Picking the right type of financing for a small business isn’t as simple as it was a few years ago. There are more options available today, but those options are often very different in the terms they offer, how they are priced, and where they might provide the most value to your business. Answering these four questions will not only help you narrow the field of potential lenders, but you’ll likely be able to determine which loan makes the most sense for you and your business.
Why am I looking for a loan?
Understanding loan purpose is a critical part of determining what type of loan is a good fit for your business. Long-term loans and short-term loans are very different and some loan types are better suited for some purposes than others. Loan purpose will help you know where to look. What’s more, you may discover you need something different than you originally expected.
For example, a traditional five-to ten-year loan could still be a good option for purchasing new space, buying an expensive piece of construction equipment, or adding a new location, but might not be the best choice for meeting a short-term cash flow need or investment opportunity. Traditional lenders, like banks, typically offer longer-term loans while many online lenders offer shorter-term loans.
Once you’ve determined your loan purpose, you can look for lenders who offer the type of loan that best fits your situation.
Which loan term best fits my situation?
This is an important question. Short-term needs like buying quick turnaround inventory, ramping up a new employee, or borrowing to bridge a seasonal cash flow gap will likely be better addressed with a six- to 12-month loan rather than a longer-term loan. That way, your business can borrow, meet the need, and pay off the debt quickly. Paying interest for several years on inventory that will turn over in five to six months would be like buying an automobile with a 30-year home mortgage. While the payments might be ridiculously low, the total cost of the interest could eliminate any profit you would capture when you sold the inventory.
For longer-term needs where the value of the loan purpose will be enjoyed over the course of many years, like a new warehouse, an additional location, or purchasing heavy equipment, a more traditional 4-, 5-, or 10-year business loan may be a better fit. The nature of the loan purpose and the associated cost will help you determine the length of the term.
As a general rule, the longer the loan term the smaller the periodic payment, but the greater the overall cost of the loan. Shorter-term loans often have a lower overall cost, but the periodic payments will be higher—making it important to accurately evaluate your cash flow to ensure you can make the regular payments.
How much money do I really need?
Loan purpose also informs the loan amount. In other words, the amount of capital you’re looking for should be in line with your loan purpose. The cost of borrowed capital (even on a low-interest loan) is too expensive to borrow when it is more than what you really need. What’s more, lenders appreciate borrowers who know exactly what they require and aren’t looking for a blank check.
The loan amount will also influence where you look. A bank isn’t typically interested in smaller loan amounts, but SBA-affiliated banks or credit unions are encouraged by the agency to offer loans under $150,000. Loans the SBA considers micro-loans, or those under $50,000, are available from the SBA through their micro-loan program.
Along with the SBA, other non-profit lenders specialize in micro-loans for borrowers who can leverage a relatively small loan amount into positive impact within their business.
In addition to traditional lenders like banks and credit unions, there is a relatively new category of lenders who do business online and offer loans anywhere from $5,000 to $500,000. Different lenders specialize in different loan amounts and terms, so depending upon how much you are looking for you can narrow your search to a lender who specializes in the loan amount and terms you’re looking for. What’s more, many of these lenders will work with borrowers with less-than-perfect credit provided you can demonstrate a healthy business.
What does my credit profile look like?
If you don’t already know what your credit profile looks like, it’s relatively easy to find out. For most small business owners, your personal credit will be part of the equation, so you can start there. Experian, Equifax, and Transunion are the three biggest personal credit bureaus. Federal law allows you to check your credit report for free once every year. And, an Internet search will provide several options in addition to the three bureaus noted above.
The three biggest business credit bureaus are Dunn & Bradstreet, Experian, and Equifax. They are motivated to make sure the information they collect on your business is as accurate as possible so they want small business owners to check their reports regularly to make sure the information they have is correct—giving you the opportunity to see the information they have about your business.
Some lenders like banks, credit unions, and the loan guarantee programs at the SBA, consider a potential borrower’s personal credit score a very important metric when evaluating your credit and treat a certain threshold as a go-no-go measurement. For example, if your personal score drops below 680 it’s unlikely you’ll find much success at the local bank. The SBA will work with a borrower with a credit score as low as 650—provided the business meets other requirements. Many online lenders will work with otherwise healthy businesses if the business owner has a lower score, but you should expect to pay more for that credit.
In addition to the loan types mentioned above, crowdfunding, merchant cash advance, invoice financing, and other specialty loan products are available for specific things like purchasing equipment or factoring your accounts receivable. Asking yourself these four questions will help you determine where to look, what to look for, and will likely point you in the direction of where you’ll have the most success. They will also help you determine which type of small business loan makes the most sense for your business.
Finding the right small business loan isn’t as easy as walking into the bank anymore, but the good news is there are more options available today and more capital available to help small business owners fuel growth or fund other working capital needs.
Copyright © 2023 SCORE Association, SCORE.org
Funded, in part, through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.