Small Business Financing Options
Financing Options for Your Small & Medium Business
"...Whether you’re starting, running or growing a business, funding that business is the fundamental way of receiving funds. ...While business loans are common place, they are by no means easy to secure..."
Small & Medium business loans are a segment of the funding market secured from lenders, traditional banks, alternative lenders, and online technology funding platforms.
Whether you’re starting, running or growing a business, funding that business is the fundamental way of receiving funds. Most businesses think of banks as their go-to source for funding their business. But there are other lending options which SMB businesses can consider including, credit unions, commercial lending companies, government (SBA) backed loans, and online funding platforms, such as “Kickstarter”.
While business loans are common place, they are by no means easy to secure. Due to the risk lenders assume by making loans, borrowers are asked to meet certain requirements to secure their funding. In this article we’ll discuss the aspects of business loans, loan criteria, types, and how to choose a lender.
The Business Borrowing Credit Spectrum.
Lenders have a large pool of potential borrowers and see a vast range of creditworthiness from those borrowers. Based on where a business falls on the credit spectrum will determine the various options of lending products available to them. The businesses at the higher end of the credit spectrum can commonly secure loans of their choice at favorable rates, but those businesses further down the credit spectrum usually will have less financing options at less favorable rates and more restrictive loans.
Along with the broad credit spectrum there is also a vast spectrum of financial products from traditional banking and lending institution, and SBA lenders, serving the creditworthy borrowers, and many types of alternative lenders, including the newer fintech online platforms, serving both the more and lesser creditworthy borrowers. With funding options including both secured and unsecured loan products, with some products requiring guarantees from the borrower.
Fintech has helped bring more financing options to the small & medium business community, in some cases businesses are able to start the loan process in minutes by completing a simple online application. And the full online lending platforms bring both the investors & lenders together with borrowers and facilitating the financing. But in all cases. to qualify and secure financing options businesses will need to meet the requirements set by the lenders.
What do lenders look for when considering a business loan?
For many businesses the first stop when seeking funding is a bank or some other type of conventional lending institution, such as your local bank and credit union. These traditional lending institutions offer a variety of financial products, including term loans and SBA 7(a) loans.
Currently, with fintech and the continued rise of alternative lenders, there are many more financing options for the small & medium business community than there were in the past. Offering similar if not better terms then the traditional lenders, sometimes offering quicker turn around and additional lending options. With the rise of fintech, a small business owner can start the lending process in a few of minutes by completing a simple secure online application.
Your Business and Personal Credit Score Counts.
For a business, there are two types of credit scores that matter, your business credit report and your FICO credit score. Lenders will utilize this information to help determine if they will lend your business money, how much money, and the interest rate they will charge you on that loan.
- A business credit score is tied to your employer ID number, which can be registered with Equifax, Experian or Dun & Bradstreet. Each organization uses their own methodology of calculating a business credit score. For example, they’ll consider factors such as credit utilization, business size, age of business, public records and the owner’s personal credit score to calculate a score.
- A FICO credit score is your personal score, which can range from 300 to 850. It is tied to your social security number and is calculated by 3 credit bureaus, Equifax, Experian, and Transunion. A FICO score is calculated using multiple factors, such as debt repayment history, outstanding debts, length of credit history and any new lines of credit opened.
Debit to income ratio.
Your debit to income ratio is a percentage that expresses how significant your required debt service payments will be in comparison to the money you bring in. For example, you owe $300 vs an income of $1000, you debit to income ration is 30%. Commonly, lenders would like to see a debt to income ratio in the low to mid 30s, but loans can be approved with a ratio up to 43%.
The assets held by your business are also considered, and the business may be ask by the lender for them to be used to back certain types of loans or if other factors in your loan package aren’t strong enough. Conventional assets used as collateral include equipment, real estate, machinery, or other assets.
After deciding you are ready to apply for a loan it’s time to gather all the legal and personal documentation required to complete the paperwork and application. As part of your loan package, you will usually have to provide several current months of bank statements providing the lender an understanding of the business cashflow and ability to make loan payments. Other documentation required by lenders may include, corporate documents, if applicable, proof of ownership, tax returns and other documentation, determined by the type of financing you are interested in securing.
Getting a Small Business Loan with Bad Credit.
Yes, you can get a small business loan with bad credit. When trying to secure a SMB loan with bad credit it’s important to check your credit score by obtaining a free credit report. Review that credit report to determine if there are any inaccuracies, if so reach out to the credit bureaus and dispute any incorrect information.
Consult with a lending professional to understand your options on the types of financing programs which you may be eligible for based on your credit situation. Alternative lenders may provide additional options. Unlike a traditional bank or lending institution, alternative lenders have programs for all types of credit profiles. Don’t let your credit score prevent your from seeking financing for your business you may still qualify for specific products and programs offered by these lenders.
Types of Business Loans.
There are many different types of business loans available depending on your planned uses of the funds you are trying to secure. It may be difficult to determine the type of loan which will best meet your needs and be best for your business. So do your research or consult with a professional business financing advisor. When broken down to their fundamental level there are two basic types of loans. All loans are either secured or unsecured loans.
Secured loans require collateral, while unsecured loans do not. It is important to understand the differences between these two types of loans. There are many factors, such as your business size, age, and sales to mention a few, that will determine which type of loan your business qualifies for. Many loans can be either secured or unsecured. It will depend on the terms required by the lender. The following are some of the specific types of loans available.
Business Line of Credit.
A business line of credit is a type of loan that gives a business flexibility when accessing funds. Instead of a fixed amount at one time, businesses can access funds as needed. This type of loan allows businesses the ability to scale their business without being restricted by obstacles along the way. Some of these scaling activities may include inventory purchases, unexpected machine repairs, acting on new opportunities, and bridging the occasional cash-flow shortfalls.
What are the Types of business lines of credit?
A secured business line of credit.
A secured business line of credit requires the business to use one of their assets as collateral to obtain the business line of credit. This type of loan may be one of the best options for businesses with a lower credit ratings, enough time in business, or other prior credit issues that may raise concerns, with lenders with unsecured loan.
The unsecured business line of credit.
An unsecured business line of credit doesn’t require the businesss to use of an asset as collateral. However, liens and/or personal guarantees may be requested by the lenders. An unsecured loan is commonly a higher risk to the lender. Businesses with stronger credit history, and positive business attributes, are more likely to receive unsecured business lines of credit. Also, unsecured business lines of credit may have higher interest rates than secured due to the risk to the lender.
Where to secure the best business line of credit.
Alternative lenders tend to offer the best business lines of credit available in the lending community. When businesses are shopping for the best busines line of credit its important to consider options that include:
- A true revolving line, access to additional funds once you begin to pay back the line
- Fast processing, from application to funding.
- Access to a wide variety of ending options.
- Ongoing access to the line to be used to assist with cashflow in times of opportunity and emergency
- Better rates and terms that will meet your needs.
What is equipment financing and equipment leasing?
Equipment financing refers to the funding businesses use to purchase business related equipment. Equipment financing can be achieved through equipment leasing or equipment financing. Both providing to the business, the benefit of not having to expend a large cash outlay to secure necessary and potentially business growing assets, ultimately freeing up working capital for the businesses.
Equipment leasing & equipment financing are similar, though when a business is leasing equipment they are technically paying a rental fee to the equipment owner each month. At the conclusion of the lease the business can opt for a buyout and purchase of the equipment or end the lease contract and return the equipment to the ower. Keep in mind, one disadvantage of renting equipment without the prospect of owning it may be it is more expensive in the long run.
Equipment financing is funding used as an outright purchase of business-related equipment. As an alternative to using the company’s working capital to purchase that equipment. Equipment financing provides the business, like a traditional car loan, the ability to finance the full purchase price of the equipment and repay the interest and principal over a fixed time frame. At the completion of that payback period the business owns the piece of equipment outright.
What is an SBA loan?
An SBA loan is a government backed loan that can be used to start or expand a business. SBA loans have specific eligibility requirements, such as business size, ability to repay their loan, and business purpose. The SBA does not lend the money they work with approved lenders who offer SBA programs, with those lenders benefiting by eliminating loan risk due to the government backing the loan.
SBA’s requirements include.
- For profit business
- Good to excellent personal credit
- Must be considered a “Small Busines” under SBA definition
- Must be in business for at least 3 years
(SBA 7(a) may be available if your business doesn’t meet the minimum time in business or credit score requirements.)
Types of SBA loans.
- An SBA 7(a) loan is the primary loan product from the SBA. This loan isn’t issued directly from the SBA, instead the SBA, assisting the business owner, acts as partial guarantor of the loan, capping interest rates, and limiting fees. The 7(a) loan can generally be used for any business purpose.
- An SBA 504 loan is generally used for purchasing fixed assets such as equipment or real estate which ultimately acts as collateral for the loan. The 504 loan may require a down payment from the business and are available through Certified Development Companies (CDC’s) not lenders.
Accounts Receivable Financing.
Accounts receivable financing or AR financing is a type of financing where the business finances their outstanding invoices for working capital. It can either be in the form of out right selling the asset, (factoring), to the lender or using the accounts receivable (invoices) as collateral for the loan.
AR financing uses your outstanding invoices as collateral to help the business secure financing or an advance to the business. Though, unlike factoring, the business isn’t selling their invoices to a third party. The business maintains responsibility for collecting their outstanding invoices while making payments against their loan. AR financing doesn’t work well for business that work on small gross profit margins due to the interest cost eating away at to much of the profit margin.
Merchant cash advance (MCA) Loans.
A merchant cash advance is a cash advance not technically a loan, which is repaid by withdrawing a percentage of the businesses credit card sales, typically daily or weekly. Since the merchant cash advance (MCA) repayment is based on a percentage of the daily balance the greater the businesses credit card sales the quicker the advance is repaid. The downside of an MCA is during a business downturn the payback period will become extended or leave limited funds available to pay the businesses expenses.
A merchant cash advance will provide your business a lump sum of money in exchange for a percentage of your future credit card sales. Instead of making a fixed payment over a period of time the advance is repaid usually daily or weekly by the lender collecting the agreed upon percentage of your credit card sales.
What is an Asset Based Loan?
An asset-based loan is secured by owned collateral. Typically, they may be secured by real estate, accounts receivable, equipment or other assets owned by the business owner. These assets secure the loan for the lender if the borrower defaults on the loan, the lender has the right to receive the pledged asset.
Franchise Business Financing.
When you’re looking to finance a franchise business your first choice may be to contact your franchisor and inquire with them of any available options to assist with your business financing needs.
Regardless, of their recommendation you may still want to shop around for a less expensive and more favorable options.
Alternative lenders generally have financing options for franchises that may assist with the franchisors mandated updates, at a lower cost then the franchisor is offering.
Guaranteed loans require a written promise from a business owner or third party stating whom will be responsible for paying the loan in the event of a business default. Guaranteed loans are considered unsecured since the lender is relying on the guarantor’s credit worthiness instead of physical collateral.
Business Loans with Personal Guarantee.
A personal guarantee is when the business owner provides the written promise (guarantee) of the loan repayment. When a business owner signs a personal guarantee they are assuming the risk from the business against their personal credit and assets. If the business fails or is unable to repay the loan the creditors will go after the business owner for the loan repayment.
Standard Guaranteed Loan.
A standard guaranteed loan, is where a third party investor, spouse or SBA guarantees repayment incase of the loan default.
SBA Guaranteed Loans.
SBA guaranteed loans, as mentioned earlier, the SBA sets lending guidelines, and then guarantees the loan for the borrower. Providing inducement for the lender’s to lend to the business.
Bridge loans act as the name implies. If a borrower needs money for a short period of time to “bridge” an upcoming expense. A lender can provide a solution for that short-term financial need. For example, a construction company may require a loan to pay their sub-contractors while completing a project. After the project is completed and the contractor secures permanent financing the bridge loan will be re-paid.
Start Up Business Loans.
There are financing options available for businesses regardless of how long they’ve been in business, their revenue, or their credit score. However, your options are limited if you have been in business less than 6 months or have less than $15,000 in monthly gross revenue and questionable creditworthiness. Securing a startup business loan from a bank is extremely difficult because of the strict lending guidelines.
Traditionally most startup businesses are forced to rely on nontraditional lending sources such as, friends and family, private investors, and alternative lending sources. Thanks to the fintech revolution startups can turn to, marketplace lenders, and crowdfunding platforms. These types of platforms leverage a technological platform to bypass banks and conventional lenders and connect borrowers directly with investors and or lenders. While banks make loans with deposited money, financial technology platforms connect investors and borrowers directly.
How to Choose a Lender?
Lenders are unique, just like their borrowing needs. It’s important to thoroughly assess your company’s needs before deciding on the type of financing your business requires and the prospective lender that best fits your needs. Such as, if your needs are for quick cash a traditional loan from a traditional lending institution, probably isn’t going to work for you. That need dictates you looking towards lenders offering cash advances or factoring. If your needs point towards a term loan with low interest rates, and you have time on your side. You can do your research shop around and choose a lender that best meets your needs and priorities.
If you have a solid business with a good credit history, you’ll enjoy the luxury of a choice of multiple and suitable lenders that will fulfill your financing needs.
Items to consider when seeking business financing:
- Research multiple lenders interest rates.
- Ask about any and all fees associate with initiating and terminating the loan? Are there any early re-payment penalties?
- Look for reputable lenders. Check reviews, and ratings of lenders.
- Consider nontraditional lending solutions.
The online lending marketplaces can save you the hassle of having to do all the legwork yourself. They aid borrowers with a review of multiple funding options from several institutions focusing on your business’s specific requirements and needs.
What a Lender Looks for in your Business.
Lenders are just like any other businesses, except unlike most, their product is cash, they are trying to make a profit And similar to most reputable businesses, operate in a competitive market place, and want to do the right thing for their clients and meet their needs. They to want repeat business. When a business successfully repays their loan, both parties benefit and profit.