If you are hoping to start a small business, or need some extra help funding your existing one, you are probably going to need a loan. Unfortunately, the process of acquiring a small business loan can be an arduous and complicated one. The 2008 recession frightened many lenders, and most have not quite regained their confidence yet. Should you seek to obtain a loan in the near future, here are a few best practices it may be wise to follow.
Determine what kind of loan you need
There is no one-size-fits-all approach when it comes to loans. There are several types that come from multiple sources. Before you begin sending in applications, determine what variety of loan suits your business best. Business News Daily lists many of them. Here are a few we’d like to highlight:
Small Business Association Loans: The SBA offers four kinds of loans, which are the 7(a) Loan Program (the organization’s primary program, which is flexible and can be applied to an assortment of purposes), the Microloan program (gifts small amounts for purchasing capital but not for paying back existing debts), real estate and equipment loans (long-term financing for major assets), and disaster loans (for after events like hurricanes or fires cause damage).
Alternative Lenders and Conventional Banks: Sources other than the SBA can offer similar options or others with different terms. These include working capital loans (short-term solutions), equipment loans, merchant cash advances, lines of credit (a take-what-you-need system where you only pay interest on what you use), franchise startup loans (for getting off the ground), and professional practice loans (specifically for professional service providers, like architects and physicians).
We at Currency are an alternative lending source. We host a platform of various lenders, so when you apply for a loan, we evaluate your creditworthiness and match you with a lender with rates and terms best suited for your needs.
Applying for a loan
Once you have chosen the kind of loan you are going to apply for, determine how much money you need. It’s tempting to borrow a high amount and convince yourself that you’ll pay it back without any problem, but this is a thinking trap you do not want to fall into. US News notes that the formula you should use is net operating income divided by your total annual debt, which calculates your Debt Service Coverage Ratio. US News elaborates:
“Lenders are looking for small businesses that have a 1.0 ratio. This means your cash flow is equal to your monthly loan payment. However, it’s ideal to have a bit of a buffer, so lenders prefer a 1.35 DSCR. For example, if your annual net operating income is $135,000 and your total debt is $100,000, your DSCR is 1.35.”
You will also need to consider the impact new capital will have on your business. Many small companies borrow sizable amounts of money thinking it would serve as a cushion, but they succumb to interest payments and borrowing expenses that make the loan a source of grief rather than aid. Do not borrow more than what you absolutely need, or else it may be difficult to pay back.
Smart borrowing is about more than numbers and figures, though. Strategy also requires creativity. When you apply for a loan, you will need a narrative, something that attests to the “five C’s of Credit”: your character, your requested conditions, capacity for repayment, capital, and collateral. Jeff Parker from US Bank’s Small Business Segment tells Redshift:
“A good banker will want to understand the story. What does the business do? Who are the customers? What industry is the business in? What products or services are provided? How do you get paid? When do you get paid? When does the company pay providers? What are the margins? Why is a loan request being made? How has credit been managed in the past? What are the company’s sales and financial trends?”
You will also need a strong business plan and personal credit score. Lenders are putting their faith in you to succeed, so smart personal borrowing practices and planning assure them that not only do you know what needs to be done, you are willing to follow through. Best practices for small business loans necessitates both a significant amount of planning and some practical creativity.
When you follow tested strategies and plan accordingly, you will have more success in your financing search. Contact us today if you have any questions about the best financing options your small business. We’re always available for a call at 877-358-4595, and would love to answer your questions and guide you toward the best option for your business.