Small Business Loans: 5 things you need to know

One of the biggest challenges facing a small business owner is how to go about getting bank financing.  One of my blog readers asked me to write about the 5 most important things a business owner should consider when trying to obtain small business loans.  Thank you to Joe M. for the suggestion!

  • Large Bank or Small Bank:  Make a list of 3 large banks and 3 small banks in your area.  Then, call the small business lending group in that bank and ask them about their lending criteria.  Two things you should take into consideration are cash management and customer service.  The large banks have made a significant investment into their online cash management functions and they tend to be more robust than what a small bank offers.  As for customer service, you may get better service from a smaller bank because they tend to have less small business customers and can focus more time on them.  There are trade-offs, so choose whatever is most important to you.
  • Conventional loan or Small Business Administration (SBA) loan?  A conventional loan is one where your bank takes all of the risk in making your loan.  Typically, the criteria for these types of loans are pretty strict.  On the other hand, an SBA loan has less strict criteria and may offer expanded loan terms.  Keep in mind that the SBA does not physically make loans.  The SBA provides a guarantee to the bank that is making your loan which means that the SBA is assuming some of the risk of the loan.  Since it offers less strict criteria and more expanded loan terms, an SBA loan typically carries higher fees than a conventional bank loan.  The decision on conventional vs. SBA loan won’t be made by you.  The decision is made by the bank after reviewing your financial situation.
  • How much can I borrow?  Presently, most banks offer a product known as an asset-based revolving line of credit.  What does this mean to you?  It means that you are able to borrow a certain percentage of your accounts receivable at any given time.  For example, you have a $500,000 asset-based line of credit that permits you to borrow 80% of your accounts receivable.  Today, you have $300,000 in accounts receivable which means that you can borrow $240,000 ($300,000 times 80%).  Banks also offer a product known as term debt.  Term debt is similar to a car loan.  You borrow all of the money up-front and then you pay it back in equal installments over a period of time; typically 5 to 7 years.  The amount of money that you can borrow will be determined by the bank’s credit policies and your company’s ability to repay the loan.
  • Collateral:  A bank typically requires a lien on the assets of your business as security for making the loan.  Furthermore, the bank will also require your personal guarantee.  What does it all mean?  In a worse case scenario, if your business is unable to repay its loan, the lien permits the bank to sell your business assets in order to recover the amount of the loan.  If the proceeds are not enough to repay the bank, then you are responsible to make up the difference via your personal guarantee.
  • Repayment:  Ask yourself why you need to borrow money in the first place.  For example, if your accounts receivable terms are 45 days and your bills are due in 30 days, then you have a 15 day gap in cash flow that you can make up by using a line of credit.  You would borrow against the accounts receivable and then when you collected the accounts receivable, you would immediately repay the line of credit.  If you collect the accounts receivable and you are not able to repay the line of credit, then you have a problem.  Where did that money go?  It is a subtle, but very important concept.  If your business is losing money, then a bank is probably not going to want to lend your business money.  How is the bank going to get paid back if your business has no profits?  Before you borrow, always be sure to analyze the impact that borrowing money will have on your business.

Remember, running a business successfully does not need to be complicated.  Keep it simple!

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