What you need to know before opening a small business loan or line of credit
From upgrading machinery and expanding your workforce to launching an innovative marketing campaign, building a successful small business requires hard work, a lot of determination and access to cash to invest in the business’s growth.
As the saying goes, cash flow is the lifeblood of small businesses. But for entrepreneurs growing their businesses, money can sometimes be tight, so it’s important to understand the financing options available.
For small business owners thinking about taking their business to the next level, here are five things to consider before applying for financing:
- Have a Business Plan
Not all lenders require a formal plan, but it is important to demonstrate knowledge of your industry, articulate that you are passionate about the market opportunity and highlight your competitive advantage. Be prepared to talk about your credit history and how financing will increase your business’ bottom line, whether it’s to help scale faster, plug a short-term financing gap or fund a large asset. If you’re unsure how much you need to invest in your company to grow, meet with an advisor before applying for a loan.
- Compile the Right Paperwork
Besides an overall business plan, lenders will require financial projections and may ask for tax returns, proof of ownership for assets and current bank statements for you and the business. Where possible, it’s also useful to have documentation handy that validates the market opportunity and your ability to attract talented employees.
- Check Your Credit Score
This is an important indicator of your creditworthiness. If your score is high (above 700), you have a better chance of being approved for a more attractive interest rate. Request a copy of your personal credit report and check for errors, such as a cable bill you paid on time but that was reported as late. Contact the credit bureau to resolve any issues, and if your score is in the 600s or lower, take steps to improve it before you approach lenders. One important indicator for credit bureaus is the percentage of available credit you are using at any one time, so aim to keep your credit card account balance, for example, below 50% of your credit limit.
- Research Different Lenders
Traditional lenders like banks and credit unions may offer the most competitive rates, but the process can take up to four months and they generally don’t lend to businesses that require loans under $500,000. Merchant cash advances provide fast finance to borrowers with lower credit scores, but the trade-off can be shady and expensive in lending terms. Peer-to-peer and marketplace lenders, like Funding Circle, are nonbank platforms that match businesses looking to borrow with investors who want to lend. Wrapped in a user-friendly online interface, these lenders ask questions relevant to the loan you’ve applied for, offer competitive rates and give you a decision typically within days.
- Compare Rates and Fees Before Signing on the Dotted Line
Interest rates and fees fluctuate considerably between lenders and depend on a number of factors from the type of financing and term to your credit score and whether the loan is secured by assets. For example, shorter loans (generally under 12 months) that have repayments based on the cash flow of a business tend to be really expensive, while longer term loans are usually much cheaper. Fundastic, a free online resource for small business financing advice, has built some great calculators to help businesses compare the true cost of borrowing across different types of loans.
Sam Hodges is co-founder and U.S. managing director of Funding Circle. He oversees the overall strategic direction and day-to-day operation of the company in the United States.