More than 32.5 million small businesses are the backbone of the United States economy.
But that doesn't mean your fate is secured. Unfortunately, 20% of small businesses fail within the first year. And financial hurdles are one of the top reasons for failure.
So when you are strapped for cash and looking for a small business loan as a relief, it's best to understand the ins and outs before signing on the dotted line.
In this article, we'll cover everything you need to know before applying for a small business loan to drive future growth.
Let's dive in.
Banks don't hand out money to anyone. They loan money to the entities that are the most likely to repay the funds, so they can make their money back and then some.
And since banks are notoriously stingy with their cash, it might seem like there's no way you can convince them to give you any money — especially if you're a new business that lacks a proven track record.
Choosing the proper legal structure for your business can play a significant role in your ability to secure a loan and protect your personal assets if anything goes wrong.
A popular choice among small business entrepreneurs is the LLC structure. Many choose this option because it comes with many benefits, such as independently maintaining assets and liabilities that are separated from the business operator. You can use competitor analysis tools and see and get an idea of the type of structures they use for their business.
So when you apply for the loan, the small business loan won't affect your personal credit and is owned by the LLC. Further, forming an LLC shows your seriousness about your venture and can make it easier to work with banks and find suppliers.
To operate as an LLC, you can either establish it through a lawyer or an online LLC formation service. Whichever you choose, be sure to maintain and secure all of your paperwork. You'll need to present it when applying for a small business loan (more on that later).
There are several different types of small business loans, and the best one for your business depends on what you need it for.
For example, if you're a women's clothing business applying for a loan to expand inventory or hire new employees, a short-term loan with a variable interest rate may be best.
On the other hand, if you are a fleet management business looking to invest in enhanced security equipment, technology, or electronic logging devices, a longer-term fixed-rate loan might be better suited.
Let's take a closer look at the three main types of small business loans in more detail.
With a term loan, you receive a single lump sum. You pay it back in increments over the agreed term plus interest. Term loans range from $5,000 to $2,000,000 and often offer fixed interest rates.
This loan is ideal for larger equipment purchases such as server equipment for your VDS (Virtual Dedicated Server) or extensive renovations and helps if your income isn't stable enough to qualify for a business line of credit.
You can draw down funds as needed with a business line of credit.
You'll usually pay interest only on the amount you use, with no set payment schedule or term limit like with a term loan. A business line of credit allows you to take out more money whenever needed without having to reapply for additional financing if your cash flow changes.
With this option, you can get $1,000 to $500,000, which is ideal for those who need quick access to cash but don't want their money tied up in one big project.
The Small Business Administration (SBA), a government agency, provides financial and technical assistance to small businesses to help them grow, create jobs, and contribute to the economy.
While each lender has specific requirements and guidelines, the SBA's loans are generally available to businesses that might not get help through other terms of funding.
The maximum loan amount varies depending on state law and the type of business, but most fall between $50,000 and $5,000,000.
When applying for a small business loan, you must be realistic about the money you need. Answering this question correctly will help you avoid a situation where your business has too much debt, which could lead to financial trouble down the road.
Remember that debt will affect the value of your business if you decide to sell. When selling a business, it's important to consider company debt and liabilities as part of the exit planning process.
So take a hard look at your expected financial obligations. Not just right now in the moment, but what you might need as you continue to grow.
Leverage your business plan to help determine how much money your business needs to succeed. It should give you an idea of other expenses that might come up along the way, like advertising costs or new equipment purchases.
For example, in the early stages of your business, you might get away with using free tools to store your company data. But as you grow, you may need space in a colocation data center for secure storage and management of your sensitive company and client information.
Tools and software simplifies your task in data collection and storage. With customer software development you can digitize your business, understand your clients’ needs and give appropriate solutions.
Are you still feeling lost? It never hurts to chat with an accountant. They can help you estimate how much your business will make and what expenses will likely occur in the coming months or years.
When applying for a small business loan, the lender will ask you to complete an application. This process is similar to applying for a home mortgage or personal loan — where the lender runs a credit check and performs a financial analysis of your business.
You'll also need to provide documents proving your income and assets. When it comes time to close on the loan, you'll be required to sign some paperwork that spells out all the terms of your agreement with the lender.
Pay extra attention to these three things:
Find out how much the loan will cost you over the years with a business loan calculator. Make sure it seems reasonable and aligns with your budget and borrowing needs.
There's a lot to think about when applying for a small business loan, but as long as you do your homework, you can be confident that you're making the right choice for your company.
By understanding all of these factors before applying, you'll be able to find the best option for your business and have an easier time securing funding.
About the author
Kelly Moser is the co-founder and editor at Home & Jet, a digital magazine for the modern era. She's also an expert in freelance writing and content marketing for SaaS, Fintech, and ecommerce startups.
