Guide to First Time Business Loans: What You Need to Know as a Borrower
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You don’t have to start a business to go through the process of trying to get a bank loan. If you’ve ever bought a house or car, you know the drill. The burden is on you to prove yourself creditworthy, usually through credit checks and salary verification. A lender wants to know that you can reasonably afford to repay the loan before handing money over to you.
A similar process applies if you request a loan for your small business. You’ll need to demonstrate that you not only have the revenue to pay back the loan, but that you have the credit required to borrow money. Neither of those is easy for a new business trying to establish itself. However, with all the obstacles startups face, there are still things you can do to up your chances of qualifying. Here’s what you need to know about first time business loans.
Getting a business loan isn’t always easy
Before you start looking for a loan, put yourself in the position of the lender. You’re walking in, assuring them you have a viable business idea, and asking them to trust you to repay what you borrow. Even if you’re sure you’ll be able to pay the loan back, the bank has no reason to have that same confidence. For that reason, you need to learn as much as possible about the process before you start looking for a first time business loan.
One of the top challenges new businesses face comes from their lack of history. According to an insuranceQuotes.com study, 20 percent of new businesses fail in their first year, and 50 percent don’t make it past five years. Only 30 percent of new businesses are left standing a decade after starting out. Lenders are generally well aware of statistics like this; they’ve seen these dynamics in action.
Another ongoing challenge for new businesses is the need to demonstrate a strong credit score. With no history in business, new entrepreneurs may find it difficult to achieve a strong rating. This means the lender will likely check your personal credit, using that score to try to get a sense of what they can approve. Try to strengthen your personal credit before asking for a business loan. You’ll need either good, very good or exceptional credit, which is in the 670-850 range. With some scoring models, you’ll need a score at least in the 700s.
Lenders often find that small business owners rush through the application process, missing essential information or walking in without sufficient preparation. In a rush to get financing, entrepreneurs also make the mistake of asking for small business loans without the appropriate supporting documentation, such as business plans and financials. Timing is important as well, and many business owners don’t check market conditions before approaching a lender.
How to qualify for first time business loans
The good news is that you can do things to boost your chances of getting a first time business loan. A little careful preparation can help you avoid a “no” that sends you back to the drawing board.
Develop a business plan
It may sound intimidating, but there are tools available that can help you create a professional-quality business plan. The more information that paints your business in a positive light, the more likely you are to have positive results. The U.S. Small Business Administration has a Business Plan Builder that walks you through creating a top-quality document, but you’ll also need to populate it with information that shows you’re prepared to succeed.
Establish business credit
This one can be tricky. You need credit to get credit, but you have to start somewhere. A business bank account can be a great foundation, especially since that same bank may be more willing to loan you money once you’re ready. Taking out a business credit card and paying it off every month can also help. One good idea is to establish credit relationships with vendors such as major office supply stores. Another is to put utilities and other bills that pertain to your business in your business’s name instead of yours as an individual.
Know the costs you want to cover
Among the top questions a lender will ask is, “How will you spend the money?” Make sure you can describe where the money will go, preferably in detail. Will it help you purchase a piece of equipment? Provide operating expenses? Launch a marketing campaign? What effect will this likely have on your business? If you are able, provide the numbers to show the revenue you anticipate this investment will generate.
Have the proper paperwork for the lender
In addition to a business plan, you should also show up for your meeting equipped with all the documents a lender might request. These include your business license, contact information for all owners and affiliates, loan application history and resumes for each principal. You’ll also need to supply a business plan and financial documents, including a balance sheet, income statement, cash flow accounting, bank statements and tax returns.
If you have collateral you plan to use to secure the loan, bring proof. This would include any document that shows the cost or value of any personal or business property that will serve as collateral.
Determine if you have collateral
If you ask for a personal loan, you’ll generally be asked to provide collateral. If it’s a mortgage or auto loan, the house and car are the collateral. For a new business with little worth, personal collateral may come into play. If you aren’t prepared to risk your personal assets, some lenders will accept a general lien on your business, combined with a personal guarantee that you’ll repay.
The types of first time business loans available
Things get a little more complicated once you learn that there are multiple loan types available to new businesses. Here are some of the most popular options for first time business loans:
- Term loans — These loans are the traditional type; the lender issues cash that you repay with interest over a set period. These are best for discrete one-time business needs.
- Lines of credit — Instead of handing you money to spend, your bank will issue an account with funds that you draw upon as needed. These are good for funding ongoing operational needs.
- Equipment loans — These loans are specifically meant for purchasing equipment. For new businesses that haven’t yet been able to build up solid credit, these can be beneficial because the equipment can serve as collateral for the loan.
- SBA loans — If you’re credit-challenged and unable to get loans from traditional lenders, turn to the U.S. Small Business Administration (SBA), which works with lenders to guarantee loans to qualifying small businesses.
- Invoice factoring — Small businesses frequently have unpaid invoices on the books, and some alternative lenders will issue funds as an advance on those outstanding invoices. This type of lending often comes with high rates and fees.
- Business credit cards — There are plenty of credit card options for small businesses, which provide easy-to-secure alternatives to loans. However, interest rates on credit cards can be extremely high, so this is not the best option for major or long-term borrowing.
The bottom line
For a new business, establishing a strong credit rating and maintaining it is a top priority. But there are alternatives for startups that are still working on it. Prepare for a meeting with a prospective lender in advance by gathering documentation and understanding your own company’s goals. With a little bit of organization and effort, you’ll soon be on your way to securing your first business loan.