What You Should Know About Small Business Loans

It is true that small business loans help businesses start up, also it helps the one that are already running to by fixing certain financial issues that may be disturbing the business. However, if you are applying for a small business loan, there are basics that you should know in order to get the best from the financing which you seek.

You know that as lending companies are different, so are their procedures for approving small business loans. Knowing the procedure is very important. The good news here is that some of these procedures are very basic hence they cut across as being the same through different lending institutions.

Your credit history is very important to lenders. Be it good, poor or bad, they say a lot about you. This is one very useful piece of information the goes a long way to determine if you will qualify for the loan or not.

Another point to note is your pay back ability. You might have a great credit history and still fail to pay back when due if the business fails or down slides, so getting approved by lenders is also very much anchored on the success prospects of the business.

The best way to show the lenders that your business will not fail is to outline the success plans, growth potentials of the business and submitting it to the loan lender.

Your experience is also important since it gives details of what you done in the past. This clearly reveals your capacity to the lender.

Also, it is important that you buy the right insurance protection for your small business once set up.

Where to get this?

How to Apply for a Small Business Loan

Before lenders will grant a small business loan, they want to be sure that the loan will be repaid. Every loan is a risk, but banks and brokers want to take as little risk as possible. They look for businesses that show promise, and they award loans to businesses that have solid personal and business backgrounds and are committed to the success of their businesses.

What are the first things the lender will look at? The following are the five basic items that all lenders look at before they will approve your business loan:

1. Credit history One of the primary factors lenders look at is the condition of your personal and business credit. This is generally reflected in your credit score that is obtained from the three credit reporting agencies. Your personal credit score is associated with your Social Security number, but business credit reports are tied to your tax ID number. Before you even start shopping for a loan, request a copy of your credit report from all three major reporting agencies: Equifax, Experian, and TransUnion. Review it carefully and correct any mistakes before you start the application process.

2. Your investment Business loan applicants should have a reasonable amount of their own money invested in their business. Lenders want to know that you will be motivated to work hard to make your business a success. When they see that you have invested a substantial amount of your own money in your venture, they will assume that you will work hard to make it a success. The amount of your required investment may vary, but it should be at least 20% of the amount you need for the business venture.

3. Working capital Working capital consists of your current assets minus your current liabilities. Working capital can also be thought of as cash on hand or what is available to pay current debts and keep your business running. A lack of adequate working capital increases the risk that your business will fail and makes lenders much less likely to approve your loan.

4. Ability to repay Banks want to see two sources of repayment: cash flow from your business and a secondary source which is typically collateral. Lenders will look at your past and projected financial statements. They will want to see your personal financial statements, personal tax returns for the past two-three years, business financial statements for the past three years or for three projected years, and accounts receivables and payable aging. If your business has consistently made a profit or you can reasonably project a profit, you are more likely to get approved. If your business has not been consistently profitable, you can increase your chances of getting a loan by including detailed information of new opportunities, new contracts, or other information showing that your company’s future will be profitable.

Most lenders require collateral to secure the loan. Collateral is required for all SBA loans. Collateral can be business assets and personal assets. If you plan to purchase equipment and other assets with borrowed funds, these assets will be used as collateral for the loan. Lenders will also require you to personally guarantee the loan.

5. Experience and character Lenders will expect you to have experience in the type of business that you plan to run. If you do not have that experience, lenders will expect you to hire people who have experience. Even if you do not have experience in this type of business, you should at least be able to show experience in other businesses and managerial experience.

What documents will lenders require? In order to expedite the process, the following four documents should be available for the lender to review:

1. Business plan A business plan is particularly important for new businesses, as they lack a track record for lenders to review. Your plan should convey all important facts about your business in a concise manner. A professional business plan will be at least 20 pages long, plus financial projections. The business plan will include:

Balance sheets, Profit and loss statements, and Cash flow projections

from the last three years or for three years’ projections.

Accounts receivable and payables aging

breaking your receivables and payables into 30, 60, and 90-day categories.

Market data showing demand for your type of business

Research on competitors including their customer base and price points

2. Loan request This can be included with the business plan and should detail the amount of money requested, how the loan funds will be used, the type of loan, the amount of working capital you have, the collateral that will secure the loan, the personal guarantees of the loan, and how the loan will be repaid.

3. Personal financial statements You will need to provide personal financial statements for anyone who owns 20 percent or more of the business. The financial statements must include a complete schedule of assets, debts with balances due, payment schedules, maturity dates, and collateral used to secure other loans.

4. Other documents Lenders may also require articles of incorporation, taxpayer ID number, legal descriptions of real property, leases, equipment inventories with serial numbers, proof of insurance for collateralized items, and letters of intent showing that commercial accounts intend to do business with you.

What is the loan process? Some lenders like to prequalify potential borrowers to determine how much they can afford. This also gives you and your lender an opportunity to see which loan program would be most appropriate for your needs. After the lender gathers basic information and your application is received, a loan officer or processor will review your credit reports, the amount of available collateral, and your income.

The loan officer will determine if any additional documentation is required. If you are purchasing real estate, you may also need to submit preliminary environmental reports, area maps, title reports, property appraisals, and lease summaries. Next, your commercial loan package is submitted to the decision makers — either a loan committee or underwriter. During the underwriting process, you may need to furnish additional documentation.

After the underwriting process, you will receive a letter of intent or term sheet. A letter of intent or term sheet is a formal document intended to put all parties (the lender and your company) on the same page. The letter of intent will include the names of all parties, amount of financing, type of collateral, and other key terms. After all underwriting conditions are satisfied, the final loan package is resubmitted to the loan committee for final approval.

At this point, the lender will issue a final full loan commitment. If your loan is approved, you will receive closing documents and they may be handled by a title company. The title company will record deeds and mortgages, order title insurance, coordinate the exchange of funds, and arrange for you to sign the loan documents. At the closing, the lender funds the loan with a cashier’s check, draft, or electronic wire transfer.

Being prepared and organized can save time and help your loan get approved. Be prepared to have all required information ready to submit if your lender requests it.

Jo Ann Joy, Esq., MBA, CEO
The future of your business starts here!

You may contact Jo Ann by phone at (602) 663-7007, by fax at (602) 324-7582, by email at [email protected] Business Solutions.net, and by mail at 2313 East Ocotillo Rd., Phoenix, AZ 85016. I have many published articles, and I will send any article to you free of charge. Most consultations are free.

An Outline of Personal and Business Loan Categories and Their Uses

The number of loan products have increased over the past 20 years as economic necessity and a demanding public in need of specialization to solve financial circumstances. From personal loans, educational loans, business loans and even municipal loans. The entities that took part in the creation of the various financial products are actuaries, risk management professionals, “information and informatic engineers” and Wall Street amongst others. It was necessary to create, enhance or break down for better or for worse loan services and products to keep money fluid in a diverse marketplace that required funds to address niche demographics.

  • Personal Loans

Signature Loans – A signature loan is just as it sounds. One applies for a loan and gives a signature on a promissory note to repay the loan in a certain amount of time. That amount of time is called a “loan term ” and may be from six months to five years. Signature loans usually require good credit and the criteria for loan approval are mostly based on the borrower’s credit and and to a lesser degree on assets. Not all signature loans have the same parameters for qualifications. Some loans may require the borrower even with good credit to account for assets to show the lending institution for underwriting purposes. The institution may or may not place a lien on the assets but nevertheless wants to have documentation proving that there are indeed financial or physical assets owned by the borrower. Signature loans usually come with lower interest rates than other types of consumer loans like payday loans, credit card advances, title loans and some car loans. More on these topics later. Who are the lenders in signature loans? They range from large subsidiaries of auto manufacturers to banks, savings and loan institutions, finance companies and payday loan companies.

Credit Card LoansCredit Card loans or cash advances from credit cards are another form of personal loans. These quick loans are more readily available to the general public and does not require a credit check. To obtain the initial card more than likely required a credit check or at least the process of identification for secured credit cards. Credit card loans or advances usually come with higher interest rates and also other fees for having access to the cash. Various entities allow access to the credit card cash advances from bank tellers, check cashing facilities and automated teller machines (ATMs). The fees vary based on source used to access the funds. To lower the fees for cash advances some use check cashing facilities to have the card charged and receive cash back in turn for not having to incur the fees of ATM machines as cards are assessed a fee twice; first by the ATM company and also their bank. The interest rates on credit card loans or advances are usually higher than signature loans. There are some states that have usury laws that have lower interest rates on credit cards. The loan or advance on a credit card is not a “term loan” as with most signature loans. It is more or less a line of credit the borrower has access to when they need it as long as there are funds available on the credit card. Interest on consumer loans are no longer tax deductible as in previous years. They were designed for short term borrowing needs but many have come to use their credit cards as a regular source of funds in tight economic times or between paychecks.

Wedding LoansA relatively new form of loan to carve out a niche for the lending industry and meet the needs of the increasing costs of weddings is the Wedding Loan. Because of the expense of weddings which can range into six figures, it sometimes requires a personal loan or even a business loan of the families involved to provide a proper wedding. Wedding loans can be secured (using assets for collateral) or unsecured (signature loans) to obtain funds for the ever growing need to pay for the escalating wedding costs and all the various services and products that a successful matrimonial ceremony would need. The credit criteria and the term may vary based on the amount needed and financial status of the people involved.

Payday or Cash Advance Loans is a fast growing market because it usually requires the least of credit criteria used for loan approvals. One can have bad credit for a quick and instant loan. Just having proof of income, proof of identity and a checking account is all that is necessary to secure funds. Even today many have checking accounts without checks one can still obtain a cash advance by asking their bank to produce a one time check to give to the payday loan agency. Many payday loan companies and stores can get approval with no faxing of documents as they utilize other means for proof of income. Although payday loans come with very high annualized interest rates they sometimes are the only source of emergency cash loans for those in need.

Automotive, Motorcycle, RV (recreational vehicle) and Boat Loans – These personal consumer loans are usually not signature only loans but asset based loans. In other words a financial lien is placed against the asset to secure a loan to purchase or refinance the car, boat et al. These consumer loans may sometimes require a down payment of five to twenty-five percent to secure enjoyment and use of ownership. Because these are not funds that are already available as with credit cards they come with a “loan term” from one to six years depending on the choices of the consumer, the marketplace and the credit status. The interest rates can range from very low usually offered by manufacturers of cars, motorcycles, RV’s (recreational vehicles) and boats to very high if the borrower uses a credit card, a finance company or a “buy here – pay here” lender – or the car dealer who finances the purchase of the car by giving the borrower a term of months and years to pay the balance of the loan off.

  • Business Loans

SBA (Small Business Administration) Loans are loans that are given to small businesses which are not able to qualify for a loan from a financial institution for various reasons from lack of business history, lack of collateral to “secure” the loan or not having an adequate credit history. The SBA is not a direct lender but acts as an underwriter on behalf of the bank that funds the loan for the business entity. If the borrower defaults on the loan the SBA will pay the bank a percentage of the balance for taking the financial risk to loan the funds to the business. There are various types of SBA loans which will not be covered in this article but a future article will explain in more detail.

Conventional Business Loans are loans that are either unsecured meaning no asset is used to approve the loan or secured and called “asset based loans” where assets from inventory, equipment, accounts receivable or real estate are used for underwriting for loan approval. Conventional business loans are given to business entities that have great banking relationships, established business credit history with trade lines with other businesses they do business with and good standing with various credit reporting entities like Dun & Bradstreet. There are short term loans with interest only payments with the balance due at the end of the loan usually referred to as a “Balloon Loan”. There are also longer term loans that are fully amortized (principal and interest in each payment) paid over one to five years or more.

Equipment Leasing is a financial instrument which technically is not a loan. Meaning based on tax ramifications and who owns the equipment – leasing is just that – leasing an asset owned by another entity. Leases are usually from large corporations or a bank. The lease term can vary from one to five years or more and there usually are tax benefits to the business entity in leasing new or used equipment.

Equipment Sale Leaseback is a transaction to use equipment that is already owned by the business or municipal entity to secure funds for the present need for operations. The term can vary from one to five years and the amount of funds can vary based on credit history and a percentage of the fair market value of the equipment. The company then in turn leases the equipment back in usually a monthly payment. The company or the lessee normally has different choices on what they want to do with the equipment at the end of the term. They can roll the lease transaction into newer more updated equipment or software. They can buy the equipment for one dollar or ten percent of the fair market value of the equipment.More and more companies are leasing today as opposed to paying cash or using bank lines or loans.

Merchant Cash Advance is used by businesses that need fast cash and can’t qualify or don’t want to go through the process of getting bank approval for needed funds. A Merchant Cash Advance is also not a loan product but it is the selling of assets or credit card receipts at a discount. In other words the Merchant Cash Advance company buys the credit card receipts and then attaches a fee usually every time the business “batches”, settles or closes the day’s or week’s sales until the funds advanced are paid off. There is no term with merchant cash advances as it is not a loan so there is no set payment amount or period. The paying off of the advanced funds vary based on a the credit and debit card transactions of the day or week.

Factoring Accounts Receivable Invoices enables a business entity that normally has to wait 30 days or longer to be paid by other businesses or governmental entities. Again factoring is not technically a loan but a selling of invoices at a discount for cash now. In a typical transaction the company applies with a Factoring Company and the company looks primarily at the credit of the other business or governmental entity that the company is doing business with. Based on that as long as the client of the company is a solvent business or government agency the invoices are bought and funds are dispensed to the business usually within three days of due diligence on the company they are transacting business with. In other words the funds are dispensed after there is a credit check and processing of the other company. The dollar amount that is advanced can vary from fifty percent of the invoice to eighty or ninety percent depending on various factors such as the size of the invoice to the credit criteria of the other company or governmental entity whether it is a city, county, state or federal agency.

Medical Factoring is a financial transaction that benefits medical entities like hospitals, clinics and various health care professionals that have to wait to receive funds for services performed on patients. Like Factoring and Merchant Cash Advances Medical Factoring is the selling of assets in this case invoices for cash now. In many instances the health care industry receives payment from third party entities like insurance companies, Medicaid and Medicare and state entities that provide funds for those in need of medical procedures. The medical facility or professional in turns sells the invoice(s) on a on going basis or one time for cash now. Once there is an interest is selling the receivables then a Factor steps into analyze the billing so that funds can be advanced. This process can vary in length but is usually shorter in length than the process of getting bank financing.

Contract and Purchase Order Funding allows companies to bid on large projects for governmental agencies, hospitals, universities, prison systems and municipalities or also to sell to larger corporations even if the business does not have the credit or bank approval or the wherewithal to service or fulfill a large contract order. Similar to Factoring which works hand in hand with Purchase Order Funding it is not a loan but a simultaneous transaction that involves advancing funds based on the credit of the governmental agency or larger company and the size of the contract. The funds that are advanced are for the cost in completing the order of products or performing services. So the profit that will be gained is not advanced but the costs as in raw and finished material, transportation, production, labor, expertise and any other costs involved in completing the contract. Once the contract is completed or once an invoice is ready to be sent to the client a factoring company which is sometimes owned by the same company buys the invoice at a discount and the funds that would normally be advanced to the company are usually used to settle the amount advanced for the material and other services that were needed to complete the order. Contract and Purchase Order Funding usually requires large transaction amounts as opposed to factoring that can be utilized for invoices as small as one hundred dollars. With the use of Contract and Purchase Order Funding companies that were locked out of the process of bidding on large contract s may become players in multi-million dollar deals.

Commercial Real Estate Sale Leasebacks are similar to Equipment Sale Leasebacks featured in this article. Instead of utilizing owned equipment to secure cash when bank borrowing is not wanted or not available the commercial real estate is used to access funds now. This can vary from office buildings, medical buildings, retail franchises, industrial buildings and manufacturing to large utility plants. This frees up cash “locked” away in real estate. Many entities find that at the present time the business they are in whether it is retail, manufacturing or another field that the holding of commercial real estate is not in their best financial interest for now. They prefer to put to use funds for their industry. So a retailer selling retails goods decides to focus on the retail operations and to lease the space because that real estate when factored into a myriad of calculations does not fit their financial goals during the present time. Yes the ownership of commercial real estate is an asset and can be used as a security for a loan but may also be viewed as a fixed non-performing entity that does not meet the needs of the business, organization, group or individual that owns the building. Commercial Real Estate Sale Leasebacks are another form of getting access to funds and has increased over the years.