How to Secure Startup Business Loans

Posted on April 19, 2021 in Loans

When attempting to start up a small business, there will eventually come a time when you need to secure outside funding. Paying for inventory, staff, or leasing the space for the business will all be fairly expensive in the beginning before the profits start rolling in. Traditional banks generally don’t like to get involved with unproven businesses as the risk of lending money is often too high. Once you become an established and profitable business, loans will be fairly simple to take out, but how do you get there when just starting out?

How To Apply For A Business Loan

Whenever you apply for small business financing, it’s important to know what information small business lenders will need to see. For the most part, you will need to present the following documents when applying for a business loan:

  • Up to three years of financial statements or tax returns
  • At least three months of bank statements
  • Accounts receivable reports
  • Proof of ownership

In addition to these documents, there will be other factors that will heavily influence whether or not you are approved for a small business loan. Credit score, cash flow, and a strong business plan are other factors that will dictate whether or not you receive your loan.

Credit Score

Credit reports are one of the most important tools that a lender will use in determining whether or not to approve a loan application. If your credit report shows a history of issues repaying debt, then you may be rejected for the desired loan. If you are considering a loan, you should at least have a credit score of 700 or higher. If your score is lower, you will have a hard time getting approved for a business loan regardless of the other factors involved. Start off by checking your personal and business credit scores to ensure that they are accurate. 

Sometimes, more commonly than you may think, they are inaccurate or have errors in them. Disputing, correcting, or removing these errors can help get your score a little higher in a hurry. You can order a free personal credit report yearly from each of the three credit reporting companies of TransUnion, Equifax, and Experian. In order to check your business credit score, contact Equifax, Experian, and Dun & Bradstreet.  In addition, you should attempt to drive down as much as debt as possible prior to applying for a business loan.

Most loans will require some form of a down payment, this is typically based on the borrower’s financial history and the collateral put up for the loan. Due to this, most loans range from 0 to 20% down payment, depending on credit score and existing debt.

Cash Flow

One of the first things that a lender will look at in order to gauge the health of your business is the cash flow. This is the measure of how much cash you have on hand in order to pay back a loan. An insufficient cash flow is a flaw that most lenders literally can not afford to overlook. Therefore, it’s one of the key factors that you need to consider when determining if you can afford to repay a loan. 

In order to figure out how large of a loan payment that you will be able to afford to repay, divide your net operating income by your total annual debt. This will give you your debt service coverage ratio. The ratio will be 1 if your cash flow is equal to your monthly loan payments. 

Although this ratio can be acceptable to lenders, they will typically prefer a ratio of 1.35 or higher, which demonstrates that you have a buffer built into your finances. 

Business Plan

In the financial world, it’s much better to have a solid and well thought out business plan as opposed to simply hoping for the best. Applying for a business loan without a business plan or one that’s merely half baked will not help your case for getting approved. While it isn’t uncommon for smaller businesses not to have a formalized business plan, it’s best to at least attempt to develop a comprehensive plan before applying for a loan. 

A standard business plan will include a summary of your company, market, products, and financials. You should also be prepared to thoroughly explain how you plan to use the money that you are attempting to borrow. For example, instead of asking for $100,000, it’s better to say you need $33,000 for inventory, $37,000 for new hires, $20,000 for upgrading the store, and $10,000 for advertising. 

At the bare minimum, you should be prepared to explain why you need a loan and your plan for how you intend to repay it.

Where To Get Small Business Loans

While a bank loan may be your first choice, it may ultimately be out of reach. Banks normally have very strict standards when lending money to small businesses, so it may be difficult to be approved. However, there are plenty of other options available for startup loans including:

SBA 7(a) Loans

For the most part, the Small Business Administration doesn’t make loans so much as it guarantees them. Individual lenders will be approved by the SBA to make loans under various SBA programs. There are several different types of SBA loans, but one of the most popular is the 7(a) program which offers loans up to $5 million. In the 2020 fiscal year, 17% of the money lent to small businesses through the 7(a) program went to start ups. However, getting an SBA loan isn’t necessarily a super fast or easy process, but the SBA Express loan program does try to speed it up, although these loans are typically for less than $350,000. 

There is no minimum personal credit score required, but for 7(a) loans of $350,000 or less, the SBA requires a minimum FICO SBSS credit score of at least 155 to avoid a manual credit review. This commercial credit score can take into account the personal credit of multiple owners in addition to the business credit of the business. SBA 7(a) loans are more likely to be granted to business owners with experience in their industry, or to those purchasing an existing business. 

SBA Microloans

SBA microloans are made by approved intermediaries, typically community development financial institutions and other non profit organizations. The maximum loan amount is $50,000, but the average loan is closer to $14,000. An SBA microloan is a term loan, with a maximum term of 72 months, with the average being for 40 months. Funds may be used for working capital or for the purchase of inventory, supplies, machinery, equipment, fixtures, and furniture. 

Equipment Financing

These loans are specifically designed to pay for the purchase of equipment and machinery, so depending on the business you are entering this may not be useful. In general, these loans will work similarly to conventional loans, with monthly repayment terms over a set period of time. The stipulation is that the proceeds must be used to purchase equipment or machinery.

 The lending standards of equipment financing can be much less strict than other loans because the equipment itself will be used as collateral. In other words, if you default on the loan, the lender will have the right to seize the equipment to cover the cost of their lost money. 

Business Credit Cards

Credit cards can be a safe and convenient way to pay for a purchase, but they are also easy access to unsecured loans in the form of credit lines. As a result, business credit cards can be a solid alternative to start up business loans. They can also be beneficial to helping you to separate business and personal finances, in addition to establish business credit. 

In order to qualify for a business credit card, the issuer will generally look into your personal credit scores and combined income of personal and business. If possible, try to find a card offering a 0% introductory rate offer. This will allow you to make purchases and carry the balance for several months without having to pay interest. A recent Federal Reserve Small Business Credit survey found that 53% of small businesses reported using credit cards in order to help fund their operations. 

The Takeaway

When trying to secure a startup business loan, it’s important you have a good credit score, solid cash flow, and a well thought out business plan. Attempting to secure a loan without these three factors will almost certainly end in denial.

Starting up a business can be a long process that will take lots of financial maneuvering. However, if you get your finances in order and come up with a solid business plan, you should be able to find a lender willing to extend the money that you need. 

SOURCES:

https://www.sba.gov/sites/default/files/2020-11/WebsiteReport_asof_20201127.pdf

https://www.fedsmallbusiness.org/medialibrary/FedSmallBusiness/files/2020/2020-sbcs-employer-firms-report

https://www.accountingtools.com/articles/what-is-cash-flow.html

https://aofund.org/resource/how-secure-startup-business-loan/

https://www.fedsmallbusiness.org/medialibrary/fedsmallbusiness/files/2019/sbcs-employer-firms-report.pdf

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