Small businesses face a lot of challenges. Most often if you have a small business, you might be the only employee. Even if you have a small staff, all the business decisions and stress are left for you. I have my own small business and I know all the stress you feel. Sometimes it is because of good circumstances, such as you have so much business that you cannot keep up with it. Sometimes, there is a downside, especially if you have a seasonal business.
It can be difficult to ride out the off season, especially in your early years. There are many times when a business needs to consider a small business loan. The thought of borrowing money that you have to pay back may seem frightening. It does not have to be, though. Borrowing money can give you the cash flow to put you in a better position. Continue reading to find out more about small business loan shopping and how to qualify for a small business loan.
What Is A Small Business Loan?
It may not surprise you that in many ways a small business loan is similar to a personal loan. I always like to break terms down into the simplest definition possible. I think it is important to make sure you understand all aspects of small business loans. You need all the information to make the best decisions for you and your business. You cannot do that if you do not understand the terms.
A small business loan is when you as a business owner requests to borrow money from a lender. The type of lender of small business loans can vary from a traditional bank, credit union, online lender, or a lender that is not a financial institution. If your business has multiple owners, then you are all requesting to borrow money for your business. You are agreeing to repay the loan by making regular payments of a set amount. The lender charges interest as a fee for allowing you to borrow money. These terms vary from lender to lender and based on your qualifications.
You agree to these terms when you sign the loan agreement. The lender sets the interest rate and the length of the loan repayment period. The lender also sets how often you repay the loan, such as bi-weekly or monthly. These terms drive how much you pay with each payment. As long as you have a fixed interest rate, the amount you repay remains the same and does not fluctuate.
Five Easy Steps To Qualify For A Small Business Loan?
There are five steps you should take to qualify for a small business loan. They are fairly easy steps, but it is incredibly important that you are sure to follow all the steps. Missing one of them, or having incomplete information, may cause a lender to deny your loan.
1. The Why
The first step is you need to think about why you want a loan. You have to determine if a loan for your business is a good idea. There are some instances when a loan is a good idea for your business. However, there are many instances when it is a terrible idea for your business to take out a loan. Later in this article, I talk about the benefits and negatives to a business loan.
2. How Much Money You Need
If you determine that a loan is right for your business, you need to understand how much money you need. It is important to make sure you obtain the right amount for a loan. If you ask for too little, you may not be able to pay all the bills. If you ask for too much, you may not be able to repay the loan timely.
3. Create a Business Plan
This is a key step to your business. And since it is so important, we dedicated an entire section to this topic. So keep scrolling.
4. Gather Your Financial Information
Lenders require documentation and it is important that you gather this information before you apply for the loan. You must provide both the personal and business tax return for the past three years. And you must provide balance sheets including cash flow, along with profit and loss statements. You should also have the financial statements for your business and all projected finances. Of course, the last thing you need to do goes without saying, and that is fill out an application.
5. Know Your Credit Score
You should know your credit score. Pull your credit report and take a look at its contents. This is what a lender see when determining if you qualify for a loan. If you know what is on your credit report, you can correct any errors it contains. You also know your credit score and have a good idea of what type of loan for which you qualify. This also helps you shop business loans to find the perfect lender for you.
What Is Considered A Small Business?
Before you can determine if you qualify for a small business loan, you must understand what counts as a small business. I should tell you that the government defines small businesses in a document that is close to 50 pages. Do not worry, I am not going to reproduce all those pages here. I am going to give you the condensed version. It is typically the number of employees and the type of business that defines whether or not you have a small business.
A Sole Proprietor
Instead of focusing on the type of business you have, I want to focus on the organization of small businesses. One of the common categories of small businesses is a sole proprietorship. It is easy to create and has a fairly simple structure. The easiest definition is when you are doing work in which you receive a payment, but you are not an employee of another person, or business, then you are a sole proprietor. Consultants, freelance writers and entertainers are a great example of this type of business. You get to make all the business decisions for yourself. That also means that all the profits and losses are yours, too. There is not much paperwork for you to fill out, except an additional form or two when you file your income taxes.
A partnership has two or more owners of the business. This is similar to a sole proprietorship, except more people are making decisions. That certainly can complicate the daily operation of your business. With a partnership, you can distribute the liability in varying ways. You can have a limited partnership where one of the partners has more liability for the negative aspects of the business. Those partners with limited liability also have limited control. You can create a limited liability partnership where all partners have limited liability. This protects all partners from taking on the debts of the company. When there are multiple people making decisions, it is smart to protect yourself.
More About Small Businesses
There are few more businesses that can qualify for a small business loan. One of those types of businesses is a limited liability company (LLC). This type of business organization protects the owners from the liability of the business, but allows the owners to enjoy the benefits of being taxed as a sole proprietor. This means if your business begins to tank and losses money, lender cannot touch your personal items. The organization is a separate entity for you personally.
Corporations are a business that is completely separate from the owners of the business. Each individuals of the business are not held liable for any of the actions the business takes, including loss and liability. This type of business requires a lot of paperwork, more than just a few extra income forms. There are some additional tax requirements associated with a corporation. The corporation pays taxes on profits and on the dividends that the shareholders receive. Each shareholder must report all profits from the business on their own tax returns. Corporations are able earn money by selling stock.
Another type of corporation is a S Corp. S Corps avoid paying taxes twice on their own profits and again on the shareholder dividends. This type of business does not pay taxes on the business profits. Shareholders pay taxes on the profits on their personal tax returns. Those in a S Corp benefit from limited liability similar to a LLC. S Corps have a limitation on the investors and stockholders they can have. They cannot have more than 100 shareholders with one stock.
Do I Need Collateral To Get A Small Business Loan?
You probably are not going to like this answer, but you might need collateral to get a small business loan. It really depends on your credit score, the loan’s purpose, and if you have a relationship with the lender. If those things are in shaky standing, you may need to provide collateral. Any collateral you use must be valuable to the lender. Just because something may be valuable to you does not mean a lender appreciates it. Please keep in mind, if you put something up as collateral and you do not pay the loan, the lender will take that item. It does not matter if it is your personal house, the lender will take it. This may allow you to get a lower interest rate, but it may not a chance you are willing to take.
Lenders do not want to take your item. They would much rather that you pay your loan on time. For the lender to get money from the collateral item, the lender must sell it. That takes time and effort and possibly a little money. It is easier for both you and the lender when you repay your loan.
Will I Have A High Interest Rate?
When it comes to interest rates for a small business loan, your credit score matter. Not only does your business credit score matter, but so does your personal one. Do not feel distress if you do not have the best credit. Times have changed and in the past less than perfect credit meant that you could not get any type of loan. Today, you can get loans with bad credit, but you may have to do some research first. You can even get small business cash loans when you do not have the best credit, but most likely you will have a higher interest rate.
Lenders have some freedom and flexibility when deciding what interest rate to give you when you apply for a loan. You should shop around and do some research on the possible lenders and what type of interest rate they can offer you. You should look at online lenders. Do not dismiss them. There are many reputable online lenders and you may be able to find a deal that works best for you.
Pay attention to all the details of the loans that are available to you. Look at the length of the loan, the amount you can borrow and how often you must make payments when it comes to loans. All of these items should factor into your decision. If a lender is not offering you the best interest rate, but their other terms are much better, you may want to go with that lender. After you have built some trust and credit with the lender, you may be able to renegotiate your loan for a better interest rate.
Do I Need A Business Plan?
Yes, if you have a small business, you need a business plan. Even if you have no need for a small business loan, a business plan is the most important thing you can do for your business. A business plan is the roadmap for your business. How can you achieve results, if you do not know what they are? In short, a business plan is an outline of the goals for your business. It is a detailed description of how you plan to achieve those goals. It does not have to be long but you should have a formal document. You must have a written plan. It is great if you have all of these ideas in your head, but getting them on paper makes them real.
Once you have them written, you can share them with potential lenders and investors. You can print them and hang the where you can see them. They can be a reminder of your goals, especially during a time when you forget them. Your business plan can be a living document, which means it can change. As your business grows, you may expand or change your goals and your business plan changes. You may achieve results faster than expected which changes your timeline. You may hit snags along that you for which you did not plan. This may also change your plan.
You should make sure that your business plan includes an executive summary, an overview of your company, and your marketing plan. And you should include a detailed description of the financial plan of your company. You should provide a listing of the milestones for your company. Be sure to include information about your company and the services or products it provides. You might also want to include a short bio of anyone in management of the company and information of their role within the company.
Positives To A Small Business Loan
There are many reasons why you might want to consider a small business loan. Typically one of the most common reasons why your business may need a loan is because you need to expand. This expansion could mean that you need a large space because you have outgrown your current space. Perhaps you have more work than you have people and you need to do some hiring. You could have many orders you need to fill and you have to purchase more supplies. It is also possible that you need some new equipment or computers to make your business more lucrative.
These are all great reasons why you might need a loan. If borrowing money is going to put you in a better position to generate more revenue, then it may be a great idea. Even if you have the cash to pay for these items, you still might want to consider a loan. This helps you save your cash reserves and not dig into them. This can also help you build positive credit. All of these are positive reasons why you should consider a loan. Anything that can help you and your business grow and helps you find positive momentum should be great for your business.
Negatives To A Small Business Loan
There may be just as many reasons why you should not consider a small business loan. One of the major considerations when thinking about a small business loan is can you afford to repay the loan. Are you currently falling behind on your bills, or close to falling behind on your bills? If so, you may not want to consider a loan. Taking on a small business loan may not be the best idea for your business. You should also take a good look at why you want the loan and how it fits into your business plan. Have the circumstances around your business changed requiring you to take a hard look at your existing business plan? If your business requires a loan for reasons other than fast growth, you may want to think about the direction in which you want your business to go.
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Do Small Business Loans Have Fees?
Yes, most small business loan lenders charge fees. The fee schedule and reasons for the fees may change from lender to lender. You should read the entire loan agreement, even the fine print, before you agree to and sign anything. A lender is required by law to disclose to you all the fees they charge. Most lenders charge late payment fees. I am sure you do not plan to make late payments. Sometimes, things happen that may cause you to make a payment late. You should be aware of those charges in the event that something happens. Some lenders may not charge a direct fee, but instead charge you additional interest.
You should ask the lender when they consider the loan is in default. When you default on a loan, it means that you have not paid the loan. Some lenders consider one missed payment to put your loan in default. Other lenders do not consider you to be in default until you go several months without paying your loan. You should find out upfront what you lender considers default. You should also find out what the lender does when they consider you in default. Some lenders charge an early termination fee. This occurs when you pay the loan in full early. Some lenders do not like when you pay the loan early because it may take money away from them. You should confirm this before you sign any documents.
How Does My Credit Impact A Small Business Loan?
You credit score makes a difference on any loan, including a small business loan. It is important that you have a clear understanding of you credit score before you apply for a loan. This can help you determine which lender is the best one for you. You should pull your credit report to see what it contains. If you have a low credit score, many lenders will give you a high interest amount. Lenders tend to see you as a high risk when you have less than stellar credit. Your credit history shows the lender a picture of you as it relates to credit worthiness. The lender can see if you have a late or missing payment history.
A typical credit score is anywhere from 350 to 850. Most people have a credit score between 600 to 750. Good credit falls between 670 to 800. Anything below 570 is the danger zone of bad credit. When you have bad credit, it is much harder to get a good interest rate. You may find it is difficult to be approved for a loan, if you have bad credit. It is still possible to get a loan, but you have to work harder and do more research.
Is There Anything Else I Should Know About Small Business Loans?
There may be a few more things you should know about a small business loan before you take the plunge. There are few terms of which you should be aware before you sign the loan documents. The full amount of the loan you borrow is called the principal. The lender adds interest on to the principal of the loan to calculate the full amount of the loan you must repay. The length of time between when the lender gives you the money and when the loan principal and interest must repaid by the borrower to the lender is called the loan term.
The APR is the annual interest rate that is given to you as a percentage. You will commonly hear interest referred to as an APR. A small business loan also has a factor fee. This is a different way of stating interest that is charged on a percentage of the amount you borrow. You may also hear of it referred to as a factor rate. This is most common with short term business loans.
I have given you a lot of information about a small business loan. There are many things for you to consider when thinking about a small business loan. The most important of which is why do you need the loan and how do you plan to use it. This can help you determine if you really should take out a loan. You want to make sure that any type of loan you obtain for a lender is going to benefit your business.
Just like a personal loan, you do not want to take on a loan that you cannot afford to repay. You can put your business in a sticky situation if you cannot afford to repay the loan. You do not want to overextend your business and take on more debt than you can afford to repay. There are many good reasons why you might want to consider a loan for your business. You just need to make sure that you are making the right decisions for your business and its needs.
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Julia Peoples is a long-time business manager focused on providing decision making assistance to the public. She works with people at key points of their lives who are making important retirement and financial decisions. She has had many articles published that educate the public on sound financial decision making.
Julia writes for those who are working towards financial freedom or a better understanding of how finances work. She has shared her financial insights with individuals on a one on one basis for years.