When starting a small business, one of the most important things is to secure a reliable source of funding. In the initial phase, the company is not yet self-sustaining, which means that the entrepreneur is most likely operating in a state of loss. It’s as if the business needs a bit of a jumpstart before it can venture out on its own. Of course, money can be hard to come by for such small operations, since the person running it may not have much more than an idea. This is the reason why a comprehensive business plan is essential in this embryonic phase of the company.
The problem is that many entrepreneurs that are looking to break into the world of business have no idea where to turn when it comes to funding. It’s almost a rite of passage to be denied by several potential lenders until one finally decides to throw its hat into the fray. While there’s no way to make the process less tedious, there are, thankfully, more ways to access funding than ever before. The days of being relegated to using nothing but banks have been over for years now.
Most of the small businesses that are looking to acquire a loan have gotten past the starting phase. However, even when a company has been operating for some time, various events and needs can come up that require funding, which is simply not available from the business’s resources. This is the most common reason that small business loans are taken.
The idea of this article is to do a deep dive into a selection of the best avenues of acquiring funding for small businesses. Note that this is not a compilation of every potential source that is available. However, the ones that you do see here are those that you should explore before looking toward any others.
Traditional Business Loans
While there are now many ways of securing funds, there is no denying the power of this loan alternative. This is the reason that it remains the most commonly used method by new business ventures. Be that as it may, traditional business loans continue to stand as one of the most challenging loan types to acquire. In fact, studies show that as much as 82% of these loan applications are turned down by banks.
As stated before, this is a normal situation. Eventually, many such businesses do strike gold in this regard, but it can be a bit of a challenge to get things going. While there is no guarantee of getting the funds this way, there are a couple of steps that you can take to increase your chances of successfully being granted one of these loans.
First, there is the matter of a credit score. As you may know, this is one of the most significant indicators of your level of creditworthiness. Financial institutions tend to check on this using an available credit bureau to get an understanding of the kind of risk that is associated with providing you with a loan. This tells the bank how feasible providing the said loan to you is and the kind of terms that are necessary to ensure that the value of the loan can be recollected along with any prescribed interest.
The rule of thumb is that a better credit score tends to lead to better terms. Better scores imply that repayment is all but guaranteed, regardless of the stipulated loan period. Therefore, banks can afford to give longer repayment terms and lower interest rates. On the flip side, unfavorable credit scores may mean that granting a loan to a business is not a very good idea. Even if the said loan should be given, terms such as the interest rates become very unfavorable, since the bank is concerned with recovering the cost of the loan as quickly as is possible. Providing the loan with an excessive interest rate goes a long way in doing this successfully.
As a small business owner, it is essential that you establish and maintain a good credit score in the context of the business. Many people make the mistake of lumping this in with their personal credit scores. The two are not the same, and they are checked independently. Studies show that over half of small business owners in the US have not checked their business credit scores in as much as two years. This is something that you need to stay on top of in the same way that you do your personal score. You may find that the credit bureaus have incorrect information or that they may be missing information entirely. The onus is on you to take the required steps to correct any inadequate information and to do anything else that may be necessary for the improvement of your score.
Apart from the credit score, your business plan is also a significant factor. It tells the lender how you intend to run the business, as well as what revenue and expense projections you have made for the next five years. Note that you most likely need to have facts at your disposal to support the said projections. The more that you can do this, the stronger your chances of securing the loan that you are looking for.
US Small Business Association Loans
Apart from traditional loans, you can take advantage of the US Small Business Administration to fund your business. By comparison, this is a much better route to take, though it is one that is much more infrequently explored. The funding provided comes from federal sources, which means that it is easier for lenders to offer these loans with favorable terms. Securing a loan this way allows you to acquire the money that you need for your business without potentially exposing yourself to perpetually increasing debt.
The annual percentage rates (APRs) go a long way in making this one of the smartest funding methods that you can use. All you need to do is ensure that you go through a proper preparation process before moving to apply. As opposed to traditional loans, there are fewer SBA loans that are denied by lending institutions. About 85% of businesses are successful in securing loans of up to $150,000. Loans above $150,000 are successfully acquired by 75% of applicants. The maximum loan amount is $5,000,000, and the average funding request is around the $400,000 mark. The success rate and favorable terms make this an excellent way of refinancing any existing loans that you may have.
There are four long types that fall under the SBA umbrella. The first and most popular is known as the 7(a)-loan program. This consists of federally guaranteed loans of $5,000,000 or less. Most businesses use these for expansion, working capital generation, and equipment purchases. Specialized lenders, credit unions, and banks tend to grant these.
The second loan offering is known as the 504-loan program. Again, these loans are federally guaranteed and can be as much as $5,000,000. These are typically used for the purchase of facilities, land, and machinery. Nonprofit institutions and private sector lenders tend to process these.
Third, there are microloans. These are loans of no more than $50,000. They tend to be granted to those who are just starting a business for expenses such as equipment purchases and securing inventory and for establishing a primary source of working capital. Community-based nonprofit institutions tend to process these loans.
The final loan type is known as an SBA disaster loan. These loans can be any amount up to $1,000,000. As the name implies, they are typically provided to small business owners who have been adversely affected by natural disasters or some other emergency. This loan type is directly processed through the SBA.
As the name implies, this funding type is one that is secured by assets already owned by the company. While there are asset-based loans with a traditional loan payment method, most of them are provided as revolving credit lines. The purposes that these loans are used for tend to come up repeatedly, so it’s great to have a lending pool that can continuously be accessed when necessary. Typically, these loans are used to cover ongoing expenses or investments that are made by the business. Small businesses that need a source of working capital should investigate securing an asset-based loan.
Cash flow issues tend to warrant the need for these loans. However, this doesn’t mean that, once your business has such a problem, then the only solution is to apply for one. This credit source is used to its most significant effect when the cash flow problems are directly related to rapid growth. In such cases, having this extra pool of cash allows the business to cushion the issues that stem from the said growth, which puts the company in a position where it is better able to manage and profit.
Small and medium-sized companies that are stable and have enough assets are eligible for asset-based financing. Of course, these assets cannot be used as collateral with other lenders. If you were to default on both loans, then it would obviously be impossible for two credit institutions to take the necessary actions against the same set of collateral. However, if other lenders are willing to subordinate their positions on the assets, then you may still be able to use them. Additionally, there should be no tax, accounting, or legal problems surrounding these assets.
Your accounts receivable is typically the asset that is used as collateral when you opt for an asset-based loan. However, your inventory, equipment, or other assets may also be used. Their amount that you can borrow depends on the value of the pledged collateral. Typically, companies can borrow between 75% and 85% of their accounts receivable. If you choose to use your inventory, equipment, or other assets, then you are typically allowed to borrow 50% of the total value of these assets.
Since there is a revolving line of credit employed, lenders tend to revise the maximum amount accessible. Doing this means that they must routinely inspect your assets and ledgers. So don’t be surprised if your asset-based loan allocation swings either up or down.
The APR that you receive on these loans can vary from as little as 7% to as high as 17%. The determination of what figure is used is made by looking at the kind of collateral used.
If you’ve ever heard of Swift Capital before, then this is the spiritual successor to that loan type. LoanBuilder is the result of a partnership between Swift Capital and PayPal to offer a short-term business loan service. Instead of using the traditional interest rate system, loans provided by LoanBuilder use a predetermined fee. This fee and the quick and straightforward process associated with acquiring the loans are the reasons that businesses that use the LoanBuilder service find it so alluring.
Before you get the loan, there is a simple eligibility check to be done. This simply means filling out a short online questionnaire. This allows for a prequalification process, which allows you to see an estimate of the terms and fees that are likely to apply to your loan. After getting to this point, you may adjust the loan tenure and a moment to your desire.
People often confuse LoanBuilder with PayPal Working Capital, especially since the latter is offered by LoanBuilder’s parent company. Additionally, PayPal Working Capital also provides a short-term business loan solution the small businesses. The most significant difference lies in the eligibility requirement to access the separate loan facilities. While PayPal Working Capital is incredibly useful, only PayPal sellers can access it. In contrast, almost any small business can take advantage of LoanBuilder. You should also know that the amounts that you can borrow under the LoanBuilder umbrella are higher than those of PayPal Working Capital.
The borrower qualifications that apply to LoanBuilder are not much: Your business needs to have existed for at least nine months; your revenue needs to be at least $42,000 annually; and your personal credit score needs to be at least 550. Of course, this means the LoanBuilder is not a viable solution for those who are just looking to get off the ground. Additionally, there is a long list of industries that are ineligible for access to the loan facility. This list includes:
- Credit bureaus
- Public administration
- Financial services
- Business and professional associations
- Environmental organizations
Currently, you can borrow between $5,000 and $500,000 if you opt for the LoanBuilder route. The loan term offered can run anywhere from 30 to 52 weeks. A one-time borrowing fee is paid, and it is between 2.9% and 18.72% of the amount you wish to borrow. While the costs may not be very high, as you can see, the longest possible repayment term is a year, which means that the weekly repayments can be quite large. Note that only US-based businesses are eligible.
Traditional business loans are very hard to obtain for small businesses because of the process involved in evaluating the loan provision feasibility. There is a heavy focus on a business’s credit score, which poses a challenge for most companies that are smaller than medium-sized. This is especially true for those that are just looking to get going.
A credit score is not the only indicator of excellent business performance, however. For example, if a business is thriving and it doesn’t use credit facilities because it doesn’t need them, then it is likely to have a poor credit score. That score does not mean that the business is not performing well. A variety of sites and services, such as QuickBooks, PayPal, and Square accounts, can help a business to demonstrate that there is a healthy cash flow running through it.
This is where Kabbage comes into the picture, as it is based on this cash flow data. The process associated with leveraging Kabbage is entirely seamless, as it is an online-based and completely automated process. Various sites and services, such as the ones mentioned above, can be linked to the Kabbage platform, which allows it to review and ascertain the business’s health where cash flow and other factors are concerned. While the credit score may be a factor, this is a more comprehensive review of how healthy the business is in operation.
When approved, loans between $2,000 and $100,000 are provided to businesses. Since the process takes place online and with heavy automation, your approval and loan allocation can be completed within minutes. Based on the repayment terms, Kabbage loans aren’t suitable for everyone. The loan tenure is very short, as it only spans six months. Each month, you are required to pay one-sixth of the original loan amount plus a monthly fee. This fee can be anywhere between 1% and 12% of your loan amount in the first two months. It is then fixed at 1% for the final four. One advantage that should be mentioned is the fact that early payments are allowed with no penalty. Additionally, because of the way the monthly fee is calculated, you get to lower your financing cost with such payments.
Another option that you can investigate when you rack trying to source funds for a small business is LendingClub. This is a unique lone offering that uses a peer-to-peer system to provide funds to small businesses. Additionally, the funding is offered in the form of traditional loans or lines of credit. Of course, this offering is limited to companies that are in the United States. However, the state of Iowa is excluded. Many businesses have found that LendingClub is a perfect alternative for small business financing requirements when applications to banks or other lending institutions have been rejected.
In terms of requirements, LendingClub requires that your business has been operating for at least two years prior to a loan application. This is no different from the requirement that traditional lenders have in place. However, your revenue needs to be no less than $75,000 annually. While your credit score is not as crucial to LendingClub as it is to other financial institutions, your APR can fall in the single-digit category if your score is strong.
Of course, new businesses cannot access this loan type based on the operational tenure requirements. However, if your small business has a fair or a good credit score or it needs funds quickly, then you may want to consider a LendingClub line of credit or a loan. The maximum allowable figure is $300,000, and borrowers are typically given up to five years to repay. The APR you receive can be as low as around 7% or as high as approximately 35%.
Note that tax liens and bankruptcies that are recent disqualify a business from accessing a loan from LendingClub. The person who initiates the loan request must own at least 20% of the company. One consideration that commonly comes with borrowing is that of prepayment penalties. What happens if you decide to pay off your loan early? You should know that, if this is your intention, then LendingClub is an excellent choice for a loan provider. This is because there are no prepayment penalties or interest once the loan has been repaid. Such a policy allows you to save money that you would have otherwise spent on paying interest to the lender.
Finding the SBA Loan for You
Small businesses fall into the categories of those that are just getting off the ground and those that have been operating for some time. While both business types usually need funding in the form of small business loans, the latter accounts for the more significant number of potential borrowers. Many people are under the impression that banks are the only likely lending institutions that are available for this purpose.
This is no longer the case, and the other avenues available are even easier to acquire a loan from. Consider checking out the alternatives above before you give up on obtaining the loan that your business needs.