If you own a small business, chances are at some point you’ll need a loan. Perhaps you want to upgrade your equipment, expand to a new location, or introduce a new product. There are many good reasons for an entrepreneur to take on debt in order to inject cash into their business, but it should be done in the right way. As with so many business moves, planning and research are keys to success.
Determining How Much to Borrow
Once you’ve decided to seek out a loan, you will need to evaluate how much money you need and how much debt you can responsibly take on.
The worst thing you can do is go to a bank and ask, ‘How much can I borrow?’” says Mark Quinn, district director at the Small Business Administration in San Francisco. “You should know exactly how much you need, exactly how it will be used and exactly how it will be repaid. That way, they know you’ve done your homework.
The size of small business loans varies greatly depending on the type and size of the business and the purpose of the loan. The median loan size guaranteed by the SBA is $130,000 to $140,000, but their loans range from $5,000 (microloans) to $5 million (the largest loan the SBA will guarantee).
When figuring out how much money you need to borrow, consider what you plan to do with the loan and develop a detailed budget. Get a price for any equipment or supplies you will be purchasing. Look at financial statements to get a sense of whether your revenues will allow you to pay back the loan.
Take advantage of the free counseling, training and classes offered through the SBA’s various programs. Look for a Small Business Development Center or a SCORE mentor near you. They can help you develop your loan proposal and identify an appropriate lender.
How to Get a Small Business Loan
So you’re ready to take out a loan. You will want to make sure you have all your ducks in a row before you visit the lender. This includes finding the right lender for your needs and collecting all of your information ahead of time.
Am I Eligible for a Business Loan?
Different banks, credit unions or non-profit lenders will have their own criteria for determining your eligibility for a loan, but in the end, it boils down to risk. Most lenders will consider these factors when reviewing your loan application:
Your credit score and credit history
Most lenders will check both your personal and business credit record. You can get your personal credit report from each of the major credit bureaus for free once a year.
How long you’ve been in business
From the lender’s perspective, the longer you have been in business, the lower your risk. If you can prove a successful track record, your chances of securing a loan are better. They will also want to look at the experience of your management team, your customer base and your market share.
The nature of your business
Certain businesses, such as doctor’s offices or hospitals, are considered less risky than others, such as restaurants, says Quinn. It doesn’t mean you can’t get a loan for your restaurant, but you may want to consider alternatives to traditional banks (like a microloan through a non-profit).
The purpose of the loan/business plan
The lender will want to see a well-thought-out rationale for the loan and how it will allow for repayment.
Your equity in the business
Most lenders will look at your debt-to-equity ratio (the amount you have borrowed compared to the amount you have invested in the business). They want to see that you have “skin in the game.” Most banks do not want your total debt to be more than four times your equity in the business, according to the SBA.
Your ability to pay back the loan, including collateral (personal and business assets)
In addition to reviewing your revenue and profits, the lender will want to know you can pay back the loan, even if the business fails.
How to Choose Your Lender
Gone are the days when your bank was the only source of loans. Today you can access loans from traditional banks, credit unions, community development banks, non-profit organizations and a wide array of online lenders. The purpose of the loan and the nature of your business will help determine which lender is right for you.
Here are some of your lender options:
Larger, more established businesses with good credit may choose a loan from a traditional bank. Large banks are wary of lending to small businesses because it is not as profitable, but it you have a relationship with the local branch of a national bank, that can help.
Community development banks
These smaller community financial institutions may be more willing to lend you money for your startup than a large traditional bank.
Credit unions are rapidly expanding their small business lending. Between 2008 and 2014, credit union lending to small businesses increased by 60 percent.
Online lenders represent a small but rapidly growing sector of the small business loan market. They can often provide loans faster thanks to a streamlined system for determining eligibility. But caution is needed, as some of these lenders charge very high interest rates.
Ask your lender if they offer SBA loans. The SBA doesn’t make loans directly to small businesses, but it guarantees a percentage (up to 85 percent) of the loan. This reduces the risk to lenders, making it more likely they will lend to small businesses. SBA-backed loans are rapidly growing. In FY 2014, SBA approved 52,044 loans for a total of $19.19 billion. SBA loans offer some of the lowest interest rates and best terms.
Business Loans and Special Groups
There are more specialized loan programs today than ever before. To promote business ownership among traditionally underserved populations, the government offers special financing for these groups. For example:
The SBA Office of Women’s Business Ownership (OWBO) supports women entrepreneurs through training and counseling, financing and awarding of federal contracts. Through Women’s Business Centers in almost every state, the SBA helps women entrepreneurs start and grow their businesses. In 2009, the SBA backed nearly 10,000 loans worth about $2 billion to women entrepreneurs.
The Minority Business Development Agency, part of the Department of Commerce, supports a network of Minority Business Centers around the country that helps entrepreneurs secure loans, compete for contracts, and grow their businesses.
If you are a veteran, the SBA has a number of programs designed to help you and your business. The Boots to Business program offers veterans training and assistance to start a new business. There are 15 Veterans Business Outreach Centers around the country dedicated to training, mentoring and providing referrals for veterans who own, or want to start, a small business.
Budding entrepreneurs can access a wide variety of free counseling, training and other resources through the SBA’s Office of Entrepreneurship Education. Programs like SCORE, the Emerging Leaders Initiative and the online learning portal all provide small business owners with much-needed tools to make their businesses grow.
Mark Quinn is the district director of the San Francisco office of the Small Business Administration (SBA), where he has worked for the last 30 years. Here he offers some insight and advice to those interested in securing a loan.
How does an SBA loan work?
With our main loan guarantee program (7a), a commercial bank comes to us because they have a client who wants a loan but doesn’t meet all their lending criteria. If they can get an SBA guarantee for 75-80 percent of the loan, then they will make the loan. Usually the business doesn’t meet the criteria because it is too young, it’s a startup or it doesn’t have enough collateral. These are some of the reasons the bank will say it looks like a good credit risk, but doesn’t meet all the criteria.
What if I need my loan quickly? Doesn’t the SBA loan take a long time?
From the time you first talk to the bank until you get your loan, it will usually take about 45 to 60 days, depending on type of business and the type of loan you need. Most of that time is spent going back and forth with bank. The part of the process that’s in SBA hands is relatively short.
Many banks are considered SBA preferred lenders. We delegate authority to them to approve loans. They can decide to do a loan as an SBA loan without SBA review. So it doesn’t take longer to get an SBA loan from a preferred lender. If it’s not a preferred lender, it may take an additional 6-8 days. So yes, there’s a tradeoff. It takes a little longer, but the terms are usually better from the SBA.
How hard is it to get a traditional loan as a startup?
The majority of SBA loans are for expansion of existing businesses, but we fund more startups than banks traditionally do. Probably 25-30 percent of our deals are for start-ups. Some of these are for franchises, so they have a track record.
Restaurants and hotels are particularly difficult to fund. Those businesses have trouble getting conventional financing without a lot of equity and a long credit history.
The SBA Microloan program is often used by startups or relatively new businesses. These small loans are not as attractive to bigger lenders because they aren’t as profitable, so we do it through a network of non-profits. The SBA makes a direct loan to a nonprofit and they then break it up into $5,000 – $50,000 business loans with about 5-7 year terms.
What advice would you give to someone who wants financing for a small business in the first two years?
Especially for startups or early-stage businesses, most lenders want to see as much equity [as possible]. If you have any assets that can be used as collateral, it is important. The lender wants to see that you have skin in the game.
For folks who have startups and are looking for first-time financing, it is very important for them to take advantage of the SBA’s programs like SCORE Mentors, Women’s Business Centers, and Small Business Development Centers. Through these programs, we fund training, counseling, classes and one-on-one consulting for small businesses. This is where you can get information on getting prepared for commercial financing. It’s best to start there.
In the end it’s all about money, but in the beginning it should be about planning. Without planning, small business owners often get frustrated after they get turned down for a loan because they didn’t do their homework.
The mentoring and education program for small businesses, another program of the SBA.
A national network of small business development centers offering free training and advice to entrepreneurs. Type in your zip code to find an SBDC office near you.
A Smarter Choice
A website sponsored by the nation’s credit unions to help you find a credit union that will meet your needs.
Credit Reporting Agencies
The FDIC provides information on how to get your credit report from one of the three main credit reporting agencies.