If your credit score isn't stellar, steer clear of banks. Online lenders may help, but be prepared to pay a sky-high APR.
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Growing your small business without outside funding can make you feel as though you're forever trapped in a catch-22.
You need to hire new employees, invest in new equipment and/or open a new storefront to increase sales and ultimately increase your company’s profit. But you don’t yet have enough profit needed to amass the capital you need to finance an expansion.
And, without an expansion, your business is unlikely to increase its revenue. So, as I said ... catch-22. Therefore, since you are facing a capital shortfall, is a small-business loan the best option to bridge this gap?
After all, small-business loans can help you get from A to B, providing vital capital to jumpstart your business expansion. Yet these loans are also notoriously difficult to get; and, should anything go south with your business, you may lose the collateral you put up for the loan. What's more, to qualify for most bank loans, your company will need to have been in business for at least one to two years and meet annual revenue requirements -- to name just some of the criteria required.
Getting advice on small-business-loan criteria
I had a chance to sit down with Muhammad Ali, a financial expert and founder of The Bankly, an educational online resource that covers topics like small-business financing. Of course our topic was small-business loans.
“Not all businesses meet business loan eligibility requirements,” was Ali's initial comment on this topic. “Most banks have an income eligibility threshold of 1.25 times your expenses, including the repayment amount. [So] even if you do meet the requirements, think carefully before taking on the loan, and be sure you can service the repayment terms.”
As a good rule of thumb, Ali advised choosing a loan with the lowest APR you can find, as long as your business can handle the payments. Most importantly, he said to do some “serious soul-searching” before starting the loan-application process.
“Applying for a small-business loan can be time-consuming and emotionally draining,” he said. “Do your research in advance, so you go in fully prepared, with your eyes open.”
Eligibility criteria for a small-business loan
There are three primary types of small-business loans: bank loans backed by the Small Business Administration, microloans from nonprofit lenders and loans from online lenders. Before applying for a small-business loan, confirm your business meets the criteria:
Bank loan: You’ll need excellent business and personal credit to qualify for an SBA-backed bank loan. The U.S. Small Business Administration provides general small-business loans through banks with its 7(a) loan program. According to NerdWallet, the average SBA loan size is $371,000, although amounts can vary between $5,000 and $5 million. To qualify, you’ll need to provide:
- Credit scores: Most banks require a credit score of at least 680.
- Business duration: Most online small-business loans require at least one year of continuous operation; bank loans typically require at least two years.
- Minimum annual revenue: Many banks have a minimum annual revenue threshold, ranging between $50,000 and $150,000. Know your annual revenue and confirm you meet the lender’s threshold before applying.
- Proof of ability to pay: As Ali told me, banks want to be sure you’re positioned to make the loan payment on time each month. You’ll need to present detailed financial statements showing that your income is at least 1.25 times your operating expenses, including the new repayment amount. For example, say your business makes $15,000 a month and your current expenses are $10,000. With the loan repayment added to your operating expenses, you need to be sure your income still exceeds the recommended 1.25 threshold.
Microlenders: If your company is especially small, you may need to opt for a microlender. These are non-profits that typically lend short-term loans of less than $35,000. They also have a much higher APR than bank loans but may be useful by helping you bridge a temporary cash-flow gap. Microlenders require detailed business plans and financial statements, so be prepared for some serious paperwork.
Online lenders: While you may lack collateral, run a new business and need money quickly, you may find that an online lender is your best option. In general, online lenders should be a “last resort.” The average APR for online loans can be as high as 108 percent, making it difficult for small businesses to pay the money off before the debt balloons.
Approval rates, here, however, are high, and funds are distributed quickly, sometimes within 24 hours. If you decide to apply through an online lender, stick to an aggressive repayment schedule so you don’t find your business saddled with serious debt.
A small-business loan can be the bridge your business needs to expand. But if your business goes south, the loan could also end up casting a very large debt shadow that your company can’t get out from under.
Before taking on a loan, carefully consider alternative funding options, like raising capital from local investors. Finally, be sure you’re expanding your business for the right reasons. Growing a company just for the sake of being bigger is not always better. So, don’t be afraid to take a step back and ask for third-party guidance.
When you’re in the trenches every day, working long hours to build your dream company, it’s easy to miss the big picture and get stuck in the weeds. A small-business loan can be life-changing. Just be sure it’s changing your life in a positive way.