Every small business owner needs to understand how to handle raising capital for a business. Whether the funds are for startup purposes, expanding, or assisting with cash flow, the right financing is necessary.
Unfortunately, business owners are uncertain about the types of business loans available and the common small business loan requirements that must be adhered to for success. Here is a quick guide that could help you overcome some of the challenges you may face when raising capital for a business.
Small Business Loan Types
Small business owners need to know what types of loans are available and what each of them is designed to do. Here is a breakdown of small business loan types:
- Startup Loans: These loans are precisely what the name implies. These are for a business that is just getting started and needs capital to launch.
- Business Acquisition Loan: Entrepreneurs interested in purchasing a franchise or an existing business may seek an acquisition loan. These loans are slightly more complicated to obtain.
- Business Line of Credit: This type of funding is particularly effective for businesses with ongoing capital needs to keep an inventory of material.
- SBA Loan: The Small Business Administration (SBA) offers a range of loans that are helpful to businesses that employ 500 or fewer people.
- Short Term Loan: These loans are ideal for business owners who need a quick infusion of capital to hold them over for a period and then can be paid back.
- Business Term Loan: Loans that are a longer term may require the business to agree to have liens placed on their assets until the loan is repaid.
- Merchant Cash Advance: This type of borrowing is becoming more popular. Businesses get the working capital they need, and repayment is made regularly based on incoming receipts for the business. These loans are not ideal for seasonal businesses but often work well for those selling using eCommerce.
- Equipment Financing: When a business needs capital specifically for investment in new equipment, this may be the best option available. Often, those who are handling the sale of equipment offer favorable terms to those who are purchasing.
- Commercial Mortgage: When a business invests in real estate for their use, they may obtain a commercial mortgage. There are advantages and disadvantages to this type of financing, making a mortgage less advantageous for some businesses.
- Accounts Receivable Financing: Commonly known as factoring, this method of financing allows businesses to borrow capital today against future income. Once the business has issued an approved invoice, the company can obtain a portion of the balance due and use the funds for any needs they have.
- Credit Card Loans or Financing: Using a credit card is a popular but expensive option for business owners to meet their capital needs. This is one of the least attractive options for most businesses because of higher interest rates.
The Most Common Small Business Loan Requirements
Lenders have a low tolerance for risk, which most business owners will quickly learn during the underwriting process. For new entrepreneurs or those who could get started on their own without the need for funding, one of the most common questions that need answering includes “how do I qualify for a small business loan?” Small business loan criteria vary from lender to lender, but there are some basic small business loan qualifications every business owner should be aware of, including:
- Credit Scores Matter: Whether you are seeking a loan based on the credit of your business, or your personal credit, credit scores are the initial criteria banks use to determine how much risk they will be taking on should they approve your loan. The higher the credit score, the less collateral you may need and the better your interest rate is likely to be.
- Be Prepared With Data: Lenders are not going to accept estimates on the value of your business. You will likely need to present copies of bank statements, profit and loss statements, balance sheets, and more. Remember, the better prepared you are to address questions raised by an underwriter, the faster the process will go. Always have a copy of your business plan (modified if things have changed since it was drafted) when applying for a business loan.
- Gather Information About the Lender: Before you apply for a small business loan, make sure you find out something about the lender’s operations. Determine what types of loans they offer, whether they offer accessible funding, whether they have a history of providing the right financing, and determine the convenience cost associated with doing business with the lender. Remember, not all loans are created equal, and you may need more flexible options than one lender can offer.
- Be Prepared to Offer Collateral: For some borrowers, the right financing will require they offer the lender collateral in return for financing. Be prepared before you meet with an underwriter to provide some form of collateral if necessary. Whenever possible, you should use company assets versus personal assets as collateral — this prevents you from losing valuable personal assets should something go wrong.
Raising capital for a small business can be complicated, and numerous things can potentially go wrong. Making sure you fully understand all business loan requirements before you begin the application process can help ensure you are fully prepared for all questions you may be asked.
In general, you will want to have numerous documents available before applying for a business loan, including:
- Tax returns: Personal and business returns for up to three years
- Most recent bank statements: To show current balances, should they be required
- Accounts receivable statements: This shows how much income you are expecting from invoices issued
- Accounts payable statements: This shows what your business currently owes
- Statement of inventory: This shows your current assets
Any documentation you can provide, including upcoming contracts that can bolster your case for a loan and prove your ability to repay a loan, is helpful.
