Business Loan Basics Spelled Out: Loans 101
In many ways, business loans are very similar to any other sort of loan you might consider. You evaluate your needs, prepare your financial information, and shop for a lender willing to offer terms you consider acceptable. As with any other loan, the better your credit history, the better the terms you’re likely to be offered.
How Do Business Loans Work?
That doesn’t mean, however, that newer or smaller businesses can’t secure reasonable loans to meet their needs. Nor does bad credit in your past automatically disqualify you for all loans. Sometimes, the unique nature of a growing business actually makes it easier to find attractive interest rates or willing lenders. It all comes down to doing your research ahead of time and opening yourself to a variety of business loan options based on your particular business needs.
Let’s look at some business loan basics and talk about the realities of business loan shopping.
Are Business Loans A Good Idea?
Some of them are. Others might be a horrible idea – at least right now. Perhaps a better question would be,
“Is a business loan a good idea for me right now?”
Have you outgrown your current space? Do you consistently have more orders than you can fill in a reasonable time? Are there opportunities you should be seizing but which require capital up front beyond what you can immediately access? Be honest with yourself – the line between taking initiative and taking a bath can be a bit blurry in the heat of the moment. If your eyes are open, however, growth is often a very good reason for the right business loan.
Do you need new equipment? Is it time to update technology or add other hardware in order to maintain or increase productivity? It’s usually a bad idea to buy new toys just because they’re shiny and no one else has them yet, but if your business relies on machinery or computing power to succeed, it’s an even worse idea to let your workplace become obsolete.
Is your business seasonal? Can you say with great certainty that the rush is coming and you need to be prepared with the right items or ready to offer the right services when it does? There are plenty of lenders ready to work with you in these sorts of circumstances. It’s a great problem to have!
Do you need to establish credit? Even if you could probably “make do” with less for now, sometimes a few small loans you pay back in a timely manner lay the groundwork for larger loans down the road when you really need them. You shouldn’t borrow just to borrow, but when an opportunity arises to build your business and your credit at the same time, it’s certainly worth looking at your options.
If you decide to shop business loans now in order to build business credit, consider starting small. Explore your options through several business loan companies and choose the one which seems right for you. Then, if you’re happy with them (and if they’re happy with you because you make your payments in a timely manner like the awesome business owner you are), you have a relationship established for next time.
On the other hand, taking out loans to make ends meet month after month is not a sound business strategy. If anything, it usually delays the inevitable while making things worse. Chasing the “next big thing” or over-extending yourself or your business for a “sure thing” that your most trusted friends and colleagues warn you not to trust might be a once-in-a-lifetime stroke of entrepreneurial genius. It’s far more likely, however, that it’s simply what it appears to be – a really bad idea of the sort which are usually available if we look for them.
In short, if we’re talking business loan basics, you should start your business loan search if it will help your business prosper. You should generally not shop business loans as an act of desperation to keep the doors open. Hard truths from hard knocks, my friend.
What Kind of Business Loans Are There?
There are as many varieties of business loans as there are businesses, which is great news for you. Here are some business loan basics about some of the more common types you should recognize as you begin your business loan shopping:
These come in many varieties under several different names, but essentially these are the most straightforward sorts of loans the average person imagines when first confronting the realities of business financing. Once approved for a specific amount, usually specified for a specific business purpose, you receive the full amount from your choice of business loan companies. Payment amounts and dates are established in advance and interest calculated over the life of the loan.
Installment loans are easy to understand and expectations are clear for both parties. Usually there’s no penalty for early payment, so you can repay part or all of the loan early without penalty. Interest rates vary, but tend to be more favorable the shorter the payback period – and of course you save even more on interest if you’re able to pay ahead of schedule.
A line-of-credit loan is one of the most common and most useful for small business owners. It can be a short-term or long-term business loan (depending on if you keep paying it off and reusing it) that allows you to access additional funds as needed up to a predetermined limit. You only pay interest on the amount you use according to terms specified beforehand. (Usually this means monthly payments until paid in full.) At the end of the contract year, the line-of-credit is re-evaluated and – if all has gone well – usually renewed for another year.
Interest rates tend to be modest for these sorts of loans, as they’re relatively low-risk for lenders. If you’re just starting out, or looking to establish or rebuild credit for your business, a small line-of-credit loan might be a great place to start.
These are similar to line-of-credit loans, but are more easily compared to credit cards. Your business may access funds as needed up to a predetermined limit, but as you pay back borrowed funds, your available balance essentially “refills”. Interest rates tend to be a bit higher than with line-of-credit loans, but revolving credit provides greater flexibility over time.
This is a specific type of short-term business loan. Equipment loans are similar to installment loans or term loans. As the name suggests, however, they’re intended to be used primarily to purchase essential equipment for your business. If you’re still establishing your business credit, these can be a useful type of loan because the equipment you purchase is natural collateral.
I know I don’t need to say it, but entrepreneurs are risk-takers by nature and sometimes our temptations are different than other folk’s. If you take out an equipment loan, you should use it to buy the equipment. Let’s stick to business loan basics and use the money for its intended purpose, yes?
Commercial Real Estate Loans
These are the same basic thing as an equipment loan, only they’re not used for new equipment. You’ll never guess what they are used for. What’s that? You guessed? Hmph. Moving on…
One advantage to commercial real estate loans is that lenders are sometimes more willing to work with new businesses and may even offer better rates. You’re unlikely to sneak off with three acres and a giant metal building in the middle of the night, making this a better risk for business loan companies.
These are another form of short-term business loan. Typically, an interim loan is used to pay off suppliers or contractors and then repaid once funds become available as a result.
Other Loan Terminology
While they’re not necessarily distinct types of loans, here are some terms with which you should be familiar as you begin shopping for a business loan:
An SBA loan is any type of borrowing backed up by the Small Business Administration. They’re harder to qualify for than loans from direct lenders, but the terms and interest rates are generally good. Many consider starting with the SBA to be an essential (and obvious) part of business loan basics. You’ve got nothing to lose and you don’t want to have to explain why you didn’t try, right?
Picture a large cartoon thermometer laying horizontal instead of vertical. (Put the bubble-butt part to the right.) When you borrow money with a balloon loan, you pay mostly or only on the interest during the life of the loan. That’s the long thin part. Instead of temperature, the numbers are the amounts you’re paying according to whatever schedule you worked out with your lender. At the end of the loan, you pay back the principal in full – as in, one lump sum. That’s the bubble part.
These only make sense if your business expects substantial revenue at some specific point in the future. They offer great leeway in delaying that lump-sum payment at the end. On the other hand, you’re staking a great deal on the arrival of plenty of income before the “balloon payment” is due. Lenders may require some sort of verification as to what that surge of resources might look like before advancing credit for this one.
Secured vs. Unsecured Loans
If your business is relatively new or your credit less than stellar, lenders may require some form of collateral before advancing you a loan. That collateral “secures” the loan. If for some reason you’re unable to make your payments, the lender may at some point take control of your collateral in order to regain some or all of the balance. Here’s a business loan basics tip: make your payments so you don’t lose your collateral.
Once established with a specific lender, it’s much easier to qualify without collateral – an “unsecured” loan. Your reputation and history with the lender are the guarantee, not your house, car, or children.
There are numerous other varieties which your preferred lender will no doubt be happy to discuss with you.
How Do I Qualify For A Business Loan?
The details of qualifying for a business loan will vary widely from lender to lender, but there is one qualification almost every business owner who has successfully borrowed money has in common. They’ve asked to borrow money. (Hey, it’s called “Business Loan Basics” for a reason, kids.)
There are several factors which will determine how easy it will be to get a business loan and which may shape what type of loan you can get at what terms. But whatever your circumstances in relation to each of these factors, none disqualify you from asking. That said, here are the most common factors lenders will consider:
- Your personal credit history and credit score
- Your business’s debt-to-income ratio (income vs. “out-go”). This includes current business debt.
- How long you’ve been in business (2+ years is ideal)
- The type of business you’re in. (Lenders like industries they understand or which they’ve found to be reliably profitable in the past.)
- Collateral or other risk-minimizers
Remember: deciding in advance you don’t qualify and giving up before you’ve started is the only real way to be certain you won’t be getting that loan. Business Loan Basics: Loans 101 – Apply. For. The. Loan.
What Documents Are Required For A Business Loan
This one also varies with the type of lender and the type of loan. Generally speaking, traditional banks will require more documentation than online lenders, but both want to make sure there’s a reasonable chance you’ll be able to repay the loan as scheduled. In many ways, this part of business loan basics is the same as it would be for any sort of loan. Here are a few things you should have ready before you apply:
Name(s) and Address(es)
This one seems obvious, but if you or your business have had multiple addresses over the past decade, it’s a good idea to go ahead and organize those for ready reference. I’m often shocked (and a little embarrassed) at how quickly I forget past ZIP codes or even what year I lived where. Save yourself some stress and record this info somewhere now so that you can easily access it as needed.
You should also be prepared with identification for both yourself and your business. In the same way we’re often asked to present a driver’s license or other ID to confirm we’re who we think we are, lenders usually want to confirm that your business is documented as well. This can be done through your Articles of Incorporation, franchise agreements, or contracts with suppliers or others with whom you do business.
How long has your business been in operation? Unless you’re well-established and can document several profitable years, what’s your background and what are your qualifications? In short, why should the lender think you can make this work?
Your Personal Credit Report
Unless you’re a well-established business, this will be essential. Bad credit is not necessarily a deal-breaker, but avoid surprises. Check your credit report and know your credit score going in; don’t wait to be asked about it by a potential lender.
At the same time, don’t let bad credit in the past prevent you from moving forward in the present. Spend a little extra time on your business plan (we’ll look at that in a moment) and look at other ways you might present yourself in the best possible light, then go for it. And remember, there’s no need to fudge the truth here – you and your business acumen are good enough as you are. Your ideas are strong. You just need a little working capital to make it all happen. Be your best you, but still you.
Your Business Plan
You should have one of these anyway, but if not, don’t panic. This is the perfect time to create one. A good business plan isn’t just part of business loan basics, it’s part of business basics, period.
You’ll want to research this one a bit, but in general most lenders will be looking for
- The Executive Summary. This is your business plan in the most concise and clear terms. Who are you, where are you, what do you do, and how do you plan on making a reasonable profit by doing it?
- The Company Description. A more technical breakdown of your logistics and operations. How is your organization structured? What do you produce or provide? What can you document in terms of growth or profits, current or anticipated?
- Your Products and Services. This zooms in a bit more on what you actual make or do and why you think customers will pay you to make or do it.
- Organization and Management Team. Who’s responsible for what? What are their qualifications or experiences? What’s the leadership structure? (In other words, who answers to who?
- Market Research. Now that we know what you make or do, what makes you believe people will pay you to make or do it? Don’t count on anecdotes or your personal impressions; it’s time to bust out some actual charts, tables, and projections. These are even better if they’re based on something legit.
- Strategy and Implementation. How are you going to make it all happen? This includes location, marketing, pricing, hiring, etc. There aren’t always right or wrong answers, but you should sound like you’ve researched a bit and have a plan. Ideally, you actually do.
- Financial Projections. This should start with any existing financial statistics. What’s your forecast for the upcoming six months? Twelve months? Thirty-six months? On what are these projections based?
This is not the most fun or exciting part of owning your own business, but it’s one of the most important whether you business loan shop or not. Entrepreneurs are valuable because we reach and dream and risk; that makes it all the more important than we discipline ourselves to remain anchored in reason and reality. A detailed business plan is one critical way to do that.
Other Financial Paperwork for Your Business
Some lenders will also ask questions about or require copies of your personal and business tax returns for the previous three years. They may ask for documentation supporting your financial projections or going into more detail about the information in your business plan. They may even request your bank statements. The details vary from lender to lender, but it wouldn’t hurt to have this information available and organized ahead of time.
Have I mentioned that being prepared and organized ahead of time are absolute business loan basics? I have? OK, just checking. Because they are.
What Can A Business Loan Be Used For?
There are no set rules on how you use your loan, although some lenders may require you to share this information as part of their business loan application process. Some types of loans, as we covered above, are intended for specific purposes, and you shouldn’t be surprised if the lender requires some evidence they’ve been used appropriately.
Generally, though, business loans can be used for whatever your business requires.
- Expansion – Maybe you need more room or storage. That’s a good problem to have.
- Upgrades – It might be time for better equipment or new technology. You might even replace that dot matrix printer that requires that special paper with the tear-off strips down the side. *shudder*
- Inventory – You can’t sell what you don’t have, and you can’t use what you haven’t ordered. This is classic “you gotta spend money to make money” territory.
- Salaries or Bonuses – Human resources are often the largest expense of any business, especially when it’s growing. Be careful with this one, though. You should only borrow money to pay people if you have a clear plan forward. If you’re borrowing to meet payroll every few months, something is seriously wrong.
- Special Events – Congratulations on a great year! Great work, team! Drinks for everybody! Again, it’s up to you how you spend your borrowed funds, but only do this if you know the funds are coming soon and reliably. It’s only a great party if it doesn’t bankrupt the company, kids.
Small Business Loan Shopping
Now that you know your business loan basics and have an idea of what sorts of loans are out there, let’s talk about taking action, shall we?
How Can I Get A First-Time Business Loan?
Start by revisiting the requirements above. No matter where you’re seeking your startup business loan, you should begin the process by gathering and organizing your information. Update your business plan and revisit your plans for using a new loan effectively. Take a moment and talk yourself through anything which might come up. There’s simply no substitute for being prepared.
It might not hurt to remind yourself of why you’re doing this in the first place. You’re an entrepreneur. You offer products and services no one else does, or at least offer them differently or better. Confidence matters. It’s nice when it overflows without effort, but sometimes we have to choose it and embrace it for a while until the flow kicks in again. Don’t get cocky, of course – but believe in what you’re doing.
Otherwise, why should anyone else?
Where To Business Loan Shop
It never hurts to start with traditional sources – local banks, credit unions, etc. In the 21st century, however, more and more people are working with online lenders. The best approach is to explore your options. Visit some brick-and-mortar financial institutions in your area, then spend some time looking into online alternatives.
As you may have suspected by now, we can help you with that part. Loanry simply gathers some guiding business loan finder information from you, then connects you with lenders who work with you to discuss business loan options.
Please understand that we’re not selling anything. There’s no surprise on Step 17 asking for your credit card and no ‘free trial period’ that suddenly turns expensive once you’ve forgotten all about it in a few months. In short, we’re not asking for anything from you on this one. We connect potential customers with experienced lenders – the rest is between you and them.
Obviously we want for you end up happy and tell everyone about it. Not to brag, but we’re pretty good at this sort of thing, so that happens a lot. We’re all about business loan basics, auto loan basics, medical loan basics, and a variety of other services as well. Because in the end, it’s not just about the money. It’s not even just about the business. It’s about helping people get from where they are to where they believe they can be.
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Blaine Koehn is a former small business manager, long-time educator, and seasoned consultant. He’s worked in both the public and private sectors while riding the ups-and-downs of self-employment and independent contracting for nearly two decades. His self-published resources have been utilized by thousands of educators as he’s shared his experiences and ideas in workshops across the Midwest. Blaine writes about money management and decision-making for those new to the world of finance or anyone simply sorting through their fiscal options in complicated times.