This is a contributed article from Samantha Novick, a senior editor at Funding Circle.
If your local business needs capital, a business loan is usually the most reliable source of financing. Yet, banks only approve around 13% of business loan applications, which makes scoring a top-notch loan all the more competitive.
Navigating the world of business loans can be tricky, especially for the first time. This is why it’s important to get organized, especially if you're applying for a loan with a big bank.
If you’re considering financing, this quick-and-easy guide will arm you with all the tips you need to prepare a loan application for your small business.
Tips for Preparing Your Business Loan Application
1. Educate yourself on business loans
Lenders want to loan money to borrowers they can trust. If they get the inclination that you don't really understand interest rates or the difference between a term loan and a business line of credit, there’s a chance your application will not be favored.
Do your research and learn the basics. Demonstrating knowledge of business loans will build confidence with your lender, increasing your odds of scoring funding.
2. Build and Maintain Your Credit
Your credit score measures the credibility of your business. It tells lenders if you pay your bills on time, open too many (or too little) credit lines, and utilize debt effectively. The catch 22 is that to secure a loan, you'll need to demonstrate a history of repaying loans on time.
This means you'll often need to start off small. If you're a brand-new business that's only been around for a few months, then you likely won't qualify for a big bank loan—however, you'll probably be eligible for a business credit card. That's because credit card companies will look at your personal credit score when determining your eligibility.
As you responsibly use your credit card, you'll build your business credit and improve your credit utilization ratio —both of which will help you score bigger, better loans down the road.
You’re More Than Your Credit Score
Most lenders rely on your credit score to evaluate the credibility of your local business and your trustworthiness as a borrower. But there are some lenders, like Funding Circle, who consider other factors like how long you’ve been in business, your previous experience in your industry, and even your reputation with your customers and community. If you aren’t approved for a business loan, remind yourself that you are more than your credit score.
3. Organize Your Documents
Everything about your business needs to be documented for proof. That includes your revenue, expenses, debts, and assets. You must be able to back these items up with paperwork. Avoid waiting until application time to get organized. By establishing your accounting and bookkeeping practices now, you’ll make the application process smooth and easy.
Consider using a cloud-based bookkeeping tool to organize your business finances. There are free tools (like Sunrise, Wave, ZipBooks, and more) that'll help manage your income and expenses, send and track invoices, generate financial reports, calculate taxes, and more.
4. Get Your Finances in Order
Get quotes to determine how much you need
Before applying for a business loan, it’s important to determine exactly how much money you need. Securing a loan with excessive funding could cost you unnecessary accumulated interest on top of prepayment penalties. Requesting less money than you need may require you to go back for a second loan or leave a project unfinished—both of which are avoidable with a little research. Get accurate estimates before you speak to potential lenders.
Determine what you can afford
Once you know how much you’ll need, start considering how much you can realistically afford. Look at your revenue and expenses to ensure you can afford an additional monthly payment.
If not, you might need to adjust your loan amount or loan type. For example, while you might not be able to afford a short-term loan, you could still qualify for a merchant cash advance or a business line of credit.
Crunch the numbers, and then review your options again if necessary.
Provide proof of cash flow
You’ll also need to provide proof of cash flow. Lenders will look at your past financial reports, but they also want to see your potential future. Realistic cash flow projections will show your business's future income and expenses as a result of the loan.
Use your previous cash flow statements to prepare accurate projections. When a lender sees a data-backed plan for their investment, they'll be more willing to approve your application.
5. Decide Which Type of Loan You Need
Your loan amount, use proceeds, timing, and creditworthiness will impact which type of loan you need. Here are a few popular loan types to consider:
- Term Loan: This is the classic loan option. A term loan provides you with a lump sum of cash that you'll pay back (with interest) in regular increments until you've paid off the entirety of the borrowed funds.
- Short Term Loan: Short term loans are like term loans, just faster and more expensive. You'll face higher interest rates and shorter repayment terms, but you'll get money in the bank very quickly.
- Business Line of Credit: A business line of credit is a revolving credit line that gets you access to ongoing capital. When you use your credit line, you'll only pay interest on the portion you borrowed. Once you repay the borrowed funds, then you get access to the capital again—no need to reapply.
- Business Credit Card: A business credit card works much the same as a personal credit card. Use your credit card to buy now, pay later. It's a great way to expand your available capital and build your credit score.
- Merchant Cash Advance: Use a merchant cash advance to trade tomorrow's earnings for cash today. Your lender will provide you with a lump sum of money that you'll repay with a percentage of your daily sales.
- SBA 7(a) Loan: Small Business Administration (SBA) 7(a) loans are one of the most sought-after business loans. They have large lending amounts, competitive interest rates, and generous repayment terms. They're challenging to qualify for and notoriously paperwork-heavy, but they're the best financing small businesses can find.
- Accounts Receivable Financing: Accounts receivable financing (also known as factoring) lets you trade your outstanding invoices for immediate cash. If you just need extra money to cover a slump or pay your own bills, factoring may give you all the financing you need.
6. Find Collateral
Lenders base their decision to lend to you or not based on your level of risk. If they aren’t confident they will get their money back, lenders won't invest. Collateral helps lower that risk by providing banks with a guarantee in the case that you default on your loan.
Look for things you could provide as collateral on your loan. That could be your business truck, land, or even a personal asset (like jewelry or home equity loans). Providing collateral can be scary—there's always an element of risk. However, if you've followed all the other tips and use your loan responsibly, your collateral should be safe.
7. Document Your Business Plan
Lenders want to know how you plan to use your loan. What will you spend it on? How will the investment help your business? When do you expect to start seeing a return on your investment? A solid business plan will convince your lender that you know what you're doing and that you're more than capable of repaying the borrowed funds.
Not every lender will require a business plan, but it's best to always be prepared by having one ready.t. The additional research and planning will help you strategically use your funds, establish realistic repayment plans, and prepare for worst-case scenarios.
8. Choose the Right Lender
Every lending institution is different. Large banks can provide big loans, but they're often preoccupied with enterprise clients and have strict eligibility requirements.
Alternative lenders usually provide quick approvals and more lenient requirements, but they compensate for the risk with slightly higher interest rates. Local banks may be your best bet because they allow you to meet in person, develop relationships, and potentially earn some flexibility.
There's no one-size-fits-all lender—you'll need to do your research and shop around for loans.
9. Plan for the Right Time
Don’t wait until you need a business loan to start applying. Plan ahead. If you foresee a future financial need, consider getting a loan in advance so that you’re not stuck in long application processes while your business is scrambling for cash. If you operate a seasonal business with regular cash flow fluctuations, get a line of credit to cover any potential slow periods.
Don’t Be Afraid to Ask for Help
As a small business owner, you wear a lot of hats—but sometimes it's best to delegate some of those responsibilities and focus on what you do best. Don't be afraid to seek expert advice. Bookkeepers can help keep your financial transactions neat and tidy, while accountants help with your planning, projections, and applications. Professionals can help discover opportunities and raise any red flags if there's an issue they know lenders will be concerned about.
If you’re in search of a bookkeeper or accountant, Nextdoor can help. Claim your free Business Page and connect with local experts in your community.
Claim your free Business Page to get started on Nextdoor. For resources on how to use Nextdoor to stay connected with your local customers, pertinent news affecting businesses, and more, follow us at @nextdoorbusiness on Facebook.
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