Getting a business loan can be a key step in starting or expanding your company. With proper planning and execution, business loans provide capital to launch a new venture, invest in equipment and inventory, or bridge cash flow gaps. However, business loans also come with risks and responsibilities. Utilizing smart strategies when securing and managing business loans is essential for success.
How to Secure Favorable Business Loan Terms
The first step in utilizing business loans strategically is negotiating the best possible loan terms. The following tips can help position you to get approved for a loan with favorable rates and repayment plans:
Maintain a Strong Credit Score
Lenders will carefully evaluate your business and personal credit scores when considering a loan application. Aim for scores above 720, avoid late payments on existing debts, and correct any errors on your credit reports. Higher scores signal creditworthiness and allow you to qualify for lower interest rates.
Prepare a Convincing Business Plan
Document your business concept, objectives, financial projections, and growth strategies in a comprehensive business plan. This shows lenders you have conducted thorough market research and financial analysis. Your business plan should realistically demonstrate how you will repay the loan.
Provide Collateral
Putting up business or personal assets as collateral significantly improves your chances of loan approval and secures lower interest rates. Real estate, equipment, accounts receivable, and investments are potential sources of collateral.
Choose the Right Lender
Research lenders and develop relationships with ones who finance your industry. Submit applications to lenders likely to approve your business profile and loan purpose. Credit unions and community banks are often amenable to small business loans.
Only Borrow What You Need
Limit your borrowing to the essential amount required for sound business purposes. Don’t take on unnecessary debt. Keep loan amounts conservative in relation to your projected cash flow and repayment capabilities.
Prepare Documentation
Lenders will request business and personal financial statements, bank statements, tax returns, profit and loss statements, projected cash flow forecasts, and other documents. Gather everything they will need to conduct due diligence well in advance.
How to Manage Business Loans Responsibly
Once you’ve secured financing, ongoing loan management is imperative for meeting your repayment obligations and maintaining a healthy business.Implement these best practices:
Record Keeping
Maintain meticulous records of all loan activities including drawdowns, interest charges, principal repayments, and loan balances. This documentation is critical for monitoring your overall debt obligation.
Financial Controls
Set up accounting systems to properly allocate loan proceeds and track expenditures. Implement internal controls to prevent misuse or waste of borrowed capital. Use the funds only for approved purposes.
Conservatively Forecast Cash Flow
Build padding into cash flow projections used for determining loan payments. Do not assume overly optimistic sales, margins, or other figures that will be difficult to achieve. Model for contingencies and shortfalls.
Pay on Time Every Time
Set automated reminders for loan payments so you never miss deadlines. Even minor delinquencies can provoke lenders and damage your credit. Defaulting has severe consequences.
Communication with Lenders
Keep loan officers updated on material changes in your business. Proactively inform them of any developments that could affect repayment ability. Ask about loan modifications if significant issues occur.
Refinancing Options
Consider refinancing with better terms if your business and credit improve. Refinancing can lower monthly payments, shorten loan duration, or provide needed capital via a larger overall amount.
Secondary Capital Sources
Secure access to other capital, such as business lines of credit or equity financing, that provides a buffer when facing loan repayment pressure. Investors and alternative lenders can supply emergency funding.
Reward Yourself
Allocate a portion of the increased profits generated with loan capital toward personal compensation. Set milestones for distributions to motivate yourself and fuel future success.
Common Types of Business Loans
Many loan products are available to fund different business needs. Being aware of the major types of business loans can help you identify the most fitting options:
Term Loans
These simple, fixed-payment loans provide a lump sum upfront and are paid back in monthly installments over 1-25 years. Term loans allow flexibility in the use of funds but often require collateral.
- Given as a lump sum upfront, to be repaid over a set duration (usually 1-5 years) in fixed monthly payments.
- Typically require collateral and personal guarantees.
- Use of funds is flexible – working capital, equipment, etc.
- Interest rates are usually fixed.
Lines of Credit
LOCs function like credit cards, allowing businesses to draw funds as needed up to a set limit. Interest accrues on outstanding balances. LOCs don’t require collateral but limit uses of capital.
- Functions like a credit card, with ability to access up to a set limit.
- Only pay interest on outstanding balance.
- Flexible alternative to term loans for working capital needs.
- Limits uses for funds and requires consistent repayment.
Equipment Financing
Loans specifically for purchasing equipment. Equipment serves as collateral and payments coincide with economic life of the equipment, usually 5-10 years.
- Used specifically to purchase equipment like machinery, vehicles, IT systems.
- The equipment itself serves as collateral.
- Payments are structured to match the useful life of the equipment.
- Typically 5-10 year payment terms with option to buy equipment.
Accounts Receivable Financing
Capital leveraging a company’s accounts receivables, with outstanding invoices serving as collateral. As you collect receivables, the loan is paid down.
- Capital leveraging a company’s accounts receivables as collateral.
- As you collect outstanding invoices, the loan balance is paid down.
- Provides immediate access to capital locked up in receivables.
- Interest rates tied to speed of collection on receivables.
Merchant Cash Advances
A lump sum is provided in exchange for an agreed upon percentage of future credit card sales until the advance is refunded. No collateral required but high rates.
- Provides a lump sum in exchange for a percentage of future credit card sales.
- Daily/weekly portions of credit card sales are forwarded to the lender until advance is refunded.
- No collateral required but very high effective interest rates.
- Quick access to funds with minimal approval requirements.
SBA Loans
Loans backed by the Small Business Administration to facilitate access to capital based on business needs rather than creditworthiness. Require lots of paperwork.
- Backed by the Small Business Administration to provide access to capital.
- Do not require collateral for loans under $25,000.
- Offer lower down payments and longer repayment terms.
- Require extensive paperwork and up to 3 months for approval.
Alternative Loans
Newer loan options from online lenders and investors provide fast financing by using technology and big data analytics to evaluate risk. Higher costs than banks.
Key Factors in Assessing Loan Options
With many loan products to select from, focus on these key factors when deciding which type works best for your situation:
- Interest rates and fees – Lower costs save money over the life of the loan. Compare APR across lenders.
- Loan amount – Make sure the amount fits your current needs plus reasonable future growth. Don’t take too much.
- Payment schedule – Match payments to projected cash flow. Interest-only periods help early stage companies.
- Length to maturity – Longer terms reduce payments but increase total interest paid.
- Collateral required – Pledging assets gets better rates and shows commitment.
- Time to funding – Some loans fund rapidly while others have extensive approval processes.
- Permissible uses – Many loans restrict use of proceeds for specified purposes only.
By taking a strategic approach to securing and managing loans, you can unlock growth capital while minimizing risk. With proper diligence and discipline, business loans provide fuel for ascending to new heights of entrepreneurial success.
FAQs
What documents are required to apply for a business loan?
Typical documents include personal and business tax returns, bank statements, profit and loss statements, business plans, personal financial statements, and a list of business assets that could serve as collateral. The specific requirements depend on the lender.
How long does it take to get approved for a business loan?
Approval times vary by lender and loan type. Smaller banks may approve loans in 1-2 weeks while large banks take 4-6 weeks. SBA loan approvals may take 2-3 months due to extensive paperwork.
What credit score is recommended to qualify for a business loan?
Most lenders look for credit scores above 680 and prefer scores over 720. Having excellent personal credit increases the chances of business loan approval.
Can I get a business loan without collateral?
While possible, lacking collateral will limit your options to products like merchant cash advances that charge higher fees and rates. Putting up assets improves terms.
What is the most important factor lenders look at?
Lenders focus on your ability to repay the loan as evidenced by cash flow, profitability, projections, credit, and history in business. Your business plan and financials are critical.
Are there fees and costs associated with getting a business loan?
Yes, common fees include origination/application fees, legal fees, and commitment fees. Interest expenses will accrue over the duration of the loan. Shop around for lower costs.
How do I choose the right type of business loan?
Consider factors like use of funds, collateral available, cash flow, credit profile, time to funding, loan amount, and repayment term. Match loans to your situation.
Should I take the maximum loan amount offered?
No, only take the amount currently needed for sound business purposes. Too much debt is risky. Build in cushion to projections used to qualify.
What happens if I miss a loan payment?
Delinquencies damage your credit, lead to late fees, and could trigger penalties or default if ongoing. Communicate with lenders before missing payments.
Can I apply for multiple business loans at once?
Yes, you can apply to several lenders to find the best terms, but avoid too many hard inquiries on your credit report within a short span.
