which the repayment plan is “Hopefully, we’ll make more money and be able to repay the loan”—are to be avoided.
If you know or suspect that you will need a loan at a future date, then be prepared well in advance of that date. As with many things in business, the last-minute options are generally much more expensive than the things done well ahead of time. As an example, Small Business Administration loans usually have lower interest rates and fees, but SBA loans take 60 to 90 days to process. On the flip side, you can take a huge cash advance on your company credit card at a moment’s notice, but you’ll pay a whacking great interest rate for the privilege.
Unless you’re getting a loan from a family member (and sometimes even then), you are going to need a lot of documentation and paperwork for your lender. You will need general information like your business name, names of business officers, and your federal tax ID for most loan forms. You’ll definitely need financial documents like your financial statements for the past two or three years, and year-to-date balance sheets and income and loss statements for the current year. Most lenders want to see your projected financials for the period in which you will be repaying the loan, along with your tax returns and bank statements for the past few years. If you’re starting a new business with the loan, rather than infusing capital into your existing operation, you’ll need a business plan or pitch deck.
If you want to greatly reduce the costs of your loan and make it easier to get in the first place, then a secured loan can be the option for you. In a secured loan, you have assets equal to some fraction (or even 100%) of the value of the loan, which you pledge as security to the lender. The downside of this is that if you default on the loan, the pledged assets become the property of the lender. The upside is that lenders are far more willing to make secured loans, since they know they are going to get their money back no matter what. Assets that make good security for loans include real estate, equipment, vehicles, and other identifiable assets with commonly-accepted values. Some lenders will want the business owner to pledge their own personal property as security for a business loan; this may be the only way for you to get the loan you need, but should be avoided if possible since it leaves your personal property vulnerable to a business failure.
There are many different types of lenders in the marketplace. Commercial banks, perhaps surprisingly, are not always the best sources for loans, especially small business loans. Banks charge high interest rates and fees and often have very high standards for loans; they are also very often focused on bigger deals and bigger transactions, and may not be interested in your $5,000 factory loan. Credit unions are often a better choice, as they are much more focused on member service. Small local banks, while having equally high standards, may be more interested in supporting local businesses like yours. Other sources for loans may include family members, government agencies like the Small Business Administration (although SBA loans are generally handled through banks, not directly), online lenders, and peer-to-peer lending associations.
Some business owners may seize on the first “yes” they hear and take out a loan from a lender who isn’t ideal for their situation. If it’s at all possible, shop around and take your time and get the best loan on the best terms that you can. Small differences in interest rates and fees can end up making a significant difference in your business’ cash flow down the line. Find the right lender and your chances of a successful loan experience will be much better.