Obtaining financing for a small business can be a stressful and time consuming process. Similar to getting a home loan, the bank is going to want lots of documentation on your personal finances in addition to a solid idea and the business plan.As a rule of thumb, banks will want to see the owner invest 15%-25% of their money (equity) into a start-up business. That can include cash but also any buildings, tools, vehicles, inventory and equipment that will be used in the business. It is likely that the bank will want a lien on those items.
There are a number of small business loan options, but the primary ones that are used by small businesses include:
Conventional Bank Loans - These are available at most local banks and are where most entrepreneurs start when looking for a loan. Banks are typically very conservative and place a lot of weight on the owner’s personal credit, equity and collateral. After reviewing the business plan and personal financial information, they will respond with a yes, no or maybe. Yes is great but we recommend talking with at least three banks to get the best rates and terms for your business. No isn’t necessarily bad, as a bank may have many loans with other businesses in your industry or they don’t make loans for your type of business (restaurants are a typical example). If your loan looks a little risky or if you don’t have sufficient credit, equity or collateral they may answer with a maybe and want a loan guarantee.
Loan Guarantee – When a loan is riskier than the bank wants to take on, many have the option to use the Small Business Administration (SBA). This is a federal program that provides a guarantee to the bank that will pay a percentage back to them if the loan isn’t paid by the business owner. The percentage depends on the program, but typically ranges from 50%-85%. Contrary to popular belief the SBA doesn’t provide business loans but they do help in getting money to small businesses by taking a majority of risk and encouraging the bank to make loans. Another thing to note is that SBA guaranteed loans will cost the owner more in closing costs, fees and interest.
Alternative Lenders – A newer type of lender has emerged to make it more convenient to borrow money for businesses. These lenders tend to be online, more efficient than conventional lenders and sometimes lower rates.
Revolving Loan Funds – Several communities, economic development agencies, etc. offer revolving loan funds to businesses as a way to encourage investment and job creation. They are often low interest and approval is typically not as strict as a bank since job creation in the community is a priority. BusinessLoanFunds.com has a directory of these programs.
Expect the loan approval process to take anywhere from 2 weeks to 6 months (and possibly more) depending on the amount being borrowed, complexity of the project and owner's personal financial condition.
Before stepping into a bank for financing, it is a good idea to know your credit score. A major factor in getting start-up business loan approval is the owner’s credit score. Typically scores above 650 are considered viable so if you aren’t sure, get a copy of your credit report. If there is anything incorrect on your report, take care of those issues before going to the bank. Higher scores not only have a greater approval rate, they also get lower interest rates, saving money over the course of the loan.
You can request a free credit report once a year from AnnualCreditReport.com. This report won’t have your score, but it will show all of the credit activity under your name from the three credit reporting companies; Equifax, Experian and TransUnion. This information can be used to fix incorrect information.