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On the whole, small business owners are feeling positive about their prospects. In a Wells Fargo/Gallup Small Business Index survey released during the first quarter of 2018, small business owners reported their highest level of optimism in 11 years.
One in five owners pointed to concerns about financial issues including access to capital and credit. These worries outpaced their fears about competing in crowded markets and hiring and keeping good workers. One caveat: The survey was conducted before the Trump administration unveiled its tariffs on steel and aluminum, and against China.
Business owners can make their optimism actionable by understanding the needs and financing options for their business. In this look at the funding choices, we focus on getting a loan, since it’s the simplest option, especially for small or new enterprises. It also allows you to retain full control over your enterprise, in contrast with equity financing , which allows you to raise capital in exchange for ownership interests in a company.
When your business is new and small, you may want to consider a personal loan.
To borrow against the business, banks want to see strong records of cash flow, goodwill and profitability. A new business will not have any of those things. Its owner, however, has a credit history. Banks are more willing to loan money to a responsible consumer rather than an unproven business. In fact, many banks will not even look at companies that are less than two years old. In 2016, the Small Business Administration (SBA) reported that only 10% of its loans issued went to companies valued at $150,000 or less. Even companies with valuations ranging from $150,000 to $350,000 made up just 11% of loans.
If you have a strong credit history, you'll likely qualify for a loan at an affordable rate. Again, banks shy away from smaller businesses because the loan request is often too small. Lower lending requires the same amount of processing work for a bank without the profitability of a big loan.
When considering a personal loan for your small business, keep in mind that making late payments or defaulting on the loan will damage your personal credit.
Commercial bank loans
A loan from a traditional bank is beneficial for businesses that have been around for a while. Rates can be low, lending amounts ample and repayment periods relatively long. Aside from commercial banks, many credit unions also offer loans to small businesses with competitive terms. Since most credit unions are rooted in their communities, they may be more receptive, and less strict about meeting all lending criteria, than regular banks.
However, compared with other funding options, you can expect longer processing times—approximately 1-2 months—and closer scrutiny of your application. Most commercial banks will also require that you have an excellent credit score and credit history.
If you don’t meet all the criteria, you may still be able to secure a loan from a traditional lender with help from the Small Business Administration. Debt financing options backed by the SBA are still fulfilled through commercial banks. Instead of funding the loans themselves, the SBA guarantees the loan amount up to a certain percentage. This allows borrowers to have a better chance of getting approved by commercial banks.
Financing from non-traditional lenders
Since qualifying for a bank loan is difficult for some businesses, alternative lenders have entered the market to fill the gap between personal funding and commercial bank lending. Companies, such as Kabbage and Funding Circle, generally have less stringent eligibility criteria than traditional lending sources such as commercial banks.
These alternative lenders boast easier applications, quicker processing times and simpler terms. Loans from alternative lenders, however, typically have higher interest rates and are limited in terms of loan amounts and repayment periods. Most alternative lenders only offer loans up to $100,000 to $500,000 with terms of up to one year to five years.
The article, Understanding Small Business Loan Options, originally appeared on ValuePenguin.