In order to realize your small business dreams, you’re going to need a way to finance a business. Starting up and running your own small business requires adequate capital to open those doors on the first day and then eventually, turn a profit.
There are thousands of different types of small businesses. Each small business is unique in its own way. However, one common thread that runs through each and every small business—no matter what type—is the need for adequate funding. Do you need a business loan? Should you take out a traditional loan? Find a credit union? Check out online rates? What’s the difference between the three?
We will walk you through a broad level overview of what you need to know about the various ways you can finance a business. With the proper education, planning, and preparation, you’ll be ready to take the necessary steps to find and secure the best funding for your small business.
You Need a Business Plan
The very first step of financing a business is planning how to do so. All new businesses, from one-person online shops to multi-employee large corporations, need to begin with a clearly drafted, thorough business plan.
The reality is that your business is not going to get funding from either a lender or investor unless you have a business plan to show to prospective lenders or investors. Prospective lenders or investors will need to see that they will be paid back. Investors will need to see that the capital they sunk into your business will grow over time.
1. Why Do Prospective Lenders Need Your Business Plan?
Your business plan allows you to articulate and examine:
- Company’s entrepreneurial goals
- Business’s projected finances
- Business’s plans for future growth and expansion
Preparing your business plan allows you to manipulate the figures on paper, so that you can mentally plan ahead to avoid problems and take advantage of opportunities.
A business plan can be presented to potential investors or prospective lenders as evidence that your company is worthy of funding, thus helping your business clinch that loan. Preparing a written business plan demonstrates to potential lenders that your business idea makes sense and that the numbers add up.
2. Crunch the Numbers to Project Your Business Needs
Your business plan can serve as a financial roadmap for internal use. Use a business plan to show how you’re going to use your loan or investment funds to their maximum potential.
Your business plan allows you to project the funding that you will need. You can also figure out how to best optimize that funding for a maximum return on investment. Also, your financial roadmap lays out how you plan to use the financing money.
3. Lenders Will Look Closely at Your Business Plan’s Sales Projections
At the end of the day, your business will only be profitable if it is able to make sales. One of the most important things investors will focus on in your business plan is your business’s future sale projections.
Your business plan’s sales projections should include all costs, allocation of resources, as well as data on how financially feasible your business idea is. Preparing and examining prospective sales figures will show whether the business will sink or swim during the all-important start-up phase.
For more on how to prepare a business plan to get financing or loans, visit our resource Business Plans 101.
For more on the financial components of a business plan visit our resource Business Plan Section 7: Financial Information.
Steps to Help You Get Your First Small Business Loan
Now that you’ve prepared your written business plan and examined whether the numbers make sense, it’s time for you to use that plan to help you secure a loan for your company.
The bottom line: You can’t start a business without enough money. Most small businesses are funded by loans, either partially or fully. Taking out a loan requires you to prepare the proper documentation.
So how do you actually get a small business loan? Here are the basic tips to know to take you from pending application to quick approval:
1. To Get a Business Loan You’ll Need to Prepare Proper Documentation
- Prepare proper documentation for the loan application.
- Check with the prospective lender on what they need from you.
- Be honest with your answers on the application.
- Be accurate with your numbers and projections.
- Answer all the questions completely.
- Don’t overestimate your business’s potential profits.
- Don’t underestimate your business’s anticipated expenses.
- Also, don’t apply to borrow more money than you can reasonably pay back.
These tips are simply a broad overview of a complex process. For more detailed information on how to secure your first business loan, visit our resource Behind Closed Doors — Behind the Loan Application Process.
2. Review SBA Materials and Resources on Loan Applications
The Small Business Administration (SBA) is a federal organization which was created to help small businesses and their owners realize their entrepreneurial dreams. A goal of the SBA is to provide aspiring and existing entrepreneurs with the training, tools, and resources they need to get their businesses off the ground, and then how to turn it into a profit-making successful venture.
The SBA is full of resources on how to apply for and secure your first business loan. Visit SBA.gov for interactive, up-to-date information on the small business lending landscape. Your business may qualify for special programs and rates, depending on who owns the company and what industry you’re in.
Consider the Various Loans Available to Small Businesses
The SBA can help you prepare your small business loan application, but it can also help you find out about competitive rates and special loan programs. Visit the SBA.gov for more info on which programs may exist.
Traditional Bank Loans for Applicants With Good Credit
Traditional bank loans afford entrepreneurs with favorable credit scores and credit history the chance to borrow money from a traditional lending institution.
Loans from traditional lenders may vary in terms of duration and monthly payment amounts, so you’ll want to be cognizant of the amount of interest charged over the life of the loan. It’s crucial to make payments on time, or else your credit will be harmed.
Business owners with no credit or poor credit scores may still qualify for a traditional bank loan if they apply with a co-signer. A loan co-signer pledges to make the loan payments if you cannot, which can help you quality for loan approval if you cannot do so on your own.
Some banks also consider the matter of collateral for a traditional loan. Collateral is when valuable tangible personal property is proffered by the lendee to secure the loan. If the lendee fails to make payment on the loan, the bank will seize the property and sell it to pay for the overdue balance on the loan. Some business owners use their homes as collateral for a business loan, though that option is not without significant risk.
For more on securing a traditional business loan, visit How Do I Get a Business Loan?
Microlenders Are More Flexible With Approval
Microlenders offer small business owners a way to finance a business that differs from traditional banks. Microlenders’ lending criteria are generally more flexible when it comes to approving candidates who may not qualify for traditional bank loans due to lack of credit or poor credit history.
The distinction between a traditional bank and a microlender is that microlenders take a holistic approach to the lending process. Rather than a traditional bank, which focuses on facts and numbers, a microlender will often take a more personal approach to lending when reviewing loan applications and making decisions on candidates.
Are microlenders the right way to bankroll your business?
Accion says that “In the spirit of promoting entrepreneurship, some private companies and non-profits offer small loans of up to $50,000 for individuals and businesses that may not otherwise qualify for a bank loan. Called microloans, these small, short-term loans feature lower interest rates than some other alternative financing options and are typically extended to startup companies or self-employed individuals.
“More flexible than a bank when it comes to lending criteria, microlenders tend to look at the whole picture. In addition to capital, some non-profit lenders may also provide training and education, making microloans an appealing option for startups.”
Microloans can be used for a wide variety of business needs:
- Working capital
- Purchasing needs—such as inventory, equipment, or other tangible assets
- Paying down existing business debt
- Growing or expanding current business operations
- Purchasing an existing business
- Payroll or hiring needs
- Leasing office space
- Buying office space
In order to make a lending decision, a microlender will look at the whole picture of the company, the story behind the company, and the people involved. Microlenders also provide a secondary benefit of education and training for those they approve so that the business owners can make the best use of the funding the receive.
To learn more about microloans visit Is a Microloan Right for Me?
Compare the Various Alternative Lending Options
Bank loans and microloans are not the only options which exist to fund a start-up business. There are several other alternative ways to consider which may offer the means to fund and finance a business.
1. Community Development Financial Institutions (CDFIs)
- Offer financing amounts of $250,000 or less.
- Offer low-interest financing.
- Loans may be used for business start-ups costs.
- Affordable lending options to previously underrepresented entrepreneurial groups and lower-income areas.
- May be an excellent option for first business loans.
- CDFIs provide business resources, mentoring, and technical assistance to their lendees.
To learn more about CDFIs, visit the Opportunity Finance Network.
2. Community Banks and Regional Bank
- Seek to work with other regional business owners.
- May offer more financial products and services to choose from.
- May have stronger ties to the local community.
- Value personal connections.
- May be a good option for a start-up business seeking funding.
For more information on community banks, visit the Independent Community Bankers of America.
3. Credit Unions
- Non-profit institutions
- Business loans offered to their members.
- Credit union members may have access to variety of loan products and options.
- Credit unions generally have lower interest rates than traditional lenders.
To find credit unions in your area, visit MyCreditUnion.gov.
4. Alternative Online Lenders
- Online lenders provide rapid application approval
- Loan funds are disbursed quickly.
- New business owners should proceed with caution since online lenders are often unregulated.
- Conduct due diligence before using online lending.
- Ensure you’re working with an ethical lender.
- Check the online lender with the BBB.
For more on alternative lending options, visit the Alternative Lending Landscape.
Research and Understand All Documents Before Signing
Once you’re found the lender that is the best fit for your business needs, it’s time to make sure that you’re getting the best loan.
1. Read (and Understand) the Fine Print
Loan documents can be wordy and drowning in legal jargon. It’s important to make sure that you completely and thoroughly read, and that you clearly comprehend, the entire loan contract.
You’ll want to double-check that you understand all of the terms of the loan. You’ll want to review all of the fine print to make sure there are no surprises.
Moreover, you should make sure that you fully understand what the loan obligates you to do, including paying fees, the payment schedule, and all terms in its entirety. Your lender should work with you to make sure the borrowing process is transparent and clear to you, each step of the way.
If you have questions, do not be afraid to ask questions of the lender. This is a business partnership, and they want to ensure that you understand your rights, responsibilities, and obligations as well. If any part of the loan documents, payment schedule, or fees are not clear to you, hold off on signing until you review the materials with your legal counsel or business advisor.
For more information on finding, hiring, and working with a skilled attorney visit When Should I Hire a Business Lawyer?
2. Understand the Borrower’s Bill of Rights for Protection
Ethical lenders and financial institutions value their small business clients and customer relationships. They will strive to ensure that your loan application and approval process is smooth and above-board.
An important way to protect your consumer and borrower rights is to educate yourself about the terms in the Borrower’s Bill of Rights. The Responsible Business Lending Coalition helped to write the Small Business Borrowers’ Bill of Rights to protect small business owners from predatory lending practices and unscrupulous financial institutions.
Below are the six fundamental rights every borrower should have:
- The Right to Transparent Pricing and Terms
- The Right to Non-Abusive Products
- The Right to Responsible Underwriting
- The Right to Fair Treatment from Brokers
- The Right to Inclusive Credit Access
- The Right to Fair Collection Practices
For more detailed information about the Small Business Borrower’s Bill of Rights visit our link here.
How to Finance a Business
Funding a small business venture may require outside financing to get the business off the ground. The good news is that there are many financing options that exist to help small business owners with their new business capital needs.
Securing the right financing for your small business will take some research and some legwork, but know that various accessible options do exist to fund your small business. Since taking out a business loan is a huge financial and legal commitment, you should be sure you understand all of the documents and terms of the loan before you sign.
Also, you should look at the benefits as well as the cons of each potential financing or lending option. In the end, by taking the time to educate yourself, you will ensure that you choose the right financing option and lending institution that fits your small business needs.