Small Business Loans: One Size Does Not Fit All

  • January 7, 2015

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right size-right loanDespite what many small business owners might think, there is not a catchall, one-size-fits-all, small business loan. Granted, many people think of a small business loan in terms of a traditional five- to 10-year term loan they would get at the bank—so it’s easy to assume there are limited options. Fortunately, dozens of available financing options exist for a small business borrower today, which is why the first, and most important, question you should ask yourself is, “Why do I need the loan?”

How you answer this question will help you determine what type of loan you need, whether you need a short-term or a long-term loan or whether you should be looking at a special purpose loan (like equipment financing or franchise financing). It will help you avoid wasting time looking for the wrong loan.

How Quickly Do I Need the Capital?

One of the most overlooked considerations when looking for a small business loan is how long it takes to get the funds. It’s not uncommon for it to take weeks at the local bank just to find out if a loan application is approved—sometimes longer depending on the loan type or how prepared you are to meet with the banker. For example, after filling out the 40 or so pages of paperwork required for an SBA loan, it can sometimes take weeks to get approved and months for the loan to get funded. This isn’t a problem in some instances, but could be a waste of time if you were trying to take advantage of a special deal on inventory or needed to address a different short-term capital need.

It can also take a long time to find a loan. Recently the Federal Reserve Bank of New York reported the average small business owner spends 26 hours looking for a loan. That’s a lot of time away from the important work of the business and can become very expensive very quickly. Think in terms of, “How do I value my time by the hour?”

Many non-bank small business lenders can have you approved and funded in as short a time as 48 hours, and equipment-financing companies can have you financed in under a week. Depending upon what you need the money for, you should consider a bank and many of the other non-bank options available.

What Will I Qualify For?

Understanding what financing options you have a realistic chance of qualifying for before you begin the process is critical—you don’t want to waste hours of your time filling out paperwork and weeks waiting only to hear “no” and find out you never really had a chance at getting approved in the first place.

For example, if you have a personal credit score of 650 it will be nearly impossible for you to get a traditional bank term loan. And if you have great credit but don’t have any revenue—then the new breed of online business loan probably isn’t a good fit for you.

Before you start the process, take some time to evaluate your situation. Most lenders look at the following data points to evaluate the health of your business and your credit worthiness. It makes sense for you to start there too:

  • Revenue: What are my annual revenues?
  • Personal Credit: What is my personal credit score?
  • Collateral: Do I have any collateral?
  • Time in Business: Have I been in business at least a year?
  • Profitability: Is my business turning a profit every month?

Although there are small community banks that look at other factors to determine whether or not they will approve your loan application, one of the biggest things traditional lenders look at is a small business owner’s personal credit score. In fact, a good credit score is so important going into the bank, it’s probably the biggest reason most small business loan applications get denied there.

While banks and credit unions heavily weight your personal credit score when they consider you for a small business loan, in addition to your credit score, many non-bank lenders look at dozens of other data points to determine the health of your business and your business’ creditworthiness. Your credit score is only one.

Every lender has a minimum credit score threshold they will not go below regardless of how your business otherwise stacks up. Yet, if you have a healthy business, make regular and predictable deposits into your business checking account, and have been in business for at least a year, there are options.

What Interest Rate Makes Sense for Me?

Anytime you borrow money you need to make sure it’s a smart financial decision for your business.  And, as you look at your options and analyze any potential loan, look at both the interest rate of the loan AND the total cost of the loan to see if it’s a good fit for your business.

Two important questions to ask yourself are:

  • What is the total cost of the loan to my business?
  • Does the repayment make sense for my business?

“What is the total cost of the loan to my business?”

If you borrow $10,000 and pay back the lender  $11,500 (the amount of your interest payments)—the loan costs you $1500. Depending on your need for the loan, this may or may not make sense for your business. For some uses it will be a no brainer, for others it may not make a lot of sense.

“Does the repayment make sense for my business?”

In general, you want the term of the loan to match your use of the funds. A longer-term loan is going to be the preferred option for starting a business, purchasing real estate, or buying equipment that can be depreciated over several years—but might not be the right option for purchasing inventory or filling a short-term capital need.

You’ll also want to make sure the required payments won’t hurt your cash flow. You might want to consider whether smaller, more frequent payments make sense compared to a larger, less frequent payment schedule. Some borrowers even prefer daily or weekly payments to avoid a large obligation at the end of the month.

While there isn’t a one-size-fits-all small business loan, asking yourself a few simple questions will help you determine where to start looking and save you the time of looking for a loan that isn’t right for your business.

  1. Why do I need the loan?
  2. How quickly do I need the capital?
  3. What will I qualify for?
  4. What interest rate makes sense for me?
  5. Am I comfortable with my ability to repay the loan and satisfy my objectives?