A small business needs capital to grow. But a small business owner does not always have the necessary funds to be placed timely into their business. When that occurs, they can seek out lenders to fill their company’s financial needs.
Small Business Financing Options
Small businesses have a variety of financing vehicles open to them that includes working capital for short term liquidity, leasing that is used for costly equipment purchases, a term loan that is paid off over a defined number of years, among others.
A number of factors need to be considered when choosing the type of financing that meets the owner’s needs which lenders will typically lay out to potential borrowers.
Fundamental Bank Lending Practices for Small Business Owners
Small businesses have available to them a variety of financing sources that range from a bank, a factor that will lend against accounts receivables, a purchase order lender, a leasing company for equipment, microlenders and others.
A bank is the most well-known source of business loans, but startups and early-stage companies are very often not credit worthy to gain loan approval. However, the U.S. Small Business Administration (SBA) in partnership with designated banks will provide a guarantee for some small business loans in order to gain bank approval.
Banks may also ask for the owner’s personal guarantee of the loan. When signed, the small business owner agrees that the bank can take possession of stock, their home, among other personal assets, when the business is unable to pay off the loan. Personal guarantees are fairly common in their use and is often agreed upon before pursuing an SBA loan.
Therefore, when applying for a loan, the applicant should be prepared for the bank to ask for their guarantee and they should know the value of their personal assets.
Key steps to obtain a small business loan
Use of Funds: The borrower should establish how the loan will be used in the business and the amount needed. This may determine the type of lender to approach. Your local bank is a good starting point, so developing a contact there over time and before applying for a loan is helpful.
Establish Credit History: Lenders gather background information about the small business owner and their business to determine credit worthiness for making the loan. Lenders typically obtain a Dun & Bradstreet report on the applicant business to determine if it has a satisfactory credit grade and if there are any outstanding credit issues or in its history.
Since many small business loans are based on the personal guarantee of the small business owner, the owner should check their own credit score before applying for a loan. If there is a poor credit history, the owner should work to improve it—which may require them to seek out advice on the steps necessary to achieve credit worthiness.
Research Lenders: Traditional banks, credit unions, factors, online alternative lenders, and government programs offer a range of options to a small business. Compare interest rates, terms, and eligibility requirements to find the best fit for the business’ needs.
Prepare Financial Documents: Lenders make their decisions based on the financial statements of the company, among other contributing factors. Many small businesses often fall behind in the bookkeeping and the preparation of financial statements which elongates the time needed to file for a loan and gain approval.
The lender typically requests a Profit and Loss statement, a Balance Sheet and a Cash flow projection for multiple years. These financial reports can be produced from bookkeeping software such as FreshBooks, Sage and Quickbooks, but the lender typically will ask that they be reviewed by an accountant.
An accountant can be engaged in the review and preparation of a company’s financial statements at various levels of involvement. The lender should be asked what they will accept from the accountant. They will likely also ask for copies of the company’s tax returns for multiple years.
Loan Application: Most applications request information to be inputted that is drawn from financial statements and other documentation. It asks for the purpose of the loan.
Collateral Assets: If the company’s financial condition is weak or the company is growing too quickly, the bank and others may ask for supporting collateral on the loan. Collateral from a small business is typically accounts receivables and inventory.
When lenders require a personal guarantee of a small business loan they also ask for a personal statement of assets. In some cases, the lender may only agree to the loan if it is backed up by specific collateral such as stock that is sufficiently greater than loan value.
Once the loan is repaid, the borrower should request the release of the personal guarantee and the return of any pledged collateral. There may be a public lien on accounts receivables and inventory that should be released. Dun & Bradstreet’s reports typically include the listing of any current liens that banks usually reference.
Approval Process: Applying for a loan can be a time-consuming process, if the necessary documentation is not readily available such as financial statements. After qualifying that the lender is appropriate for the type of loan being sought, the application should be submitted with the expectation that the lender will ask questions and may seek additional information.
The time for approval varies by lender, so this is an important question to ask each lender.
Review the Loan Terms: If the loan is approved, the terms and conditions should be carefully reviewed, including the interest rate, repayment schedule, fees and the definition of default and associated remedies. Having a good relationship with an accountant and/or an attorney is helpful to gain insight, particularly if this is the first time a loan is being taken.
Loan Acceptance: If satisfied with the terms, sign the loan agreement and fulfill any additional requirements set by the lender to obtain release of funds.
Use the Funds: The lender is making the loan based on their understanding as to how the funds will be used which provides them with some assurance that the loan was taken in good faith and will be repaid.
Repayment: Adhering to the loan’s terms and agreement, specifically regarding payments is critical. Timely payments can raise a small business’ creditworthiness for loans in the future of greater amounts.
If an application for a small business loan is denied, it is important that the small business owner know why. This is so the areas that negatively impacted the lender’s decision can be addressed.
Also, do not assume that denial of credit by one lender will occur with all other lenders. Doublecheck what you have heard, so you are confident about the feedback that was given and the next steps to be taken.
