In the last few years, the number of business owners has multiplied considerably. New demands are created, and consequently, new innovative ideas are formed in order to tackle them, as well as newfound confidence by entrepreneurs to succeed in the face of adversity.
Although it is profitable and worthwhile to begin a business, it can be daunting to start and difficult to maintain. A business loan is funding that is borrowed and paid back, either when you need cash quickly for unexpected expenses or to start up your company. Getting this business loan is a crucial financial step and is done in several stages; 43% of small businesses sought a business loan this year, proving that it is quite prevalent.
Before you apply for a business loan, you must first determine if you need one. If you desire a loan to pay off debt, a good way to determine if you are in need is to check is the debt-to-equity ratio, a measure of the company liabilities compared to its assets. If the ratio is above 2, it is too high, and you are in more debt than you can take on, which would mean it is a good idea to take out a loan. A good ratio is around one. However, if you are using the loan to start your business or expand it, estimating your future revenue against your expenses will show if you will be able to turn a profit.
1. ENSURE YOU MEET THE CRITERIA FOR A BUSINESS LOAN
The first and most vital step in applying for a business loan is establishing whether you are currently eligible to receive one or improvements and adjustments necessary before you can start the process. If you do not check the criteria and send your application straight away, you risk wasting time and being rejected simply because you are unaware of what lenders look for in terms of a financial profile.
In most cases, lenders require a business to be of at least two years before they consider it, which is done so that they can be sure the company is capable and severe. Unfortunately, several new businesses fail due to poor management teams, lousy marketing and irresponsible spending habits. Surviving a year or two already indicates that the bank giving out a loan is worthwhile.
Newer businesses must therefore search for specific loans designed for younger companies, which is not many.
Another essential aspect that banks check is your business and personal credit score. A credit score is a number between 300-850; a higher credit score displays a higher likeliness that the loan will be paid back to the bank. It expresses creditworthiness based on payment history (track record of repayment), debt (amount owed), length of credit history (how long an account has been open), new credit (new loans) and credit mix (number of accounts).
Generally, a good credit score is anything over 690, which will guarantee that the vast majority of banks will accept your application. If you have a bad credit score, it becomes much more difficult to be accepted, in which case short-term loans would be the more viable option.
Collateral is a valuable item that helps lenders decrease their risk of money loss and give them security. If you cannot repay your loan, banks need to cover their losses and will therefore seize your collateral to sell so that they do not lose the money they originally loaned you. Examples of this include mortgages, cash payments, cars, stocks and bonds.
2. IDENTIFY WHICH SORT OF BUSINESS LOAN SUITS YOU
With so many business loans to choose from that vary enormously, it is critical to spend some time assessing their advantages and disadvantages to work out which is best suited to your needs. The average interest rate is 2.58% to 7.16%. However, it can vary drastically and deviate from the average, sometimes over 90%.
Small Business Administration: This type of loan is for smaller businesses. It is less risk for the lenders as the government partially guarantees it, but this means that all government loans like student loans and mortgages must be current, and there are no late repayments on them. This includes disaster loans like those that have suffered from the pandemic. Of all loans, it has the lowest average interest rate.
Term loan: Here, the lender gives a sum of cash at once. This can be subcategorised into a fixed and non-fixed interest rate; however, it must be repaid within a fixed period of time. You can decide whether you need a short-term, medium-term or long-term loan based on how much time you want to take to repay it.
Short-term loan: As the name suggests, a short-term loan finances businesses with a smaller amount of cash for a shorter period of time. Although this type of loan is usually used for overdrafts, businesses with a lower credit score and history can obtain this, as longer-term loans usually reject them.
Business lines of credit: When an expected expense crops up or inventory needs to be bought, a short-term business line of credit loan is a perfect choice. The loan can range from small to large, although more considerable sums may require collateral. Here you usually do not need to specify what the money will be used for.
Microloan: This is a loan aimed at new businesses, where a small amount of money is loaned at a low-interest rate. This is appealing to new businesses that do not have the same high costs as a larger business and thus only need a smaller loan and do not have to pay back way more than they borrowed.
Cash flow loan: These loans are based on cash flow history and predicted future cash flow. You can borrow an amount of money based on the revenue you estimate to make in the forthcoming months. Collateral is usually not needed.
3. CHOOSE A LENDER FOR YOUR BUSINESS LOAN
Deciding your lender can be difficult as there are many lenders, and they all offer different types of loans. Each has different benefits and drawbacks, which need to be analysed in detail to ensure that the right decision is being made.
Be specific on how much money you want to borrow, the interest rate you want to have, the time period you would like to pay the loan back, whether your payments are periodic or paid back at once, how much collateral you are willing to offer, and ensure you read the terms and conditions. Whilst the interest rate is a good indicator of how much extra money you will be paying back, looking at the APR instead is recommended as it includes the annual interest rate as well as other fees. If possible, choose the lowest APR offered to reduce the amount of extra money you must repay.
Background research on each lender is recommended. Every piece of information is telling of the creditor, from the amount of time the business has been running to the reviews they have from pre-existing customers. Reliable lenders have many five-star ratings and may sometimes even leave customer contact information from reviews so that you can first-hand learn how the lending process goes. Customer service is essential as you should hope to find polite and hard-working employers. When this is the case, your requests are met, and the best deal possible is found for you in an otherwise stressful process.
Comparing lenders proves vital. Although you may feel loyal to the first financier you encounter, it is beneficial to check if there is a different lender with a lower APR or better overall package deal. A tip is to research whether your bank can be your lender, as existing customers often get preferential treatment as their trustworthiness and consistency has already been proved.
4. GATHER YOUR DOCUMENTS
To guarantee a smooth application process, make sure that all of your documentation is present and ready to be submitted.
Financial statements are money-oriented documents and include bank statements, tax returns, cash flow, and credit reports. Although it is not mandatory, it is also a smart idea to calculate your business’s projected income and profits in the coming months to consolidate further how stable your business is and why you should get the loan.
Business plans are ideal for demonstrating how stable a company is and summarising what it is all about. It should include a description of the products or services, management team information, history and previous statistics, marketing strategies, development plans and future goals.
Collateral, used by the bank for security, depends on the size of the loan.
If you are applying for a small loan, providing collateral may not be necessary as it is not a high-risk factor. However, in the case of bigger loans, the bank will ask for collateral of a significant value as it cannot risk not being paid back and will therefore take and sell it if you are unable to keep up payments.
Legalities are documents including business licenses, leases, agreements and contracts you may deem important and necessary to be acknowledged.
5. CREATE A BUSINESS PLAN
Lenders only give out loans to legitimate businesses that they can be confident will generate enough income to pay back their loans promptly with no complaints, which is appealing to them as they can profit from the interest rates. To prove that your company is reliable, you must provide as much information as possible- not only from a financial perspective but also from the company as a whole.
The main feature in the plan should come from a financial aspect, more specifically, projected income and losses. Here you should pitch how many sales you estimate you will make in the upcoming months and the profit from this, as well as how much money will be lost from the expenses in production, marketing and unexpected commodities.
This aims to show that the money borrowed will be used wisely, and henceforth, the company will bring in revenue. Additionally, from this financial information, the lender can really see how much money you can afford to pay back each month that is suitable for you, or contrastingly if you can pay it back at all.
Additional points are to include precisely what the money borrowed will be used for, not just how much. This can serve as a justification for the amount you are asking to borrow so that the lender recognises that the money will be used sensibly. There are many different reasons as to why you may need to take out a loan for your business.
A percentage of the money can be used for new equipment and inventory in case the old no longer serves its purpose. Secondly, you may be in debt you need to pay off and need a little extra help in order to start making a profit. A way to start exponentially increasing your revenue is by expanding to make areas so that your business reaches more people.
Similarly, it could be used for hiring new employees. Lastly, marketing can be used in a variety of ways depending on your target audience via radio broadcasts, leaflets and brochures, television adverts and billboards.
6. CHECKING THE PROPOSAL
Whilst the prospect of receiving a business loan is exciting and prosperous is it of utmost importance to review the terms and conditions before applying. Lenders would have no incentive to give money to a business unless they profited from it, and therefore it should be remembered that this is still a business transaction.
Do you make enough money to pay this loan off? Generally, only 35% of a loan should be used to cover the debt. Therefore, if your business loan is £100,000, no more than £35,000 should be used for the debt, and the rest should be used to make a profit so that you can pay back the loan with the interest rate included.
It may be worth asking for a bigger loan so that you ensure you have sufficient resources to increase revenue.
Contracts have seen an increase in operating covenants whereby companies must promise to the lender to remain open for a set time period. If the store fails to open and function, a litigation battle can ensue as revenue is not maximised, and the minimum cash threshold may not be reached. Be sure that you are aware of instructions or rules the operating covenant is asking you to maintain and whether it is possible to do so.
Beware of additional fees associated with a loan like processing (person to collect documents) and underwriting (fee for guaranteed payment in case of financial loss).
7. FILL OUT THE APPLICATION
The final stage of applying for a business loan is actually completing the application and sending it off. If the first six stages are ignored, this can seem like an insurmountable task of frantically searching for documents and failing to understand what is being asked of you. On the other hand, if you completed the tasks beforehand. The general template of an application consists of six sections.
1. Borrower information: This is identity information like business name and ID, address, phone number, email and description of the business. All of this is so the lender can review your business and also have the necessary contact information.
2. Loan request information: This includes the type of loan you have chosen, the price amount of the loan, the purpose of the loan and the overdraft information
3. Business deposit accounts: This includes the business account type you already possess and its balance
4. Debt: This section includes the type of loan you are in debt from, the balance, any collateral and whether the loan is being used to pay off this debt.
5. Collateral information: what the collateral is (if the collateral is a house, then the house address) and the price or value of the collateral
6. Agreement: this is the final section where the terms of the loan are laid out and must be read thoroughly. If you are worried, request a lawyer to check through the conditions
Once these sections are all completed, the application must be reread multiple times and then signed and sent off. After this, a response can take between one day to many months. All that is left to do is wait patiently for approval.
To conclude, applying for and receiving a business loan can be a mammoth-sized task. Lacking in information and research can be a grave move as it is easy to rush through research and miss out on critical information leading to a default on the loan, which can lead to the failure of your hard-earned business. The general idea is to pay off debt and make more money than is being lost, but the opposite can happen when the correct type of loan is not chosen.
Conversely, when the application process is done correctly, it can either save or expand a business leading to enormous success. It can be spent on marketing, expansion, hiring new employees, or purchasing more equipment, all of which make the company more well-known and therefore increase customers and sales. All in all, a business loan can really incite a business to take off. Find out more about business loans in the U.K here.
Other useful links from our knowledge centre:
What is a micro business?
What does SLA mean in business?
Is a charity a business?
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