Intro to Small Business Loans


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Getting your first loan is a milestone in the life of your small business. From making the choice to seek financing to putting together a small business loan application, you’re learning and growing as a small business owner.

Applying for a small business loan can also be stressful. It takes wisdom and foresight. However, If you prepare yourself before beginning the application process, you’ll reduce your stress levels dramatically.  In this article, we’ll show you what you need to know so you can get the best small business loan offer.

Know the Process

Before starting the application process for a small business loan, it is important that you understand your options. Are you sure that a term loan is the best option for your industry and stage of growth? Is there a better option that you haven’t yet explored? Small business financing is available in many forms, from small business loans and business credit cards, to invoice factoring or financing, to angel investment. Make sure you understand the pros and cons of each so you know what to expect and where to find the most appropriate financing for your business.

Once you’re ready to jump into the world of small business loans, you’ll need to get a firm grasp of your credit and your use case. With that, you’re ready to prepare an application for a small business loan.

Analyze Your Credit

When it comes to small business loans, credit is #1. It makes sense. Would you lend a friend $500 if their track record showed that they’d most likely never pay you back? What about a complete stranger? In the same way, lenders of small business loans need to know how much they can trust you with their money. Your credit score can be viewed as numerical shorthand for your financial reputation.

Both your personal credit score and business credit score strongly affect whether a lender will give you a loan. They also affect how favorable the terms of the loan will be. It does not give you the whole picture, of course, which is why at Bond Street we look at more than just credit score. Personal and business credit scores are two of three pillars that we analyze in small business loan applications. So let’s look at how to understand and improve these important digits.

Get Your Business Credit Report

Small business owners are notorious for mixing their personal and business finances, especially at the start of a new venture. The problem with overlapping accounts is that when it’s time to file taxes or apply for a small business loan it can be difficult to decipher between what’s what. Establishing business accounts early gives you the chance to build a credit history. It prevents personal credit issues from affecting your business credit score and vice versa. Separate business and personal accounts to protect yourself and avoid confusion.

As you do business, you are building a business credit report. How does a credit report translate into a score? There are technically different companies that calculate slightly different scores. The Dun & Bradstreet PAYDEX score only takes your payment history into account. Experian and Equifax also consider public records, legal filings, and collection agency data. All three scoring systems come up with three digits, but each employs a different scale. To maintain a healthy business credit score in any system, paying your bills on time is key.

Get Your Personal Credit Score

Even after you’ve established separate financial accounts for your company, your personal credit score matters to lenders of small business loans. Imagine hiring a professional driving instructor only to discover he’s accumulated two dozen moving violations in his off time. In the same way, your personal credit matters in business relationships.

As with a business credit score, the most important factor in your personal credit is your history of payments . The more often you pay your bills on time, the better your score is. This is true of both your FICO score and the newer VantageScore, which both range from 300-850.

But paying on time doesn’t guarantee a good score and great terms for your small business loan. Other factors include types of credit you’ve had, total debt owed, how much available credit you’ve used, the length of your credit history, and how many times you’ve applied for credit in the past.

Common mistakes that lead to lower business and personal credit scores include:

  • Having a high outstanding balance. You will be penalized for carrying a lot of debt, even if you’ve never missed a payment. Making a minimum payment is great; paying enough to keep your balance low is even better.
  • Not understanding utilization. Credit utilization measures the amount of your revolving credit limits currently in use. The VantageScore will penalize you more than the FICO score for having a high utilization rate. Calculate your utilization percentage by dividing your balance by the credit limit and multiplying by 100. It’s best to keep your utilization under 10%.

Your personal credit score matters. Whether you want to apply for a small business loan or a mortgage, you should apply these best practices to your personal accounts.

Improve Your Credit Score Before Applying

The first step to raising your personal and business credit score is accessing the information used to calculate them. Thanks to the Fair Credit Reporting Act, accessing your credit report is free and easy. For business credit reports, visit Nav (formerly Creditera) or CreditSignal’s website. There are even more options for personal credit reports, including freecreditreport.com, Credit Karma, and AnnualCreditReport.com.

Accessing your credit report is a huge step to preparing for a small business loan. While raising your credit score is generally an exercise in persistence, your credit report gives you the information you need to make a few quick fixes.

  • Check for errors. It’s not uncommon for businesses to find out that certain trades that could boost their score haven’t been reported or to see accounts that aren’t theirs in the report. For both personal and business reports, look for mistakes made by your bank and negative activity you’ve already addressed. If you catch an error, report it immediately. Keep in mind that errors or late payments will remain on your credit report and won’t disappear until after they’ve been successfully disputed.
  • Look for any past-due debts. You’ll see them on the report, along with how much you owe and to whom. Get in touch with your creditors and pay your debt down as fast as possible. You can even ask for a goodwill adjustment, in which a lender erases a late payment from the report. And don’t forget to pay down your credit card debt!
  • Pay off any tax liens. If you have a federal or state tax lien, reach out to the relevant government entities and get started on a payment plan. Better yet, pay off the whole thing all at once.

Clearing up errors and late payments will boost your score in the short-term, but the only way to obtain a perfect score is applying good habits long-term. Some are common knowledge, while others may come as a surprise. These practices will help you get good rates on debt, from car loans to small business loans.

  • Keep your balance down. Try to use less than 30% of the total credit available to you. This shows that you’re able to pay off your debts, but that you don’t need to rely on debt financing for everything.
  • Keep your utilization rate low. Don’t close an account just because you’re done paying it off. This will lower the amount of credit you have available, which could negatively affect your score.
  • Diversify your credit mix, if you can afford to. Buying something on installment (like a home or car) or opening a credit account (other than a credit card) can improve your score, assuming you can pay for it. However, opening several accounts at once can do more harm than good, as it makes you seem desperate for cash.
  • Diversify your credit mix, if you can afford to. Buying something on installment (like a home or car) or opening a credit account (other than a credit card) generally improves your score, assuming you can pay it. At the same time, opening several accounts at once can hurt your score, making you seem desperate for funds.
  • Hire a credit monitoring service. Credit bureaus and other companies offer monitoring services starting at $20 per month. If you want to stay on top of your credit report or check the credit of companies you want to do business with, this can be a great investment.

    Know Your Use Case

    Higher is always better when it comes to credit scores. When it comes to small business loans, however, more is not always better. Many have been crushed under the weight of small business loans they can’t repay. As a small business owner, you need to figure you exactly how much money you need as well as how much you can afford. Working with an accountant before applying for a small business loan can help you get accurate estimates of both amounts.

    Be Specific

    Making your request as specific as possible helps you even more than it helps lenders assess your small business loan application. Know exactly what you’re asking for and why.

    An excellent way to show you understand your business is to build out a budget for the funds you’d get from a small business loan. Understand what you want to use them for and how much that will cost. If you need to buy an expensive piece of equipment, cite the market price of that piece and any costs that come with it. Project how much revenue owning that machine will bring into your business. These numbers don’t need to be exact; just use whatever information you have available to back up your request.

    It’s easy to justify needing money, but when you know your needs inside out, you’re more likely to receive a small business loan offer for the amount you need.

    Study Up

    Like credit scores, financial statements say a lot about your business. Take a look at your financials from the last couple of years. Ask your accountant to help prepare the following statements in preparation for your small business loan application:

    • Income Statement (also known as a Profit and Loss Statement)
    • Balance Sheet
    • Statement of Cash Flows (optional but helpful)

    Use these statements to get an understanding of what’s been going on from a top-line (revenue) and bottom-line (profit) perspective. (Because we’re cash flow lenders, at Bond Street we care most about your business’ profit/net income.)

    Once you have your financial statements lined up, you can answer these (and a number of other) important questions, which affect your small business loan application:

    1. How are you making money?
    2. What are your primary costs?
    3. Are you profitable?

    If the answer to #3 is no, you need to have a plan for how to get there. Where is the operating leverage in your business going to come from?  If you’re a retail brand, perhaps it’s from securing better rates from your suppliers once you start ordering in bigger quantities. Understand how you’re going to get to profitability, and you’ll have a stronger case for getting a the loan you deserve.

    Prepare Your Documentation

    You’ve analyzed your credit, you understand your use case, and your financials are in order. You are now prepared for applying to a small business loan! With this knowledge, preparing mere paperwork will be easy, especially if you use the Bond Street simple small business loan application.

    While you’ll need to understand the requirements of each lender, most will ask for the following:

    • Financial Statements: Lenders will need your income statement and balance sheet for at least two years of business operations.
    • Tax Returns: Lenders like to see at least one year of your business’ tax returns. Some may require two years.
    • Accounts Payable and Receivable: With your accountant’s help, prepare a full breakdown of both money your business owes and is owed.

    Understand the Offer

    Your bulletproof small business loan application will naturally land you an offer. How did the lender come up with this offer, and what does it mean? The lender uses your financials to determine what loan is right for you. Their offer includes an APR as well as an interest rate, both based largely on your credit score.

    How High Is Your Debt Service Coverage Ratio?

    The debt service coverage ratio is a tool to assess whether you’re applying for the right size small business loan. Calculating your DSCR helps determine whether a business can pay the loan payments. It answers the question, “Will this business generate enough cash throughout the term of the small business loan to cover payments?” If the answer is no, all your profits will go to paying off the loan, or, worse, you won’t be able to pay at all.

    DSCR Calculation: The ratio of your net income to your annual debt obligations

    To calculate your DSCR, divide your net income by the total debt (principal + interest + associated fees) you owe. If you run a business with a net income of $100,000 and an annual debt obligation of $50,000, your DSCR is 2. Your business’s net income can cover its debt obligations twice over. At Bond Street, we require an average annual DSCR of 1.15 to approve a small business loan.

    Note: Many people confuse DSCR with interest coverage ratio. Interest coverage ratio measures how comfortably a company can pay off its interest payments, not the entire debt obligation.

    Annual Percentage Rate vs Interest Rates

    In addition to the small business loan amount, your offer will include two other numbers: your interest rate and annual percentage rate (APR). The interest rate is the percentage of the principal amount of the loan that the lender charges you to take out the loan.

    APR represents a more complete picture. It represents a yearly average of the total interest you will pay, including fees and service charges. A small business loan with a low-interest rate and big fees may have a higher APR than a small business loan with a higher interest rate and low fees. It’s important to compare both numbers.

    Bond Street bases the terms of their offer on your personal credit score, your business credit score, and your business financials. To get an offer for a small business loan with the lowest interest rate and APR, remember best practices for keeping your credit score high:

    • Access your credit reports.
    • Check for errors in the report.
    • Pay off past-due debts.
    • Pay off any tax liens.
    • Keep your balance and utilization rate low.
    • Diversify your credit mix, if you can.
    • Consider hiring a credit monitoring service.

    Accepting the Loan

    You’ve analyzed your credit, assembled your financials, applied for a small business loan, and like the terms you’ve been offered. Congrats! You’re ready to accept. What happens next?

    Once you’ve accepted a small business loan from Bond Street, they’ll give you the full balance of the loan less the 3% origination fee (the only fee we have). Payments will occur semi-monthly, on the 1st and 16th of every month. If you pay off part of the loan early, you will effectively shorten the term of the loan, because that balance will not longer accrue interest. If you pay the small business loan off early in part or in full, they won’t charge you a prepayment penalty. Your success is exciting! If your business continues to grow strongly 3-6 months after accepting a small business loan from Bond Street, you may be eligible for additional capital.

    Getting the right small business loan, with the best terms, in a fair and transparent way is important to Bond Street. From preparing mentally to building a strong application, to getting more capital as your business grows, Bond Street will give you tools that work well so your business can grow.

Guest post by our talented friends at Bond Street.  Bond Street is transforming small business lending through technology, data and design. 

Discussions — One Response

  • fatama June 4, 2016 on 9:10 am

    Its really beneficial.Great to read.
    Thank you so much for your nice blog.

    Reply