Business Loans for Startups
So you are thinking about looking for a loan to launch your startup? Well, the first thing you need to understand is that debt financing is not the preferred way to go for financing startups. The reason is that even if the startup fails, you are expected to repay the loan off in full plus interest or have your credit rating destroyed. Ouch! This is precisely why entrepreneurs prefer equity capital. Equity capital is considered a gamble on the startup. Heads you win; tails you lose. If the startup fails the investors settle for a tax write-off. They do not go after the founders for repayment.
To determine if you can qualify for a startup loan from a bank or other lender, there are a number of questions to consider:
- What is the purpose of the loan?
- How much needs to be borrowed?
- How much time will you need to repay the loan?
- What assets can you put up as collateral?
When preparing your answers to the above for your application to the lender, be as specific as possible. What exactly will you use the loan money for? Is it for production equipment, inventory, delivery vehicles, work space, technology? What is the time frame for repaying the money? What type of loan do you seek? Short term or long term?
Types of Business Loans
Banks offer two basic types of loans, short-term and long-term.
Short-term loans typically reach maturity in one year or less and are used to help a seasonal business survive its slow months. Short term loans include lines of credit, working capital loans and accounts-receivable loans.
Long-term loans, on the other hand, usually mature in one to seven years. They can extend even further for real estate or heavy equipment. They are used for major business expenditures such as construction, manufacturing machinery and equipment, vehicles, buildings, and leasehold improvement. They also can be used to assist a business through a depressed cycle.
The Most Common Types of Business Loans
These are the most common loan types that banks will offer to startups and small businesses:
- Working capital lines of credit — These are used for day-to-day operations. A credit line is usually for a short-term, about 90 days, but can be rolled over regularly if the company is complying with all of its covenants. The interest rate will be variable.
- Equipment leasing — Leases are a variant of the loan used for helping businesses acquire revenue producing equipment when cash is too tight for an outright purchase.
- Letters of credit — With LoCs the bank acts as an intermediary, promising to pay the seller if all conditions are met. Important for reducing risk for a business practicing international trade.
- Credit cards — A revolving credit card, such an AMEX card, can be a helpful cash management tool.
How to Improve Your Odds for Being Approved for a Loan
When it comes to startups, banks are leery lenders. They understand the high probability of failure and are not swayed by the entrepreneur’s passion. Banks prefer to lend to companies that have been around a few years and can show with their financials and tax returns that they have been making money. Furthermore, banks prefer businesses with a track record as borrowers because they tend to have collateral such as inventory, accounts receivable, fixed assets, and even real estate. Banks are not affected by the entrepreneur’s optimistic predictions for his or her startup. These are irrelevant to them. Basically, it comes down to the founder’s credit history and collateral. Yes, the founder will have to personally guarantee any loans or leases and put up collateral.
Types of Loan Guarantees
Here are common types of loan guarantees that banks will accept:
- Real estate such as your home
- 401K plan
- College fund
Improving Your Chances of Being Approved for a Loan
One lesser known option is to have someone with deeper pockets cosign your loan or credit-line. This is typically done by a wealthier individual who may not have the liquidity to give you cash but would be comfortable enough to cosign with you. It is possible to also find people find people who will cosign for a small fee. be sure to check with your legal or financial advisers.
Don’t forget the Small Business Administration (SBA) which can also help you get a loan for your new business. The SBA is a U.S. government agency that backs and guarantees loans made by banks to small businesses. This backing gives the bank a higher level of confidence in being repaid. With less risk, it is more likely to approve a loan. In the event you default, the SBA has guaranteed the lender that it will pay up to 90% of loan back itself. The guaranteed percentage will vary with the type of loan and amount. The SBA offers many types of loans for many situations that affect communities and local economies. As a small business owner seeking a loan, you (and anyone else who owns at least 20% of your business) will be required to personally guarantee the loan. Your business must also qualify as a small business.
With the standard SBA-backed loan (7(a) Loan Guaranty Program), you can borrow up to $2 million; however, the SBA will only guarantee the first $1 million. If your loan is $150,000 or less, the SBA will guarantee 85%. If the loan is for more than $150,000, then they’ll guarantee 75% of it.
The downside to the SBA are large amounts of paperwork and time delays. Be prepared to wait many months for money to arrive in your bank account.
The SBA Express is a new option offered by the SBA. It provides a 36-hour approval process for loans up to $150,000 but only guarantees up to 50%. You can also qualify for an unsecured line of credit up to $25,000 under this program.
Microloans are another option backed by the SBA. These loans are small and top out at $35,000. The average microloan is $10,500. The maximum term is six years. The SBA will forward your loan application to a local SBA-approved lender who will make the final credit decision. In this type of loan program, the lender is required to provide the borrower with business training and technical support. In fact, the lender may even require the training as part of the loan application process. You may have some difficulty finding lenders who participate in microloan programs simply because of the small profit in it for them.
The SBA offers numerous other loan programs not mentioned here. Go to the SBA.gov for more information, as well as a listing of your local SBA-approved lenders. Most local lenders have SBA experts on staff, so you can begin the loan process directly with them.
If you need more than $500,000 and haven’t had luck with banks, consider approaching commercial finance companies. They will usually take on higher risk loans than banks. Keep in mind, however, that their interest rates will also be 2% to 5% higher than banks’ rates.
Here are Some Final Business Loan Application Tips
Every banker will have a slightly different set of criteria to consider when deciding whether or not to approve your application. They will all look at your financial projections and credit history. However, their perception of your character is also important. This means that it will require applications to several banks before you finally find one that will take a chance on your business. So, don’t give up after a rejection or three.
Here are some tips to improve your chances of being approved.
- Call first to make an appointment and be on time.
- Dress for success. Wear your best business attire and groom properly.
- Have a well-prepared business plan and model and all financial documents with you.
- Be professional.
- Listen carefully and answer all questions honestly.
- Accept feedback from the banker. Don’t argue.
- Be prepared to answer questions about anything and everything related to your business, your credit history, and your financial status.
- Act in a confident manner.
- Don’t come across as desperate or fearful.
- Don’t waste any time “selling” your business idea (they don’t care).
- Keep in mind that they only want to know how they’re going to get their money (and interest) back out of you.
- Have some skin in the game: The larger your own financial investment in the company is, the better your chances of being approved.