Setting up and running your own business may be a very difficult undertaking, but the rewards make everything worth it. It is risky and it requires a lot of hard work. You may need to overcome a many obstacles before you enjoy some semblance of success. However, it provides you the opportunity to set your own schedule, and be your own boss. No one can give you orders, and you can pay yourself the salary you think you deserve.
The issue of capital – or the lack thereof – is perhaps the biggest challenge that every new entrepreneur faces. After all, you need to have money to make more money. While it may take time to get your business in a financially healthy condition, there are ways that can help you get a head start. These include getting your much-needed business funding through business loans.
So, What Is a Business Loan?
A business loan is a financing option intended specifically to cover business-related expenses. It is usually extended by a bank or financial institution. The loan is expected to be paid back within a set period of time at a given interest rate. The interest rate charged on the loan depends on the debtor’s credit history as well as the perceived risk pertaining to his specific business.
Various Kinds of Business Loans
Other than the traditional bank-provided business loans, there are alternative types of business loans that an entrepreneur looking for funding can consider. These include, but are not limited to:
- Small Business Loan
- SBA Loan
- Business Cash Advance
- USDA Business Loan
Small Business Loan
“Small business loan” is actually a general term used to refer to various kinds of business financing options that cater to “mom & pop” stores and other types of small businesses. It is usually a loan product for an amount that ranges anywhere between $5,000 and $500,000 offered at competitive rates of interest and practical repayment terms. The loan cost and qualification requirements depend on the borrower’s ability and willingness to provide collateral, his credit history, and his company’s expected revenues.
Startup or Small Business Loan
There are many startup loans intended to help startup businesses. However, it is difficult to qualify for this type of loan. It usually requires presentation of a viable and comprehensive business plan that details about the company, including its structure, goals, target market, and marketing objectives.
Other than the detailed business plan, a lender may also require a high-value asset to secure the loan. This is because extending loans to startup businesses is perceived to be among the riskiest undertakings in the lending industry.
By definition, a startup is an unproven business that is still looking for its niche in the capital market. When a lender agrees to provide funding to a new business, it can be said that it is investing in the idea and capability of entrepreneur. If the business fails, the creditor stands to lose a significant amount of money.
To compensate for the risk, collateral is required, which can be any of the following:
- Home equity
- Company assets
- Personal guarantees
- Business equity
Business Cash Advance
Also known as merchant cash advance, a business cash advance is a small and quick business loan that is sometimes mistaken as the same as a personal cash advance. Despite the similarity in names, a business cash advance is a lot less costly than a personal loan such as a payday loan.
A merchant cash advance allows businesses in need of immediate access to cash to quickly address their financial needs that may include:
- Salary of employees
- Equipment upgrade
- Inventory purchase
- Securing a lease
It takes a short amount of time, usually 7-10 days to process a business cash advance application, and have the money deposited to the borrower’s account.
Likewise, many lenders are amenable to the idea of being paid based on the borrower’s credit card transactions. This means that payments for the loan will be drawn only from profits. Thus, when revenues are low, repayments will also be low, which is favorable to the business. Loan payments will increase accordingly once the business gains momentum and start to rake in more revenues. This kind of loan arrangement is perfect for entrepreneurs who want to lower the risk while at the same time obtaining a relatively small loan to cover immediate financial needs.
An SBA loan is a government-backed business financing option extended to qualified businesses in the US by the Small Business Administration or SBA, a government agency. It is a great low-interest financing package that small businesses in need of funds should consider. However, there is a single downside to this type of loan – the very strict qualifying requirements.
SBA Disaster Loan
Aside from granting regular and generic business loans, the SBA can also be relied upon for help in times of emergency situations. An SBA disaster loan comes with an extremely low interest rate, and payable at much longer than usual periods. It is available for businesses in disaster-stricken areas. Disasters include tornadoes, floods, droughts, and storms.
When the disaster loan is made available for specific areas struck by disasters, an announcement is made by the SBA on their website. SBA service centers are then set up proximate to the covered areas where applicants can file their loan requests. Applicants can also apply directly by calling the SBA.
USDA Business Loan
This is another government-backed financing option for businesses, but it is more exclusive compared to the regular loans made available by the SBA. A USDA business loan is offered by the US Department of Agriculture specifically to businesses, including startups, in rural areas.
Following are the uses of the loan:
- Working capital
- Machinery and equipment purchase
- Building and property acquisition
- Refinancing of specific types of existing loans
Cost of Business Loans
The total cost associated with commercial loans pertains mainly to interest rates and payment terms (or how long the loan is to be repaid). For example, if a mortgage is taken out for a term of 30 years, it means that the borrower has to pay the loan in installments for a period of 30 years, after which the mortgage will be deemed complete.
The terms vary depending on the type of loan and the amount applied for. In general, the longer the term, the bigger the amount of interest will accrue. Thus, the loan becomes more expensive.
Interest is computed and accumulates based on the given rate, and is affected by various factors, the most significant of which include the following:
- Borrower’s credit score
- Value of offered collateral
- Current economic and political climate
- Current level of success the borrower’s business enjoys (for existing businesses)
- Overall perceived credit risk of the applicant.
Similar to other types of loan products, business loans are significantly affected by the borrower’s credit rating, specifically in terms of getting favorable interest rates. Simply put, the credit score is an indication of a loan applicant’s credit-worthiness. The higher the score, the lesser the risk in the eyes of the lender, and this is rewarded in the form of a lower interest rate.
This does not mean, however, that you cannot obtain a business loan if you have a bad credit. You can still qualify for a loan, even if you have no credit history to speak of. There are lenders who specialize in extending loans to borrowers with poor or no credit history, but you can expect to be charged with a higher interest rate if you go by this route.
Perceived and Current Business Success
A business’s perceived and current success is heavily considered by lenders when deciding whether to approve or deny a loan application. If the business is deemed to be profitable, lenders will think that the proceeds of the loan will be put to optimum use, and will most likely be repaid.
If little success is expected or is seen on the borrower’s business, on the other hand, lenders may think twice about approving the loan, for fear of not getting their money back.
It is therefore important to have an impressive track record or to present a clear-cut plan on how you intend to steer your business to success in order to improve your chances in obtaining a business loan.
Collateral pertains to something of high value that a borrower provides the lender to mitigate the risks of extending a loan. Business loans almost always require collateral. The higher the value of the collateral, the better the interest rates will be.
Economic and Political Climate
In 2008, the collapse of the housing market made it seemingly impossible to obtain a mortgage even if you can still afford to pay. Likewise, in 2013, the government shutdown due to lack of funding caused all pending loan applications to be put on hold because lenders were unable to perform background checks and gather necessary information provided by the federal government.
These are shining examples on how the country’s economic and political state can affect not only the availability of loans, but the interest rates as well. If the country is in economic or political shambles, lenders will try to hedge the perceived risk by charging more in exchange for loan approval.
All the previously mentioned factors contribute to the overall risk the lender assumes when lending money. They also affect the rate of interest that will form part of the total cost of the loan to the borrower.
If loan applicants are not happy with the interest rate offered, they have the option to look for other possible lenders and ask for quotes. If no offer with favorable terms is received, then improving one’s perceived credit-worthiness in the eyes of lenders should be a priority.
It may be true that some factors are beyond the borrowers’ control, improving the credit score can be easily achieved. Instead of just accepting the loan offer with unfavorable terms, a borrower can first try to improve his credit reputation. Once a better credit score is achieved, it would be easier to get better loan offers.
Getting Commercial Financing
If you’re looking for ways to finance your startup, getting a business loan is a viable option. Although the business loan application process may be more complex than other types of borrowing, it is comparatively easier and less stressful than establishing and running your own company, which you have already hurdled.
There are two options you can choose from. You can either apply for a business loan or apply for a merchant cash advance.
Business Loan Application Process
The business loan application process starts way before approaching a possible lender. You must first prepare a business plan; otherwise, you may not even be allowed to apply.
Once you have a sound business plan, collate your income reports and personal tax data. This is particularly important if you are try to secure a loan for your startup since your business has no track record to show yet. Thus, prospective lenders would be more interested about your personal information.
When applying for business loans, aside from submitting a detailed plan, you also have to meet with lenders in person. Thus, you have to clearly explain and justify the loan you are requesting. Be sure to know every detail of where the loan proceeds will go, as well as how you plan to pay the loan.
Approach your preferred lender only when you are ready. File your application with all supporting documents attached, then wait for a response. After reviewing your submission, the lender will let you know whether your application is approved or denied.
Merchant Advance Application Process
The process of application for a merchant cash advance is much quicker than that of traditional business loans. You only have to fill up and submit an application form that is usually available online.
An underwriter will then review your application, after which you will be contacted for the results of their evaluation. If your application is approved, do not accept the offer immediately; perform due diligence first and clarify the following:
- All the fees that you have to pay related to the merchant cash advance
- How repayment will be made – fixed installments direct from your bank account or a portion of every credit card sale
- The annual percentage rate (APR)
Only when you get acceptable answers should you accept the offer and expect to receive the proceeds within a few days. Usually, it will be deposited to your company’s bank account.