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Does financing your business seem overwhelming? Understandable, since there is a plethora of products to choose from. And business lending practices are not as transparent as what you may be accustomed to with your personal finances.
But positive change is happening in small business lending. The Responsible Business Lending Coalition (RBLC) is a network of advocates who support fair business lending practices. They created the Small Business Bill of Rights, which has been signed by numerous companies in the small business financing space. Look for companies who have signed the bill as a source for reputable lenders and other resources.
Still, proceed with caution when choosing to finance your business. These tips will help you understand the crucial steps you should take when you’re weighing the pros and cons of a financing offer to ensure that it will be beneficial to your business.
When you shop for funding, consider these four questions:
- Am I likely to qualify?
- Do I understand the cost?
- Can I afford it?
- How long will it take to get funding?
Am I likely to qualify?
The first factor you should evaluate is whether you’re likely to qualify for the financing offer you’re considering.
Why? Because you don’t want to risk an inquiry on your credit profile for financing that you won’t qualify for. Inquiries into your personal credit reports can lower your individual credit scores by a few points. Plus, it’s a waste of your time to apply for financing that clearly won’t work for you.
Check the offer to see if your business meets the criteria the lender is looking for. Some typical qualifiers a lender may look at are:
- Months in business
- Company revenue
- Your personal credit score
- Your business credit score
- FICO SBSS score
- Incorporated legal identity
Many will also check to see if you have an open personal or business bankruptcy, or tax liens. Some lenders will not lend to a business with multiple UCC filings, as these indicate other creditors have a security interest in company property or assets. Also, find out if you’re going to be required to put up any collateral or personally guarantee the financing.
Know that the industry you’re in can make or break your application, too. Some industries are considered higher risk, like restaurants, retail, and real estate investing. Other industries, like gambling, adult entertainment, or cannabis, find it even more challenging.
Your business credit report will often list the Standard Industrial Classification (SIC) or North American Industrial Classification System (NAICS) code identified with your business: make sure yours is correct.
Do I understand the costs?
You’ll want to look for a loan product that clearly states its terms, pricing and fees upfront. Except for new legislation in California, there are no laws requiring consistency in the way interest rates are disclosed to small business borrowers. And there are lenders out there that want their terms to be confusing.
The amount you are borrowing (principal) and interest are the most significant costs involved in any business financing scenario and will comprise the bulk of your payments. In consumer lending, the easiest way to compare costs is with an APR, but business loans don’t require the disclosure of an APR. It’s worth the extra effort to translate the lender’s offer to an APR.
Also, depending on the specifics of the loan or credit offer, you could be charged any or all of the following fees:
- Application fee
- Processing fee
- Underwriting fee
- Origination fee
- Appraisal fee
There could also be prepayment penalties, monthly service charges, or something called an exit fee. The point is, make sure you’re aware of each and every cost associated with the financing offer you’re considering.
Can I afford it?
Taking out a loan is not beneficial if it detracts from the long-term profitability of your business. For every financing offer, you’ll want to calculate your debt service to make sure that making the payments does not negatively affect the health of your business. If the loan payments dramatically shrink your cash flow, make sure you can operate within a smaller monthly margin.
If you accept funding that comes with a payment that’s going to be tough to swing every month, you could be hurting your business as opposed to helping it.
If you can afford the loan, make sure you’re spending your funds on things that grow your business and give you a good ROI. These items will vary depending on your industry. It could be as simple as an increase in your marketing, or a large purchase like new equipment.
How long will it take to get funding?
Attractive sources of financing, such as loans from banks or credit unions (including SBA-guaranteed loans), often take the longest to get approved. They require more extensive documentation and must go through several layers of approval. Applications can take weeks and sometimes months.
Many online lenders and even small business credit cards offer faster financing options that can often be approved in minutes. Funding can take place in a few days.
If you have an immediate and critical need for funds, you’ll need to find a fast financing source. However, if you have more time, shop for lower-cost funding to save money. That’s why it’s essential to start looking for funding before a crisis (or urgent opportunity) hits. Try to prepare before you need it by taking these steps:
- Check your business and personal credit scores
- Make sure your bookkeeping and tax filings are up to date
- Know your numbers: note your annual revenues and average monthly revenues
- Gather documentation, such as your letters of incorporation and a copy of your lease (if applicable)
- Update your business plan if you plan to apply for traditional financing through a bank or credit union
These steps are vital whenever you’re considering accepting a business loan or line of credit. Financing could help your business grow, or it could put it under. Take it slow, do your research, and always read the fine print before accepting the terms offered by the lender.