Managing debt is one of the most critical aspects of building a business that lasts. Used responsibly, debt can be a powerful tool for getting your business off the ground. But the key to making debt work in your favor is to get it right the first time. If you’re considering applying for a loan for your business, here’s what to expect early on in the borrowing process.
Choosing The Right Type Of Lender
Your first decision will be the type of lender to approach for a loan - a traditional brick-and-mortar bank, an online lender, or the federal Small Business Administration (SBA). Which type is right for you will depend on the nature of your business and how quickly you need the money.
A traditional bank is often best for businesses that have been up and running for at least a few years. The reason is that banks will want to see that you have collateral and good credit. These things usually come after several years in the game.
Online lenders, however, can be a good choice when you want to move fast, have no collateral, and have little or no history in business.
Finally, an SBA loan offers some of the lowest rates available. This option is the long route, though. There’s plenty of paperwork to complete, and obtaining financing can take months.
For some perspective, here are average annual percentage rates for small-business loans from these different types of lenders. As you’ll see, their rates can range substantially, especially in the case of online loans:
- Bank Loans -----> 5.75% – 13.00%
- SBA 7(a) Loans -----> 5.50% – 8.70%
- Online Loans -----> 7.30% – 98.40%
Once you've narrowed your choice of lenders, familiarize yourself with their loan terms. Take the time to ask questions about monthly repayments and fees. Often borrowers underestimate the real payments inclusive of all fees. Remember, the fine print is boring until something goes wrong.
Getting Your Paperwork In Order
Expect to become an open book. Know going in that the lending institution will want to examine every aspect of your company’s financial picture. In many cases, in fact, even your personal finances will be subjected to scrutiny.
More than anything else, the lender wants to assure itself that you will have the ability to repay the loan. This early stage is where the borrower usually learns the wisdom of the old adage, “To get a loan you must prove you don’t need one.”
Your lending institution will provide a long list of documents for you to supply. Income statements, balance sheets, and statements of cash flow will all be part of the request. Lenders will ask how long you’ve been in business, how much revenue the company earns, and how you plan to make the payments. These questions will all need to be answered with documentation.
Each lender will have its own list of documents. But here are a few items you can expect almost any lender to request:
- Personal Tax Returns
- Business Tax Returns
- Lease Agreements
- Articles of Incorporation
- Third-Party Contracts
- Business Licenses and Registration
- Loan Application History
- Profit & Loss Statements
- Completed Application
All of these documents primarily serve to answer that one overriding question: Will you be able to repay the loan? Exploring that question is a valuable exercise for the borrower too. As a business owner, you should be every bit as concerned about your ability to repay as the lender is.
Without question, the lender will ask to see a pro-forma analysis built with assumptions that are reasonable and realistic. Smart business owners will draft three scenarios. The first is an optimistic forecast. That’s followed by a mid-level forecast and finally a pessimistic outlook. Make sure you’re comfortable with the cloudy scenario.
Waiting For An Answer
Financing rarely comes through as quickly as you might hope. SBA loans, in particular, are often slow, typically taking several weeks to provide an answer as to whether you’ve been approved. However, there are SBA plans designed to accelerate the process. “SBA Express,” which is part of the 7(a) loan program, guarantees an answer in just 36 hours.
With traditional banks, the response time can be as short as a few business days. However, allow for at least one to two weeks. The bank may request additional information even after the due diligence process is complete. Sometimes it will ask you to clarify a figure in the research. Or it may decide it wants to see material that was not part of its original request.
Finally, once the cash comes through, expect to start the repayment plan immediately.
The key to successfully navigating the borrowing process is to have reasonable expectations and a little patience. From start to finish, the process will take a minimum of a month. If your expectations are realistic, the process should be relatively smooth. But try to rush it and the timeline could double. Reports will need to be redrafted and errors corrected. If you have the slightest hunch that you’ll need a loan anytime soon, get started now so you’re ready when that day comes.