A clothing startup may need production financing to fulfill a large production order from a thriving boutique.
A construction company may need equipment leasing to pay for a new excavator, bulldozer or boom lift for a massive city contract.
A corner restaurant may need a merchant cash advance to survive a winter rut.
Small businesses need loans for different reasons. But before considering the different products available, ask yourself these questions first.
STEP 1: SELF ASSESSMENT
1. “Would I lend my own money to my business?”
2. “Do my customers recommend my business to their friends and family?”
3. “Do my employees feel engaged, valued and good about coming to work?”
4. “Do I have a mentor or experienced entrepreneur at my side?”
5. “Are my financials current?”
STEP 2: CONQUER CASH-FLOW & FINANCIALS FIRST
Once you've finished your assessment, get your paperwork in order.
- To obtain a traditional bank loan, it’s important to understand what lenders are looking for. You’ll be evaluated on business profitability, cash flow, credit history and collateral.
Inaccurate and incomplete financial records are the leading setbacks for small-business owners in the lending process, according to Ami Kassar of MultiFunding, a loan advisory and brokerage in Pennsylvania that works with small businesses across the country.
It's important to reconcile books and ensure that all money is accounted for by staying current on your payments, invoices, receipts, and tax financials, Kassar says. He adds that it’s best to disclose any concerns to the lender up front.
To make sure your financials are current, take time at the end of each week or month to review and update your balance sheets, accounts receivables, current liabilities, and profit and loss statements. As a small business owner, you should be able to discuss these financials, especially when seeking a loan.
If you struggle to find the time, consider hiring an accountant on a part-time basis to assist your financial department either monthly or quarterly.
Aaron Lenhart, risk management consultant at Sageworks, says when pursuing a bank loan, a small-business owner’s best bet is to seek relationship-based banking. Start with community banks or local branches that have proven, longstanding connections with the community, Lenhart advises. Make sure they're tapped into the local economy.
STEP 3: RESEARCH ALL AVAILABLE OPTIONS
It's possible your business can't qualify for a traditional bank loan. If that's the case, research and review alternative financing and consult with a professional to determine which work best for your small business. Kassar suggests looking to loans issued by the Small Business Administration (SBA) which offers a similar option to a bank loan.
- SBA loans usually have more reasonable interest rates, though the application process can be paperwork-intensive.
Many regulations govern this loan program so it is critical to deal with an SBA preferred lender and connect with a representative at a bank with SBA experience.
If you can’t obtain a bank or SBA loan, entrepreneurs can resort to alternative lending from institutions like CAN Capital, Merchant Cash and Capital, and OnDeck.
- For business owners in need of meeting urgent obligations, merchant cash advances offer cash up front. The lender receives a set percentage of future credit/debit card sales until the loan is repaid.
Unlike banks and the SBA loan program, alternative lenders are unregulated so it’s important to not rush this process. Know what lien they’re placing on your company, the annual percentage rate (APR) and interest rate (IR). These are often short-term loans of six months with an average APR of 56%.
Lenders like Dealstruck, Funding Circle, Fundation and Lending Club offer amortizations of up to five years and have minimal to no pre-pay penalties.
While Kassar calls alternative lenders the “wild wild west” of lending, advocates like Billy Morrissey, CEO of Merchant Solutions Group, says his industry provided a lifeline to small business during the credit crisis and has continued to gain momentum ever since.
Here’s a primer on some other options:
- A line of credit is a set amount, similar to a credit card. It’s mostly available to well-established businesses.
- Commercial mortgages are for businesses seeking land or buildings. Owners will pay equal monthly payments for a set number of years with the property used as collateral.
- If you’re seeking to lower finance charges, consider a debt consolidation loan to refinance current debts or secure a lower interest rate.
- Many service-based businesses turn to accounts receivable financing/factoring, where the lenders purchases the borrowers accounts receivables with cash up front.
- Crowdfunding for debt can offer 3-5 year amortization periods.
- Leasing equipment from a manufacturer or specialized lender can help you free up capital for other uses.
- In an equipment sales lease back, the lender buys equipment at a percentage of liquidation value and later “resells” equipment back to you once the loan is repaid. This is useful for businesses when the equipment is a primary asset.
STEP 4: REALITY CHECK
While the first round of self-assessment questions is rigorous and requires brutal honesty, Kassar says it’s best to maintain a cautionary approach. After selecting your loan option, consider how much money you really need because often, it’s a lot less than you think.
Also, make sure you get a paying customer and a purchase order in place. Gathering positive referrals and demonstrating growth are essential to becoming bankable.
STEP 5: SLEEP ON IT!
Even if you qualify for a loan product, weigh all of your options and understand the terms and conditions. Review all the associated risks such as pre-payment or early termination penalties. Before you sign at the closing table, ask yourself:
- “Will this loan allow me to focus on growing my business and making it more profitable?”
- “Will I stop lying awake at night worrying about cash flow?”
- “Is the expense worth it?”
- “Will this loan address the problem that is actually causing my cash flow problems?”
And last remember that no loan is permanent, so review your debt at least once a year.