The core problem for every entrepreneur and small business starting out is the same.
They need cash.
That holds true whether it’s a brand new business who needs cash to realize a great idea or a company who just needs to gain a competitive advantage and achieve growth.
Part of it, of course, is acquiring hard assets—equipment, real estate, office space, warehouse space, technology—and soft assets, such as regular, reliable employees and, occasionally, consultants who help guide the direction of the business.
The pressure to acquire all the needed assets to execute a great idea, especially on lone entrepreneurs, can be overwhelming. It’s especially daunting when the entrepreneur or small business sees a significant cash shortage and knows they will have to get help financing their goals.
This is where the Small Business Loan steps in.
Knowing how these loans work is critical, however. Of course, this is something we’ve covered in past articles, but today we will be revisiting those general principles with a slightly different approach on the topic as well as some new information not covered previously.
Here are a few key points to help you better understand this financing alternative:
Perhaps one of the most well known funding alternatives is the financing available through the Small Business Administration (“SBA”). One of the advantages of the SBA is that it offers products specifically geared toward small businesses.
This definition from bplans.com zeroes in on the nature of an SBA Loan:
[The loan] is not a direct loan from the SBA itself. Rather, it is a loan that has been made by a commercial lending partner, but that the SBA has guaranteed for these partners and that has been structured according to SBA requirements. This helps to minimize the risk for both partners and borrowers. Only those without reasonable access to other funding sources are eligible for such a loan.
Regular Bank Loans
The best place to get a small business loan is still a bank, says George Cloutier, CEO of American Management Services, a consultant to small businesses. Banks typically offer the lowest interest rates and many have established reputations as trustworthy lenders, though it’s not always a walk in the park for small businesses to get funding from a bank.
As NerdWallet points out:
Small businesses have a tougher time getting approved due to factors including lower sales volume and cash reserves; add to that bad personal credit or no collateral (such as real estate to secure a loan), and many small-business owners come up empty-handed. Getting funded takes longer than other options — typically two to six months — but banks are usually your lowest-APR option.
Small Business Lines of Credit
The primary difference between a line of credit and a regular loan is that with the loan it is drawn against usually once, that is, for the full-approved amount of the loan.
With the line of credit, on the other hand, it is drawn against on an as-needed basis. When the business’s cash position permits a pay-down of the line of credit’s outstanding balance, the borrower is typically permitted to do so.
The credit line situation is potentially less expensive than the regular loan situation because the outstanding principal amount of the line of credit is only for funds that have been put to immediate productive use, and hence, the associated interest charge is for immediate productive use instead of just sitting in a bank account somewhere. However, the fees (other than the interest cost) for putting a line of credit in place are usually more expensive than a simple loan.
The bottom-line is this: a credit line helps the borrower draw against the line of credit as frequently as needed (subject to outstanding principal limitations), and repayments less than 100 percent of the outstanding principal amount can be made as frequently as it makes good business sense to do so. It is incumbent on the borrower to pay attention to sensible cash management practices because of this flexibility associated with maintaining a line of credit.
BPlan.com says this about the line of credit option:
…for startups, a line of credit can help get your business off the ground, as many new businesses have limited capital needs, and a loan can quickly eat into your profits. For businesses that are already on their feet, a credit line offers a safety net, as well as great flexibility that business owners can use creatively to their advantage.
As this report notes, finding, applying, and getting approved for small business loans can be difficult, but the more prepared you are, the better. Be attentive to the following, as discussed by NerdWallet:
- Pinpoint why you need the money. Ask yourself how this loan will help your business.
- Find the right loan. Choose a type of business loan based on your needs.
- Find the best lender for you. Compare options based on the cost and terms of each loan.
- See if you have what it takes to qualify. Gather information including your credit score and annual revenue.
- Get your documents ready and apply. Know what documents lenders will need from you ahead of time.
In summary, if you keep the principles in this article in mind and look carefully at all of the financing options, you are more likely to get the crucial funds you need that will turn your big idea into a big success.