SmallBizLady: Can I qualify for a business loan?
Marc Prosser: Small business lenders are generally looking for your business to be operating for 2 years, for your business to be generating an average revenue of $10,000 per month, and for you to have a personal credit score above 650 with no recent bankruptcies or tax liens. Essentially, they want your business to have a track record and to prove its ability to generate consistent revenue. They also want to know that you have a history of paying your bills on time. If you meet those qualifications, you’ll probably find lenders willing to work with you.
SmallBizLady: What’s a personal guarantee? And if why am I asked to personally guarantee a business loan?
Marc Prosser: A personal guarantee means you’re agreeing to pledge your personal income and assets to back a loan. When you personally guarantee a loan, you and your stuff (your home, your car, your accounts, etc.) is on the hook for the loan. If you default on the loan, the lender can collect from you personally. The reason small business lenders generally ask you to personally guarantee their loans is because it makes them safer. Small business loans are risky. If a business goes under, there typically isn’t too much of value to collect on to recoup losses on a loan. A personal guarantee does more to ensure the lender will be repaid.
SmallBizLady: Does the government loan money to small businesses?
Marc Prosser: Kind of. There are popular small business loans that people refer to as SBA loans. These are loans or lines of credit that get a guarantee from the Small Business Administration. The SBA sets rules that ensure SBA loans have very low interest rates and long repayments terms, which make them very affordable. But you still get SBA loan from a traditional small business lender, like a bank or credit union. You apply with the lender and they need to approve and underwrite your loan. You don’t interact with the SBA at all, in most cases. If the lender thinks your loan might qualify for the SBA guarantee, they will seek it from the SBA.
SmallBizLady: What are my options if I can’t qualify for a traditional small business loan?
Marc Prosser: If you haven’t been in business very long, don’t have perfect personal credit, or are unable to provide enough collateral for a traditional loan, there are plenty of options. Startups, for example, can raise money from family and friends, borrow against the equity in their home, seek angel or venture capital funding, or do a rollover for business startups. More established business can look into invoice factoring, purchase order financing, or revenue based loans. There are lots of niche financing options out there for small businesses and you can usually find a lender willing to focus their lending decision on your strengths.
SmallBizLady: What are rollovers for business startups?
Marc Prosser: A rollover for business startups, which is also called a ROBS, way for startups to invest some of their retirement savings in their startup without paying early withdrawal penalties of income taxes. It’s not a loan and it isn’t cashing out your retirement account. Essentially, you roll the funds over into an new 401k, that 401k buys shares in your startup. Your new 401k now owns shares in your business and your business has access to the capital it needs. A ROBS can fund 100% of your business or be used in combination with more traditional startup financing like a home equity loan or SBA loan. The nice thing about a ROBS is, unlike a loan, you don’t have to qualify for them and they can make funds available to your startup relatively quickly.
SmallBizLady: Let’s say I need a business loan. How do I go about finding the best small business loan for me and my business?
Marc Prosser: Finding the best loan for your small business will require you to know what you’re coming to the table with. Before you start submitting applications, you’ll want to answer a few questions to help narrow things down. How long have you been operating? How much revenue do you generate annually and how much of that is profit & owner salary? Do you have collateral? What is your credit score? How much are you looking to borrow? What will those funds be used for? How quickly do you need funding?
SmallBizLady: Why is it important to review my finances before applying for a small business loan?
Marc Prosser: Applying for small business financing can be time consuming. By carefully reviewing your finances prior to shopping for a business loan, you can eliminate a lot of possible lenders and loans. And that will do two things for you: 1) It will save you from committing time, energy, and attention to loans you don’t want or wouldn’t qualify for. 2) It will allow you to more effectively compare similar loans and choose the best one for you.
SmallBizLady: How much do small business loans cost?
Marc Prosser: The cost of the loans vary widely and depend on your strength as a borrower, your business’s financial health, and the use of the loan. I like to think of business loans in three general groups: short term loans (usually under 18 months), medium term loans (generally up to 5 years), and long term loans (usually 7-25 years). Short term loans can have APRs that start at 40% and go to 85%+. Medium term loans will typically have APRs that range from 11% – 28%. Long term loans can have APRs from 5% – 9%. In general, most small business financing tends to fall in one of those ranges.
SmallBizLady: How much do personal finances factor into small business borrowing?
Marc Prosser: Personal finances play a significant role in the cost majority of small business borrowing, especially when you’re a startup or young business. Your credit score, personal debt to income ratio, and net worth all weigh heavily on an underwriter’s lending decision. That’s why it’s so important not to neglect your personal finances. If you expect you’ll need to borrow for your business, it makes sense to give your personal finance a check up.
SmallBizLady: Is there a common mistake that small business owners make with borrowing?
Marc Prosser: One mistake I see, especially from newer businesses and first time borrowers, is thinking (incorrectly) that banks are there to make loans. They’re not. Banks have the same goal you do: make money. The way they do that is by making safe loans that they’re confident will be repaid. What does that mean for small business owners? When you seek financing, you need to show the lender you have a specific plan for the funds you want to borrow, that those plans will increase your revenues by a specific amount, and that you’ll be able to afford all current business expenses plus the new loan payment (with room to spare). You have to come in prepared with all your necessary financials documents, a solid business plan with complete financial projections,
SmallBizLady: How much should a small business borrow?
Marc Prosser: The short answer is as much and little as necessary. You don’t want to pay interest on capital you don’t have a productive use for. You also don’t want to miss out on growth opportunities because you’re too risk averse to borrow. Small business loans come in all size, from a few hundred dollars to $20MM and more. But in most cases, a lender will limit your borrowing to some percentage of the revenue you have or the value of an asset you’re looking to buy. Many short term lenders will limit your borrowing to 10-15% of your annual revenue. If you’re borrowing to purchase a larger asset (like real estate), the lender might only let you borrow 65-90% of the value of that asset. In that way, a lender will typically set a maximum borrowing limit for you.
SmallBizLady: Is there ever a reason why a business shouldn’t borrow money?
Marc Prosser: There are countless reasons a small business should avoid borrowing money, but in the end they all come down to the same question: Will the borrowing help my business grow? If you’ve tested an idea and have high confidence that the idea can grow your business’s revenue, borrowing funds can be a great way to accelerate that growth. On the other hand, borrowing money to test an unproven idea can be very risky and, in most cases, completely unnecessary. Testing an idea can often be done affordably with existing revenue or some small amount of seed money. Once you’re ready to scale a promising idea, then you can look into borrowing.
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