It is often said that small businesses have a difficult time borrowing money. This is not necessarily true. Banks make money by lending money. When a business obtains a loan, they must repay the funds with interest over a specified period of time, usually based on past performance of the firm. However, the inexperience of many small business owners in financial matters often prompts banks to deny loan requests.
To be successful in obtaining a loan, you must be prepared and organized. You must know exactly how much money you need, why you need it, and how you will pay it back. You must be able to convince your lender that you are a good credit risk. A good business plan and loan proposal are a major component in the success of obtaining funding.
Terms of loans may vary from lender to lender, but there are two basic types of loans: short-term and long-term:
Long-term business loans have maturities greater than one year but usually less than seven years. Real estate and equipment loans may have maturities of up to 25 years. Long-term loans are used for major business expenses such as purchasing real estate and facilities, construction, durable equipment, furniture, fixtures, and vehicles.
There are a variety of places to get loans:
- banks, including savings banks, savings and loans, and commercial banks;
- credit unions which usually have the best terms, but primarily make consumer loans;
- consumer finance companies which make higher-interest loans to higher-risk borrowers;
- commercial finance companies which normally make loans for inventory or equipment purchases that they use as collateral for the loan;
- small business investment companies; or
- private lenders.
According to the National Federation of Independent Business, 85 percent of loans to operating small businesses come from banks. The most common types of loans given by banks to startup and emerging small businesses are:
- working capital lines of credit,
- credit cards,
- short-term commercial loans (one to three years),
- longer-term commercial loans secured by real estate or other assets,
- equipment leasing and
- letters of credit for international trade
Some banks are more likely to give loans to startups. To find a startup friendly bank near your business check out state-by-state directory from the Small Business Administration. Banks participating in the Small Business Administration's Preferred Lender or Certified Lender programs are by definition small-business friendly.
SBA loan programs are generally intended to encourage longer term small business financing, but actual loan maturities are based on the ability to repay, the purpose of the loan proceeds, and the useful life of the assets financed. However, maximum loan maturities have been established: twenty-five years for real estate; up to ten years for equipment (depending on the useful life of the equipment); and generally up to seven years for working capital. Short-term loans are also available through the SBA to help small businesses meet their short term and cyclical working capital needs.
When reviewing a loan request, the lender is primarily concerned about repayment. To help determine this ability, many loan officers will order a copy of your business credit report from a credit-reporting agency. Therefore, you should work with these agencies to help them present an accurate picture of your business. Using the credit report and the information you have provided, the lending officer will consider the following issues:
- Have you invested savings or personal equity in your business totaling at least 25 percent to 50 percent of the loan you are requesting? (Remember, a lender or investor will not finance 100 percent of your business.)
- Do you have a sound record of credit-worthiness as indicated by your credit report, work history and letters of recommendation?
- Do you have sufficient experience and training to operate a successful business?
- Have you prepared a loan proposal and business plan that demonstrate your understanding of and commitment to the success of the business?
- Does the business have sufficient cash flow to make the monthly payments?