Friday, April 3, 2020

Lesson #324: A Guide to Small Business Loans

Posted By: George Deeb - 4/03/2020

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As you know, in the wake of the Coronavirus, the federal government passed the CARES Act in March 2020, an economic stimulus recovery package, where employers who retain their employees through June 30, 2020, will be rewarded by having their payroll and certain other costs paid for with the loan, entirely forgiven.  As I write this post, the application period is just opening today, and there is a mad rush for the potential of "free money" from the government.  So if you think you qualify, you really should be applying today.  As you can imagine, the demand is far going to exceed the supply of capital, even if government is shelling out hundreds of billions of dollars from this program.

So, when that capital runs dry, what are the rest of you going to need to do, to find your much needed capital infusion.  You are going to have to seek it out from traditional lending sources.  That will be a lot harder to do, and the loan won't be forgiven, but it may just be the lifeline your business needs to survive the current economic downturn.  This post summarizes the types of small business loans that are out there, the typical requirements and the typical process you should expect.

In helping me write this post, I wanted to give a special shout out to Luke Hayward, my colleague at Funding Circle, an online lending platform for small businesses, who is an expert in this space who shared his wisdom on the lending market with me.

An Introduction

Many small businesses may not be able to meet all of their financial needs with the money they have on hand. It’s not that they don’t make enough money, but circumstances often require businesses to borrow. Maybe it is just a slow time of year, or the business might need to buy a new piece of equipment, or in the current times--a national pandemic. Whatever the case may be, it is not uncommon for a small business to need a loan.

While the need to borrow might be common, it isn’t always easy for small businesses to get the funding they need. This isn’t just about getting approved for a loan, which is difficult enough task in itself.  But, many small business owners simply don’t understand all of their borrowing options, and this can lead to them taking a loan that is not a good fit for their business.

With this introduction to small business loans, owners can gain a better understanding of their borrowing options, for both in good times, and the current bad economic climate we are currently living in. This knowledge will make it easier to find a loan when you need one, and it will also help you find the lending option that is right for your business.

Types of Loans

Term Loans

A term loan is one of the more straightforward options for small business financing. The business owner gets a lump sum of cash and they have to pay it back with interest over an agreed-upon period. Term loans are a flexible option that can be used to cover a wide range of expenses, and the funding can often be released in as little as two days.

Business Line of Credit

This is a type of revolving credit. A financial institution gives the business a line of credit with a limit. As long as the line is open, the business owner can borrow up to the limit and they only have to pay interest on what they borrow.

SBA Loans

In addition to the Paycheck Protection Program, which is getting all the attention this month, the Small Business Administration (SBA) has a range of other loan programs that are designed to help small businesses. Basically, these loans are backed by the SBA. The intention is to help small business owners get loans that they might otherwise not be approved for and to help them get loans at lower interest rates.

Equipment Loans

These are loans that are designed specifically for helping small businesses finance the purchase of a piece of equipment or any other asset that is vital to day-to-day operations, where the asset is often collateral for the loan.

Merchant Cash Advance 

With this option, the business gets a lump sum of cash that is guaranteed by future credit and debit card sales. This can be a way for a small business to access money quickly, but a merchant cash advance usually comes with high interest rates.

Invoice Factoring

This is a way for a business to get money for outstanding invoices. The lender gives you a percentage of the outstanding invoices and then they collect on the accounts. Invoice financing can be a good option for businesses that need income faster than the invoices are paid by their clients.

Peer-to-Peer Lending

P2P lending is a newer option. The business owner uses an online platform to connect with lenders. In most cases, the business would borrow from a group of investors who would all have a right to a percentage of the interest that is paid on the loan.

Venture Debt

And, I have previously written about venture debt as a a funding source.  Venture debt is a hybrid between debt and equity, and often comes at expected returns on invested capital somewhere in between stand-alone debt or equity financings.  I won't repeat the details here, but please re-read the above linked article.

It is important to note that the terms of the loan will vary significantly for different lending products. You could find short-term loans that are for just a few months, and there are also loans that can be repaid over many years. Along with that, you also have to consider the interest rates with different lending products and fees that may be associated with borrowing. Many loans also have penalties for things like late payments or for paying the loan off too early.

What a Business Needs to Get a Loan

A small business is not going to get approved for a loan just because they ask for one. Each lender has requirements that must be met for the borrower to get approval. These requirements vary from one lender to the next. Even with the same lender, the requirements may vary depending on the type of loan.

The following are a few of the things you will need to prepare in order to get approved for a loan:

Cash Flow/Income

Most lenders are going to want to see your cash flow and income before approving a loan. The better your situation is in the regard, the more likely you are to be approved. Higher income can also increase the amount that a lender is willing to approve.  Your operating income typically needs to be at least 2x the expected interest expense on the loan, and your business plan must show a reasonable path to repay the loan within 18 months or so.

Debt

It isn’t just about income – lenders are also going to want to consider your debt to income ratio. If it looks like the business is already overburdened with debt, it will be difficult to get approved for a new loan.  This works best for companies with under 50% debt to invested capital ratios, including any new loans that are being applied for.

Credit History

Your personal credit history is going to be a factor when applying for a small business loan. Check your credit report and try to improve your score before applying for a small business loan.

Business Age

The reality is that new businesses are more likely to fail. For that reason, lenders tend to favor businesses that have been in operation for at least a few years. If you have been in business for less than a year, it will be difficult to find financing.

Collateral 

It is possible to get an unsecured loan, but lenders view collateralized loans as less of a risk. If you have collateral (e.g., assets, receivables, invoices, real estate), it will be easier to obtain financing and it may even help to reduce the cost of the loan.

Turnaround Time to Get a Loan

The amount of time it takes to get approved and receive funds can be an important factor for many small businesses. This is especially true if you need the money in a hurry, as most of you likely are in today's market conditions.

Unfortunately, there is no straightforward answer concerning how long it takes to get a loan. The approval process will vary from one institution to the next. You will also find that different types of loans might have different approval times.

You will find some financing options that offer cash in as little as 24 hours, but there are also situations where it might take weeks for a loan to get approved. In general, the options that offer fast cash tend to have higher interest rates and more fees, but they can be a good option if your business needs money right away.

How much can a business borrow?

You may also wonder what your borrowing limit is for different types of loans. Different lenders have different limits. Furthermore, the lender is going to consider things like your income and debt to determine how much they are willing to lend.

On the high end, you could potentially get a loan that is for a million dollars or more. Looking at the lower end of the lending market, you also have options like microloans that can offer a sum of just a few hundred dollars.

What is the process of getting a loan?

If you want to get the financing you need and find the right loan, you are going to need to be prepared. The following are some of the steps you should take when looking for a small business loan:

Create a Business Plan

You need to be able to show lenders you have a viable business plan. Not only that, but you want to be able to tell them why you need the money and show them your plan for paying it back.

Get Your Credit Report

Check your credit score and get your credit report from the three major reporting agencies. You should also review the reports for any issues. If you find any problems, try to get the reports fixed before applying for a loan.

Compare Options

Your business plan should provide you with the information you need to know which type of loan is right for your business. Look at the available options and find lenders that offer products that are suited to the financial needs of your business.

Apply for a Loan

Once you find a lender that offers the best loan for your business, start the application process. You should try to have a few options available since you might not get approved for the first loan you apply for.

Popular Online Lending Platforms

The internet age has made it easier for businesses to find and compare loans. You have a range of online lending platforms that can help to ease the process and many of these platforms cater to specific types of loans.

There are many online lending platforms that invest their own capital or are a marketplace where lenders compete; these include Kabbage,  BlueVine, SmartBiz, OnDeck, QuarterSpot, FundBox and Street Shares.  Sites like Funding Circle and LendingClub are two of the top names for P2P lending. Kiva and LoanMe are good sites for microloans. And, that doesn't even talk about industry specific sites, like Fundrise, which is an online platform focused on the real estate market.  Or, sites that have a specific purpose, like Currency, for equipment loans.  And, don't forget about your crowdfunding options.  So, do your online research and figure out the best funding site for you.

Depending on the needs of your business, you should be able to find an online platform that offers loans that can meet your needs – you just need to take the time to find the right option for your business.

Concluding Thoughts

As you can see, there are plenty of small business loan options to consider; you simply need to know where to look!  Thanks again to Luke Hayward for his help here on helping me write this post.  If you think Funding Circle could be a good option for your business, feel free to email Luke at luke.hayward@ fundingcircle.com, and he will help point you in the right direction.  I know the current market conditions in the wake of the Coronavirus may feel bleak, but I promise you, there is a path forward with a light at the end of the tunnel.


For future posts, please follow me on Twitter at: @georgedeeb.




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