When you’re starting a business, funding is essential. One way to fund a business is with a loan. There are similarities and differences between getting a new business loan and getting regular consumer financing for something like buying a house, as an example.
The following are key things to know about business loans, how they work and what you should be aware of going into the application process.
The Basics of How Business Loans Work
A business loan can be used not just to start a new business but also to expand an existing one or get working capital.
Lenders will require that you repay a loan with interest, and you may have to use your personal credit score and history to qualify. This is especially true if you don’t have a business credit history.
Most business loans are installment loans, so you get the full amount of the loan upfront. Then, your payments are in equal installments, and you have a set repayment term.
Revolving loans can include a line of credit or a business credit card. You can access the credit when you need it and pay it back as you use it.
Check Your Personal Credit
If you’re applying for a business loan for a startup, then you don’t have a business credit history. This means approval for a loan is going to depend largely on your personal credit history.
Before you start applying, check your credit. Make sure there aren’t mistakes or things you need to do to improve it.
A lender is likely going to want to see your tax returns and personal bank statements, so get your financial information in order and go over it carefully so that you aren’t blindsided by a response from a lender.
Other information you need aside from your personal income tax returns and your personal bank statements will include any licenses and leases you have, articles of incorporation, a resume that shows your relevant experience, and financial projections if you don’t have an operating history.
You May Have to Put Down Collateral
A business loan is often secured with collateral. That is an asset that can be seized if you default on your loan. Collateral is used by lenders to reduce their risk.
The amount of collateral will depend on your credit, why you’re getting a loan, and the lender.
You have to be confident you won’t default on a loan when you’re using collateral.
Business loan collateral might be equipment or real estate. You may also have to sign a personal guarantee, which then means that your personal assets are on the line if you default on your business loan.
Some lenders may not require collateral but will make you sign a personal guarantee.
You Need a Compelling Business Plan
A lender is going to want to see what your plans for using a loan are. This means that a lot of whether or not you get a business loan will depend on your business plan.
Your business plan should be something you spend time on.
Include details of your management team, industry analysis, projected financials, and current if you have then, your marketing strategy and SWOT analysis. SWOT stands for strengths, weaknesses, opportunities, and threats.
Your business plan needs to highlight that you will have the adequate cash flow to cover not just your loan payments but your business expenses. You want to instill confidence in a lender with your business plan.
Research Requirements and Qualifications
Before you apply for specific business loans, you should know what the lender’s requirements and qualifications are.
These vary depending on the lender and also the type of loan.
For example, if you’re applying for a loan backed by the Small Business Administration, you’ll have to meet certain qualifications set by the FDA as the lender’s requirements.
What If You’re Turned Down for a Business Loan?
Finally, often startups are turned down for business loans because they just may not have enough of a credit history for a lender to approve their application.
If you find yourself in this situation, there are options available.
For example, if traditional brick-and-mortar institutions turned you down, you might want to apply with an online bank. Online banks may have less stringent requirements.
You can also explore different types of financing, or you could find out why you were denied and work on improving in that area. Then, you can reapply again in a few months, which is often what people do when they’re denied an SBA-backed loan in particular.