12 Things to Prepare Before Taking Out a Business Loan
A little preparation can make the small business loan application process faster and easier.
Are you thinking about taking out a small business loan?
Here are some steps you can take to prepare for it to make the process smooth and easy.
- Educate yourself on small business loans.
- Improve and maintain your credit score.
- Run your business responsibly.
- Organize your business records.
- Figure out how much financing you need.
- Determine how much of a loan you can afford to pay back.
- Develop cash flow projections.
- Figure out which type of financing you need.
- Identify collateral.
- Complete or update your business plan.
- Choose the right lender.
- Get the timing right.
- Get professional support.
1. Educate yourself on small business loans.
Lenders only loan money to borrowers they trust. And even if they trust you, if they trust you less than other borrowers, they will charge you more in interest.
That’s why it’s critical to do your research and learn the basics about small business loans. Knowing what you’re getting into will help you feel more confident that you’re qualified to get a loan, know what type of loan to get, determine whether you’re being offered a fair interest rate and loan term, and avoid excessive fees.
2. Improve and maintain your credit score.
Your personal credit score reflects your creditworthiness. It tells lending companies whether you pay your bills on time, have too many or too few credit lines, leverage debt effectively, and have a history of repaying loans.
You can get your personal credit report for free from each of the three major credit bureaus: Equifax, Experian, and TransUnion. You can also get your credit score free from several credit card issuers and personal finance websites.
If you’re an entrepreneur that doesn’t have a credit history or an established small business owner with bad credit, you will probably need to start slow. This is the case for many startups, new companies, and small businesses, but don’t give up. Begin by getting a business credit card and paying off the balance each month. It will help you prove to credit agencies and lenders that you are worthy of getting more credit. Over time, it will help you score bigger loans with better terms.
3. Run your business responsibly.
Many lenders consider more than your credit score when making loan decisions. They may also check your time in business, cash flow, revenue, reputation with customers, and more. Demonstrating that your company is solid and that you’re a responsible business owner could be just what it takes to get your loan application approved.
4. Organize your business records.
When it comes time to apply for a business loan, you must prove everything you claim on your application, including your revenue, expenses, debts, and assets. You must be able to back these things up with paperwork. Don’t wait until application time to get your documents organized. Doing it now will make the application process faster and easier.
Use a cloud-based accounting and bookkeeping tool to organize your business finances. It makes it easy to manage your income and expenses, send and track invoices, generate financial reports, calculate taxes, and store bank statements, tax returns, financial statements, bank account information, and other documents.
5. Figure out how much financing you need.
Before applying for a business loan, it’s crucial to determine precisely how much cash you need. Getting too much funding could force you to pay too much interest and costly prepayment penalties if you pay your loan back before its term is up. Requesting too little money than you need may require you to go back for a second loan. Or worse, it could leave you unable to resolve a financial issue, complete a project, or take advantage of an opportunity.
Work with an accountant, financial professional, or loan expert at a reputable business financing company to figure out what size loan to apply for.
6. Determine how much of a loan you can afford to pay back.
It’s one thing to know how much financing you need. It’s another to be able to pay it back.
Once you know how much cash you need, figure out how much you can realistically afford to pay. Analyze your monthly revenue and expenses to see if you can afford an additional monthly payment. Calculators are available online that can help you determine how large a loan you can handle.
If you cannot pay back the loan you want, you might need to adjust the loan amount or type. For example, if you can’t afford a short-term loan, you might still make payments on a merchant cash advance or business line of credit.
Keep crunching the numbers and reconsidering financing options until you come up with a combination you can afford to pay back.
7. Develop cash flow projections.
Loan decisions are typically not based exclusively on past financial history. Lenders also consider future cash flow, especially for loans that will be used to expand the business, for instance, to purchase equipment or a new location. Realistic cash flow projections will demonstrate your business’s future income and expenses based on how the loan money will be used.
Use your previous cash flow statements, balance sheets, and profit and loss statements to prepare accurate projections. When a lender sees a plan for the use of their loan funds backed by data, they will be more likely to approve your application.
8. Figure out which type of financing you need.
The amount of money you require, why the business needs the money, the term, and your creditworthiness all impact the type of loan you should get. Here are some popular loan types to consider:
- Term loan. A term loan provides you with a lump sum of cash that you pay back — plus interest — in regular installments (usually monthly) over a set period of time (the term) until you pay off the entire amount loaned to you.
- Short-term loans. Short-term loans are a type of term loan. You pay them back over a shorter term, and the interest rates are higher than with longer-term loans. Even though they’re relatively expensive, they’re an excellent way to get fast cash.
- Business line of credit. A business credit line is revolving financing that provides you with access to cash when you need it. When you use your credit line, you only pay back — and pay interest on — the portion you borrowed. When you repay borrowed funds, you get access to the money again.
- Business credit card. A business credit card is similar to a personal one. Use your credit card to make purchases and pay it back later, ideally in full each month, to avoid paying interest and improve your credit score.
- Merchant cash advance. You can use a merchant cash advance to exchange tomorrow’s sales for immediate cash. A lender provides you with a lump sum of money that you pay back with a percent of your daily sales. Be aware that merchant cash advances can be costly.
- SBA 7(a) loan. Small Business Administration (SBA) 7(a) loans are among the most popular business loan types, as are most SBA loans. They can provide you with significant levels of business financing, competitive interest rates, and comfortable repayment terms. The issue: They’re hard to qualify for, and the application process is tedious and lengthy. However, getting a loan backed by the U.S. Small Business Administration can be a great option if you are eligible.
- Accounts receivable financing. This funding option is also known as factoring. It lets you trade outstanding invoices for immediate cash. The factoring company keeps a percentage of the value of the invoices and can collect on them, which could harm your relationships with customers.
- Equipment loan. These are among the easiest loans to get. The lender finances a piece of equipment, and the equipment is the collateral that backs the loan. Businesses with poor credit histories can usually qualify for this type of financing.
9. Identify collateral.
Loan companies base their lending decisions on the risk that you won’t pay the money back. Collateral helps lower that risk by providing banks with a guarantee based on the value of the collateral in the case that you default on your loan.
Look for valuable things you could offer up as collateral on your loan. It could be business assets like a truck or piece of equipment or personal items such as jewelry, real estate, or artwork. Providing collateral or a personal guarantee makes most people nervous, but you can avoid losing it if you get sensible financing that you feel confident you can pay back.
10. Complete or update your business plan.
Most lenders will want you to explain how you will use your loan money, including:
- What you will spend it on.
- How the funds will help your business.
- When you expect to see a return on the loan money.
- What impact it will have on annual revenue.
The best way to explain all these things is with a complete and current business plan. If you haven’t written one — or updated an existing one — lately it’s time to get busy.
Not every lender will require a business plan, but it’s best always to be prepared by having one ready. The additional research and planning will help you strategically use your funds, establish realistic repayment plans, and prepare for worst-case scenarios.
11. Choose the right lender.
Every lender is different and serves a unique purpose.
- Large financial institutions provide big bank loans to enterprise clients for working capital and other reasons.
- Local banks are often friendlier to small businesses that contribute to their communities.
- Alternative lenders provide fast funding to riskier businesses but charge higher interest rates.
Take time to research your lending options. Look out for ones that are financially sound, reputable, and have positive ratings and reviews from clients.
12. Get the timing right.
Don’t wait until the last minute to get a loan. If you think you may need one in the future, plan ahead. The preparation and application processes may take longer than you expect.
One last note…
Small business owners need to be knowledgeable about loans and lending, but they don’t have to become experts. Don’t be afraid to seek professional advice.
A bookkeeper, accountant, financial advisor, or loan officer can all be great sounding boards to help you figure out how much funding you need, the amount you can afford to pay back, and the right loan type and provider. Getting support will help you feel confident you’re securing the right financing for your business.