Understand the Most Common Business Loan Stipulations Before You Apply
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Entrepreneurs must overcome several obstacles when successfully running their own businesses. One of the most common challenges for new business owners, and some established owners, is figuring out how to get financing for their business needs. Small business loans are a viable financing solution for most businesses, but there are some loan stipulations every entrepreneur should understand before beginning the business loan application process. In this article, we discuss loan stipulations and how they apply to the various types of small business financing.
Typical requirements for a small business loan
Small business loans are used for many different purposes, including startup costs, like money for business licenses, working capital, renovations, expansions, accounts payable balances, commercial real estate, and equipment. The stipulations for a business loan vary depending on the type of loan and the lender issuing the funds. There are several types of small lenders that specialize in working with business owners for funding options, including traditional lenders, like banks and credit unions, and alternative lenders, like online lenders. Many small businesses prefer to work with online lenders because of the variety of funding options they offer and the fast and easy approval process.
While the approval process varies from lender to lender, understanding the typical business loan requirements can help expedite the process for loan applicants. Even though the application process for a business loan is similar to personal loans, there are unique differences in the eligibility requirements. Most small business lenders consider the following loan stipulations when working with business owners:
Lenders issuing business funds review a borrower’s creditworthiness to determine the risk associated with loaning money to the entity. When approving a borrower, the lender considers both the business credit history and the personal credit score of the business owner. Business credit history is evaluated based on previous payment history, reputation, and the annual revenues of the company and reported by business credit bureaus like Dun & Bradstreet. Personal credit cores, or FICO scores, are evaluated based on previous debt activity of the borrower, like longest credit lines and payment histories, and reported by major credit bureaus, including Experian. To review credit, lenders may request a copy of both credit reports. Although there is no standard minimum credit score for loans, small business owners should review their credit report for accuracy before applying.
The second loan requirement considered during the underwriting process is cash flow and net income. A business’s cash flow measures the amount of money flowing into and out of the business. Cash flow can be determined by reviewing revenues, business expenses, and debt obligations. Net income tells the amount of money left over after the business has covered its costs. It can easily be found on financial statements, like profit and loss statements or annual income tax returns. Income and cash flow can be intimidating topics for new businesses, but there are also several loans that cater to startup entrepreneurs.
While many lenders work with new business owners, some financing arrangements, like traditional bank loans, require a minimum business age for borrowers. The eligibility requirements may include up to a minimum of two years in business which is measured by the length of time the business bank account has been open. Entrepreneurs that have been operating for less than the listed number of months may still be eligible for the loan, but with shorter loan terms and higher interest rates. Lenders review time in operations using business bank statements and business credit scores.
In addition to reviewing the creditworthiness of a borrower, a lender will also be concerned with the current debt obligations of the business to determine whether the business can take on an additional monthly payment. During the application process, a lender may calculate the debt-to-income ratio of the company or request a current debt schedule to review payment amounts and the business’s track record for on-time payments.
Collateral is an asset pledged by the borrower to minimize risk and secure a business loan. When collateral is required, the lender will seize the asset if the small business defaults on the loan. Offering collateral is a great solution for startup entrepreneurs that haven’t established business credit history or for borrowers with bad credit. Lenders can determine the volume of available business assets by reviewing the balance sheet.
Common small business loan terms
In business financing, the business loan term options describe the length of time given to repay the debt. Typically, loans are described as short-term or long-term but may also include medium-term loans. The terms assigned to each type of loan are approximate because the exact number of payments a will owe will be specified in the loan agreement after the borrower’s creditworthiness has borrower been evaluated.
Short-term business loans require that the debt be paid off in full or refinanced within 0-18 months. Short-term loans may include cash advance options, merchant cash advances, microloans, and term loans.
Medium-term loan options offer repayment periods of 1-5 years and include term loans, lines of credit, equipment loans, and some SBA loans.
Repayment terms of more than six years are considered long-term loans, which are typically term loans issued by a bank, credit union, or online lender. Long-term financing options may include commercial real estate (CRE) financing, bank loans, equipment financing, and SBA 504 loans.
Types of business loans
Choosing the right business loan product depends on the intended use of funds, desired financing costs, and eligibility requirements. Fortunately, there are several different types of business loans, so borrowers that have trouble qualifying for one type of funding may find success with another loan product.
A term loan is a traditional arrangement where the borrower receives a lump sum of money upfront and agrees to repay the loan according to the repayment terms. Interest rates for term loans can be fixed or variable, where they fluctuate based on the market rate. Term loans can be either secured with collateral or they can be unsecured, where no collateral is required. Borrowers may still be required to attach a personal guarantee or provide a down payment with unsecured loans.
Equipment financing is a helpful financial tool for startup entrepreneurs and seasoned business owners. The funds received through equipment financing can be used to purchase computers, computer software, landscaping equipment, machinery, kitchen appliances, copiers, or any other business equipment. Since the asset acts as collateral on the loan, equipment financing can offer low-interest financing. The term of the loan is determined by the useful life of the asset.
SBA loans are a business financing option for small business owners where the funds are partially guaranteed by the U.S. Small Business Administration. There are several different SBA loan programs depending on the intended use of funds, the creditworthiness of the borrower, and the amount of loan desired. SBA loans generally require good credit and offer lower interest payments and longer repayment terms than other lending options.
Some popular loan programs available through the SBA are:
- SBA 7(A) Loans – Approved credit lines up to $5 million that can be used for large purchases, working capital, and refinancing high-interest debts.
- SBA Microloans – Allows up to $50,000 for business needs based on an approved business plan
- SBA Express loans – Approved borrowers receive up to $350,000 to be used as working capital.
Commercial Real Estate Financing
Real estate financing is useful to small business owners that choose to buy an office, retail, or industrial location. This type of financing can be used to purchase land, buildings, and office space or to fund new construction. Real estate loans offer lower interest rates and flexible terms based on the loan amount, lender, and creditworthiness of the borrower.
Other types of small business financing options
Small business owners are not limited to loans as a way to fund their businesses. Some alternative funding options rely on a credit check for approval, but others may consider unpaid invoices, credit card sales, or formal financial projections when evaluating applicants.
Merchant Cash Advance
A merchant cash advance (MCA) is a way for small businesses to use future credit card sales as collateral to receive a cash advance. Once the funds are received, the borrower repays the advance with weekly or monthly payments based on an agreed-upon percentage of sales. For businesses where the revenues fluctuate, a percentage-based repayment plan allows them to make smaller payments when sales are low and larger payments when sales are better than expected. MCAs are a great financial tool for borrowers that have bad credit or no business credit history.
Business line of credit
A business line of credit is not a loan, but it is a type of revolving credit that works like a business credit card. Approved borrowers are awarded a maximum credit line and can then draw on that credit line anytime they need capital. Any funds that have been withdrawn are repaid with monthly payments that include financing costs calculated using either a fixed or variable interest rate. When the balance is repaid, the funds become available again.
Invoice financing is a way for entrepreneurs to take out a line of credit using the accounts receivable balance as collateral. Approvals for invoice financing are typically based more on the sales activity of the business and less about the credit of the borrower, so they are a great option for entrepreneurs that are still building good credit. Invoice financing allows the business to receive a cash advance based on the value of their unpaid invoices. The business is then responsible to collect on the invoices to repay the advance plus any financing costs and origination fees.
Invoice factoring is not technically a loan but a creative financing option that lets small business owners receive cash immediately for invoices. Like invoice financing, invoice factoring uses the business’s accounts receivable to secure the loan. The factoring process works when the borrower sells all or some of its unpaid invoices to a factoring agent at a discount. The invoice factoring agent then collects on the invoices and sends the balance to the business, less fees which are calculated at a set factor rate.
Crowdfunding can be a way to raise capital without loan approval. It works when an individual, or business owner, collects many small contributions from different investors or donors. Most crowdfunding is done using platforms like GoFundMe or Kickstarter. Contributors may expect nothing in return or invest funds with the understanding they’ll receive a reward.
Business Credit Cards
Business credit cards are a great financing tool for startup business owners or seasoned entrepreneurs that want to have credit available in case of an unexpected expense, like a repair or large purchase. The financing costs of credit cards can be higher than loans because the interest rates are typically higher. Business credit cards work like personal credit cards, except the activity is only reported to the business’s credit history.
Before applying for a small business loan, entrepreneurs should be familiar with the most common loan stipulations, including credit, income, time in business, current debt, and collateral. The application and approval process varies depending on the type of loan product and the business owner’s choice of lender. Once they understand each of the eligibility requirements, a business owner should consider their desired repayment terms and purpose for the loan to choose the best financing solution. For Joyal Gonsalves and Sarvinder Singh, owners of Taste of Mumbai, the best financing solution was funding arranged by Biz2Credit. If you are considering business financing, reach out today to learn about your customized loan options.