Acquiring financing to grow your small business can be a challenge, but is achievable if you plan ahead.
Why Do You Need a Loan?
Before you get started with loan applications you must have a solid understanding and justification for why you need a loan for your business. You cannot waltz into the bank and simply ask for more money because you feel you need it. Take a hard look at your business’ financial situation and be prepared to defend your reasoning on why you need a loan. A bank will be hesitant to throw good money after bad, so if your business is losing money hand over fist they probably won’t be willing to lend to you.
Types of Small Business Loans
Business loans are used for specific reasons: buying equipment or renting space to operate, financing growth of an already proven business, or providing capital to expand.
If your business needs a sum of money to buy equipment or real estate up front, you need a term loan. This is a loan set to terms, meaning there is a set interest rate, down payment or collateral, monthly payments, and a term of months or years that consistent payments will be made through.
Businesses in the startup phase must provide a lot of documentation, business planning, and personal collateral for a bank to be willing to risk lending the funds to your new business. Operations in the growth and expansion stage typically see better results because they have consistent profits or rising sales to prove they have a good chance of repaying the loan.
Lines of Credit
A different type of lending is done through a line of credit. Just like you can tap the equity in your home to finance a purchase, a bank can lend against the value of something in your business as collateral to help finance your operations. Lines of credit are usually more fluid since you may not need to use the maximum of what you are allowed to borrow.
Accounts receivable factoring is an interesting type of lending where the factoring company buys your accounts receivable amounts and proceeds to collect on them in the future under the normal terms. You could sell your accounts receivable for 97% of their value, and the factoring company earns the 3% as they are paid by the customers that owe you money.
Factoring is a different way of going about getting access to capital, but it can be quite costly with your AR being worth anywhere from 95% to 98% of its value in a month. When you add up the discount the factoring company gets over a year, the “interest” you are paying is quite high.
Small Business Administration Loans
The Small Business Administration was created to help foster the creation and growth of small businesses in the United States. If you are unable to qualify for loans through traditional banking means, the SBA may be able to help you through one of their three loan programs.
The three programs are the 7(a) loan program, the Microloan program, and the CDC/504 loan program. A 7(a) loan program has very specific requirements and is designed to help only in certain instances such as a business in a rural area or to streamline the loan process for active duty or veteran service members. The Microloan program provides very small loans to help buy equipment or inventory; funds cannot be used to purchase real estate. The 504 program is a much longer term loan designed to help businesses acquire significant assets for growth or expansion.
The SBA does not lend directly to small businesses. Instead, the government provides its bank lending partners a guarantee that the loan will be paid even if the business fails. This is to help foster some entrepreneurial risk to get businesses started up in communities across the country.