Obtaining a small business loan is a challenge, but not an impossible task. It takes a thorough assessment of your company’s income potential, knowledge of your own credit worthiness, and the determination to work through all the steps needed to secure financing.
Before you apply for a loan, be ready for the questions a lender will ask before agreeing to finance your venture. Banks first will look at your company’s debt-to-equity ratio, which measures how much money you have already borrowed as opposed to how much money you have invested into your company. The more of your own dollars you put into the business, the more likely you are to obtain a loan. If you have a high ratio of debt to equity, a better option may be to seek an equity investor to take an ownership stake in your company.
With debt financing, as with any loan, you’re borrowing money to be repaid over time, usually with interest. While you may be able to obtain loans from friends and family, financial institutions are the major source of small business loans, Such loans may be backed through the Small Business Administration or through state and local government programs. Government secured loans, however, only reduce the risk for banks and credit unions. You still need to show an ability to repay the loan.
For a startup business, the SBA also recommends you prepare a thorough loan package that explains in detail how the business will produce enough income to repay the loan. The loan package should include:
- Your personal background and resumes.
- A business plan that includes a convincing narrative and a complete set of projected financial statements including cash flow, profit and loss, and a balance sheet.
- Personal and business credit report.
- Bank statements for the previous year, tax returns covering three years, and any applicable legal documents such as articles of incorporation or organization, business licenses or other required forms.
Finally, you need to explain why you need the loan and what you plan to spend the money on.
Besides identifying the hurdles to obtain financing for a small business start-up, the SBA provides resources and training to help you clear those hurdles. SBA’s resource partners, Small Business Development Centers and SCORE, provide counseling services and management assistance -- in most cases free of charge -- to entrepreneurs looking to start their own business.
SBA Loan Programs
The SBA typically guarantees between 75 to 90 percent of the loan, improving the chance for a small start-up to get a loan by eliminating much of the risk for the lender. SBA backed loans include:
- Microloan Program: This provides loans up to $50,000 to help small business with working capital, inventory, supplies, fixtures and equipment. The average micro loan is around $13,000.
- 'Certified Development Company/504 loans: These loans finance major fixed assets, such as real estate and equipment. Maximum loan amounts range from $4-5.5 million, depending on how the loans will be used. Desirable objectives include to meet job creation or community development goals, fulfilling public policy priorities including energy reduction, or for small manufacturers to improve a local economy.
- 7(a) loans: The maximum loan is $5 million.The average loan amount in 2012 was $337,730. The loans include guarantee fees for loans above $150,000. The SBA will guarantee 85 percent on loans up to $150,000, and 75 percent of loans above $150,000. The SBA will only guarantee a maximum exposure of $3.75 million.
A bank may need more convincing of your ability to repay a conventional loan because of the lack of a guarantee, but conventional loans offer more freedom on how the money is used. Conventional business loans, however, can include shorter times for repayment and may include balloon payments that make them more difficult to pay back if your business doesn't grow quickly.