If your small business is ready to obtain financing, that means you should be in a great position – your sales are flowing, your earnings are consistent, and you’re ready to expand your business’ footprint. Before you do take out a loan, however, it’s crucial that you decide first whether taking on debt is truly advantageous to your business, and which lending product is best to meet your goals.
Should You Take Out a Loan?
One of the most pressing questions you need to answer before taking on any new financing is: how well-equipped is your business to take on new debt? To answer this question, you should complete a comprehensive checklist regarding your business:
#1 Do I Even Qualify for a Loan?
Different types of loans require different qualifications, but you should first make sure that your business meets certain requirements from lenders. Your minimum FICO score should probably be in the 680 to 700 range for certain financing products such as a term loan, although alternative lenders such as Kapitus may require slightly lower scores, depending on which financing vehicle you are applying for.
Lenders will also want to see how strong your company’s business plan is; how long you’ve been in business; what your plans for growth are, and the consistency of your cash flow in order to gauge whether you have the ability to pay back the loan.
If you’re not sure whether you qualify, you should speak to a lending officer at the institution you are seeking to borrow from, who can walk you through the steps in which your business needs to take in order to qualify for a loan.
#2 Why Do You Need a Loan?
Ideally, you are seeking to borrow money to expand your business and increase revenue, and hopefully, that increased revenue will offset the cost of capital for your loan as well as enable you to make monthly loan payments.
As we all know, however, we’re currently not living in an ideal economic environment, as small businesses are still struggling to make ends meet in a turbulent economy. Fortunately, there are a variety of financing products to choose from that can provide much-needed cash for all sorts of reasons. Some of these are:
- The development of a new product or service which you foresee increasing sales.
- Opening a new office or facility.
- An emergency such as a collapsed roof or crucial machinery breaking down in which you need emergency cash to keep your business in operation.
- Getting immediate cash for invoices.
- Increasing your inventory to meet high demand.
- Meeting off-season expenses.
- Purchasing new equipment.
Once you’ve decided the reason you need financing, you can examine several distinctly different financing products that can meet your needs.
#3 How Strong is Your Cash Flow?
After credit score and business longevity, lenders will want to see your business’ cash flow – the net balance of cash that’s moving in and out of your business on a regular basis. If you’re borrowing to finance the development of a new product, for example, and sales of that product don’t end up being as strong as you thought they would be, a lender will want to know if you’ll still be able to make monthly installment payments on the loan you took out. This is what a strong cash flow will indicate to them.
There are several ways to improve your cash flow if necessary – you may want to examine ways to cut unnecessary spending, optimize inventory management, hound customers to pay their invoices and improve your cash flow forecasting. Your loan approval could very well depend upon the strength of your cash flow.
#4 Is the Price Right?
Anytime you borrow money, be it through a business credit card, a mortgage or a term loan, you are going to have to pay a cost of capital. This can be the interest rate associated with a term loan, the APR on a business credit card or line of credit, or the costs associated with invoice factoring or revenue-based financing. Whatever financing instrument you choose, it’s crucial that you ask the lender the total amount you will be paying back over time.
It’s also just as crucial to shop around for lenders and consider which ones may be offering the best terms, and which ones can offer you a quick turnaround.
Traditional banks often have more stringent borrowing requirements, while alternative lenders often are more expensive but will typically offer a quicker turnaround time on your loan with fewer requirements.
Something else you should consider – the Fed has just hiked the overnight rate by a half percentage point – that’s after a quarter-point hike last month – so some loans are going to be even more expensive than they were at the beginning of the year.
#5 Are you Willing to put up Collateral?
Depending on your credit score and other factors, some lenders may require you to put up collateral or even a personal guarantee. Collateral would include the liquid assets of your business such as your equipment, business savings and/or investments and future invoices.
Some may even want you to give a personal guarantee that you’ll pay back the loan by putting up some of your own assets as collateral, such as your house or your personal investments, in case you default on the loan.
Putting up collateral may increase your risk in taking out a loan, but keep in mind that lenders really aren’t interested in seizing your assets – they would much rather see your business succeed and for you to pay back the loan in a financially healthy manner. Therefore, when you’re taking a loan, it’s imperative that you sit down with your lender and carefully go over the terms of collateral and the exact steps that will be taken should you default.
Carefully Weigh Your Options
Before you take out a business loan, it’s always a good idea to consider other ways to raise money besides going into debt. Crowdfunding, asking for outside investments, borrowing money from family are other options. If you do decide to take out a loan, carefully consider the above questions and decide which loan will help your business the most and which would be most cost-efficient.