By Greg Cassat
Before diving into the sea of entrepreneurship, it’s wise to take a step back and make sure you’re ready to plunge. Preparing in advance can make a difference in securing a small-business loan. You’ll also want to study up on loan programs through the U.S. Small Business Administration that can be advantageous for your unique situation.
Start by Looking at Your Personal Credit
A good personal credit score is an appropriate starting point for procuring a business loan. A reputation can’t be bought; it must be earned. And when it comes to proving your character to potential lenders, you can show that you are trustworthy to repay debt by building a solid track record of borrowing money and paying bills on time. Your credit score will impact not only whether you qualify for a loan, but also the interest rate and terms offered to you.
Once you have developed a solid personal credit score, it’s a good idea to start separating personal credit from your business credit. This will make it easier for the lending institution to more accurately assess the business and make its decision based on that information instead of only using your personal credit history.
Be careful not to submit loan applications at too many places, because each time a lending institution accesses your credit, it can affect your FICO score. Fair, Isaac and Co. came up with a popular scoring model used by many creditors, known as a FICO score, and this is often one of the gauges financial institutions use when choosing loan candidates.
Be Ready to Show Your Financial Capacity
In addition to showing your history of meeting past debt obligations, you also need the financial capacity to meet new ones. You will be required to show a lender that you have the ability to repay the loan amount. Get ready to delve into the nitty gritty of your company finances and provide business tax returns and other financial statements, including balance sheets and profit and loss/income statements for the past three years. In assessing your ability to repay the loan, lenders will look at current debt obligations and, if you’re applying for a U.S. Small Business Administration-backed loan, financial projections for the next two years.
You’ll be hard-pressed to find a financial institution that is willing to loan you money without you having some “skin in the game,” or a cash or equity investment in your business. The amount of capital required varies depending on the lender and loan type. For example, the popular SBA 7(a) loan requires a minimum 10 percent down payment. Your capital contribution can often be combined with other sources — like gifts from family or friends or money from investors — to meet the requirements.
In the context of credit, collateral is also a factor in securing a loan. The collateral can come from assets such as real estate, equipment, vehicles, furniture, accounts receivable or inventory. Absent sufficient business assets, personal resources — such as a vehicle or equity in a home — may be instead pledged as collateral.
No company is an island, which is why the business climate — both in your industry and in the broader economy — will also be a factor in whether your loan is approved. While you can’t wield economic winds, you can take advantage of market upswings and apply for a line of credit when business is going well to create a cushion for lean times. When you meet with your lender, be prepared to articulate your strategy for capitalizing on positive trends and mitigating potential risks. You should also be prepared with a detailed business plan and viable business projections.
Why You Should Consider SBA Loans
In an effort to bring more opportunities to small businesses competing for federal contracts, the U.S. Congress passed the Small Business Act of 1953. This law allowed the federal government to establish the U.S. Small Business Administration.
SBA loans are frequently used by established businesses when longer or blended terms, or different collateral requirements, are desired. But there can also be specific advantages for startups that merit consideration.
While the SBA does not lend directly to small businesses, banks receive a guarantee that the government will repay a portion of the loan if the borrower defaults on payments. This backing incentivizes banks to consider funding viable business concepts that may be considered inherently more risky for a variety of reasons, such as less than two years in business, change of ownership or operating in a particular industry segment.
Remember that all U.S. Small Business Administration lenders are different, so each financial institution will have its own set of criteria for business loans. Applications are often specific to the lender so it’s important to gear it to the lending institution where you send it. Establish a close relationship with the lender since the better they understand your particular situation, the greater your chance of obtaining a loan.
Studying Up on SBA Options
The SBA offers a variety of loans for small businesses, each with unique characteristics to meet your startup’s specific needs:
SBA 7(a) Loan. From funding start-up costs to paying for equipment, machinery, furniture, fixtures, supplies or materials, SBA 7(a) loans are versatile. With loan amounts up to $5 million, the 7(a) loan can help improve cash flow and long-term financing during your first make-it-or-break-it years.
SBA Express Loan. Express loans can put as much as $350,000 in your hands. These loans pass over excess paperwork with a streamlined approval process for an easy-to-use line of credit or a term loan. SBA offers a fast turnaround time of 36 hours to help accelerate the decision-making process.
SBA 504 Loan. An SBA 504 loan finances fixed assets like land, buildings and machinery. With an SBA 504 loan, the bank funds a portion and a Community Development Corp. (CDC) funds a portion, along with the down payment from the borrower. Maximum loan amounts range from $5 million to $5.5 million, depending on the type of business or project.
SBA CAPLine Loan. An SBA CAPline loan lets you transition between busy and slow seasons without an interruption in cash flow so you have working capital when you need it. If you are a contractor, builder, or own a seasonal business, a CAPLine loan of up to $5 million can meet your short-term cash flow needs.
SBA Export Loans. SBA Export Express loans allow your startup to expand or enter new export markets. The Export Working Capital Program gives working capital to small, export businesses so they can maintain their export orders.
SBA Veterans Advantage Loans. The Veterans Advantage loan gives fee relief to businesses that are at least 51-percent owned by veterans or military spouses. These loans offer the same terms as SBA 7(a) loans and Express loans but with reduced or waived guarantee fees.
Just as you expect your business to be under the microscope during the loan application process, look carefully at potential lenders before you sign on the dotted line. Every financial institution differs in how it approves loans, extends borrowing terms and follows timelines.
Greg Cassat is a counselor at Zions Bank’s Business Resource Center, which provides tools and resources for those interested in starting or expanding their businesses.