Starting and maintaining your own business can be one of the most difficult but rewarding endeavors to take on. There’s a lot of risk and hard work involved, but by satisfying that entrepreneurial spirit, you can be your own boss, make your own schedule, write your own paycheck, and take orders from nobody but yourself. The payoffs of starting and owning your own business are great, but there are obstacles that every motivated individual must face and overcome while on the road to success.
Of all the obstacles standing in innovative individuals’ ways, the largest is almost always money — or lack thereof.
As the saying goes, it takes money to make money, and it can take a great deal of it to get a business into a healthy position. Fortunately, there are means of getting money to kickstart your business. The most common method of acquiring money for your startup or struggling business is through a business loan.
What are Business Loans?
Business loans are a specific type of financing that are meant solely for the business-related expenses. They’re typically originated by banks or investment organizations and come with the expectation that they will be repaid by a specific date at a certain amount of interest. That interest is determined by the borrower’s credit history and the perceived risk associated with their particular business.
Types of Business Loans
Outside of conventional business financing provided by banks, there are several types of alternative business loans that prospectives borrower should be aware of. Those types include:
- Small Business Loans
- Business Cash Advances
- SBA Loans
- USDA Business Loans
Small Business Loans
The term “Small Business Loans” is actually a blanket label that encompasses many types of business financing that are tailored specifically for smaller businesses and “mom and pop” shops.
They typically come packaged in amounts ranging from $5,000 to $500,000, they have competitive interest rates, and reasonable repayment durations. The borrower’s credit history, his or her willingness to submit collateral, and their current or perceived company revenue can all play parts in eligibility, cost, and qualification.
Many small business loans are designed to service startups. Startup loans are difficult to qualify for, and typically require an entrepreneur to present a complete business plan detailing everything from goals and company structure to target audience and marketing direction.
In addition to supplying a lender with a business plan, entrepreneurs who want a startup loan should be prepared to offer a substantial amount of collateral. Reason being, lending money to startups is one of the riskiest endeavors in the lending industry.
Startups, by definition, are unproved businesses that are looking to find their place in the capital world. When banks or non-conventional lenders give money for a startup, they’re essentially “investing” in somebody’s idea and work ethic. If that entrepreneur’s vision doesn’t pan out, then their lender could find themselves out of a lot of money.
To help curb that risk, many require collateral for startup financing, which often comes in the form of:
- Home equity
- Personal guarantees
- Company assets
- Business equity
Business Cash Advances
Business Cash Advances, also called Merchant Cash Advances, are smaller and quicker business loans, but they should not be likened to personal cash advances. These are not nearly as costly as a personal payday loan, despite their similar names.
These small commercial loans allow companies who need money quickly to get it. They’re perfect for businesses that need to:
- Pay employees
- Purchase new inventory
- Upgrade equipment
- Secure a lease
Merchant Cash Advance loans result in very fast cash, usually taking about 7 to 10 days before a qualified applicant sees money deposited into their account.
Additionally, many business cash advance lenders agree to be repaid based on your business’s credit card transactions, which means you repay the loan using only profit. So when business is slow and profits are low, the amount you repay to your lender will be low as well — and that’s ok!
When business speeds back up and you begin to make more sales, then your repayment amounts will increase accordingly.
This type of loan is great for those who want to mitigate risk while simultaneously acquiring a relatively small amount of money to make necessary purchases.
The Small Business Administration (SBA) is a government branch that provides government-backed financing to businesses across the United States.
SBA loans are excellent, low-interest business financing opportunities that every small business owner in need of money should consider.
The one downside to the SBA’s commercial financing loans is that they’re prerequisites can be quite strict, thus disqualifying many small business owners from obtaining the financing they need.
SBA Disaster Loans
In addition to providing generic, everyday business financing, the SBA also steps up during times of emergency.
SBA disaster loans are extremely low interest, very long-term business loans that become available to businesses located in areas affected by disasters. Most of the time, the disasters that the SBA’s emergency commercial loans service are natural disasters, such as floods, tornadoes, storms, and droughts.
When disaster loans are approved for a particular area, the SBA makes an announcement declaring their availability and lists that area on their website.
SBA service centers are usually set up close to the affected locations, and interested applicants are required to visit those centers or call the SBA directly in order to apply.
USDA Business Loans
There’s another type of government-backed business financing, but it’s much more specialized and exclusive than the traditional loans offered by the SBA. This type is put on the by the United States Department of Agriculture (USDA), and is called USDA business loans.
USDA business loans are designed to service businesses and startups located in rural communities.
They can be used for:
- Working capital
- Purchasing machinery and equipment
- Buildings and property
- Refinancing certain types of existing debt
Business Loan Costs
The cost of commercial loans rests heavily on two aspects: terms and interest rates.
A terms refers to how long a borrower will have a business loan until its paid off. Mortgage loans, for example, are usually taken out for 15-year or 30-year terms, which means after 15 or 30 years, respectively, the mortgage will be repaid and considered complete.
Business loan terms vary depending on what type and how much an applicant needs. The longer the term, though, the more interest will accrue. The more interest that accrues, the more expensive a business loan will ultimately be.
Interest accrues in correspondence with the rate given. Interest rates are affected by a variety of factors, but some of the most influential include the:
- Applicant’s credit score
- Current success of the applicant’s business (if it already exists)
- Perceived success of the applicant’s planned business (if it does not yet exist)
- Value of Collateral
- Current political and economic climate
- Overall Risk associated with lending money to this applicant
Commercial financing is very similar to other types of borrowing in that an applicant’s credit score is one of the most crucial factors when it comes to securing a good interest rate.
Credit scores are equivalent to financial reputation. The better your score, the more credible you are in a lender’s eyes. Naturally, the more credible you are, the less of a risk you most likely are, and thus you’ll be rewarded with a better interest rate.
That’s not to say bad credit borrowers can’t get a business loan though. In fact, it’s quite the opposite. Those with poor credit or even no credit history can still qualify for a business loan. Some lenders even specialize in servicing bad credit borrowers.
Current and Perceived Success
The current or perceived success of an applicant’s business factors directly into a lender’s risk assessment of an applicant.
If a prospective borrower’s business is performing well (i.e. is profitable), then there’s a better chance that their money will be put to good use and be repaid.
On the other side of the coin, if an applicant’s business has experienced little success, or if their business plan is shaky and confusing, then a lender may be worried that they won’t be repaid if they lend their money out.
A proven track record or a clear cut plan for how you will be successful will go a long way in qualifying for commercial funding.
As briefly mentioned before, collateral refers to something of value that will curb a lender’s risk in lending money to a borrower.
When it comes to commercial loans (regardless of whether or not this financing is a startup loan or a loan for an established business), collateral in some form is almost always required.
The more valuable your offered collateral, the more likely you’ll be given a lower interest rate.
Political and Economic Climate
Remember back in 2008 when the housing market collapsed and it seemed near impossible to get a mortgage, even for those who could still afford one?
Or how about during our recent government shutdown of 2013 when all of our federal offices and services were closed down and furloughed due to lack of money? People who had loan applications in the processing phase were put on hold due to lenders’ inability to run background checks and gather necessary, federally-provided information.
The political and economic climate plays a huge part on not only loan availability, but also the interest rates that lenders will charge. If the economy or the political spectrum is looking shaky or uncertain, then lenders will hedge that risk by charging their clients more for borrowing money.
Risk in Lending
All of the aforementioned points are pieces of a larger puzzle that depicts a lender’s overall risk in lending money.
The overall risk in commercial financing is taken into consideration when setting an interest rate, and that interest rate is what will determine the overall cost to the borrower.
In the event a borrower is unhappy with an offered interest rate, they’re encouraged to approach other lenders and solicit lending quotes from them. If a suitable interest rate cannot be found from multiple sources, then that borrower should take the necessary steps to decreasing their “risk” to a lender.
While many things are beyond borrowers’ control, the easiest place to start is with their credit scores. Instead of conceding to taking out bad credit business loans, they can work at increasing their financial reputation. Once their credit score rises to “prime” levels, they should see a noticeable difference in the borrowing opportunities they’re presented with.
How to get Commercial Financing
So you’ve figured out how to start a business, and now you’re wondering how to get a business loan. While the application process for a business loan is more detailed than most other types of financing, it’s not nearly as difficult as starting and maintaining your own business. You’ve already hurdled the most difficult obstacle, so this next one is a little less stressful.
We’re going to break this section into two parts: applying for a business loan and applying for a merchant advance. Refer to that which is most applicable to you.
Applying for a Business Loan
Applying for a business loan is a process that begins long before you approach a lender. A business plan should be your very first consideration. Without a well-constructed and professional business plan, you will not get passed the bank teller.
After drafting a business plan, you will need to gather your personal tax information and income reports. This step is more crucial for those looking for startup loans, since startups are rarely established as completely separate entities from the entrepreneur. Consequently, lenders will be interested in the personal financial information of the borrowers themselves.
When you apply for a business loan, you’ll not only submit a written plan but you’ll also speak to lenders and loan consultants face-to-face. Be prepared to clearly and succinctly define your need for the money you’re requesting. Have a keen understanding for where you’ll spend your lent money and how you intend to repay it.
Once you’re adequately prepared, approach your chosen lender and submit an application along with all required documents, such as your previously gathered financial documents. After everything’s turned in, you will need to wait for a response. Whether your application is accepted or denied, you will hear back your chosen lender after they’ve had a chance to review all of your information.
Applying for a Merchant Advance
The merchant advance application is much quicker and less-involved than a traditional business loan application.
To apply for a business cash advance, you simply need to fill out an application, which, most of the time, is accessible online. You simply need to supply the merchant advance lender with the requested information and hit submit.
After an underwriter has a chance to review your application, they will contact you and let you know whether or not your application was approved.
If you are approved for an advance loan, don’t immediately accept. Instead, do your due diligence and ask a few questions:
- What are the fees associated with this merchant cash advance?
- What is annual percentage rate, or APR, of this merchant cash advance?
- Will you be accepting repayment in fixed installments from my bank account account, or will you be taking a portion of each credit card sale?
If you receive acceptable answers to each of those questions, then you can accept and expect cash to be deposited into your company’s account within a matter of days.