Starting a business requires at least some upfront funding. You can attempt to be frugal and startup on a tight budget, but most businesses will require at least a few thousand dollars to afford initial product stock, office supplies, technology and employee wages necessary to build the infrastructure of the business.
A lack of capital
If you don’t have much available capital, or if you’re struggling to find initial funding through routes like angel investors or crowdfunding, there is another option available to you: a business loan. Business loans work much like personal loans, giving you a sum of money you can use to start and/or grow your business, which you’ll then pay back over a specified period of time.
However, because there are so many different types of business loans available, it can be intimidating for newcomers to make an informed decision. Sites like Top10BestBusinessLoans.com exist to help you compare apples to apples and understand the key differences between different business loans, but what criteria should you use to pick the right loan for your business?
Related: How to Get a Loan for Your Small Business in 9 Steps
Criteria for choosing a business loan
These are the main points you should examine:
- The type of loan. There are actually several different types of loans you can get for your business, each with different advantages and disadvantages. For example, a line of credit loan will give you a floating amount of credit you can tap into for recurring needs, like purchasing inventory or paying employees, but they shouldn’t be used for buying new equipment. Installment loans are generally paid back in equal monthly installments that cover both the principal and the interest, and balloon loans are interest-only loans, with the principal due back on the final day of the loan’s term.
- The lending institution. You’ll also want to consider the lending institution that you’re working with. If you already have a business checking account or other forms of credit with a specific financial institution, it may be convenient to apply for a loan with the same organization—and they may be able to offer you better terms, as well. Otherwise, consider shopping around for a lender that seems easy to work with, or one that’s particularly open to businesses like yours; for example, some lenders are more willing to lend money to startups and new businesses than others.
- The interest rate. Obviously, you’ll also want to consider the interest rate. No matter what type of loan you’re getting, you’ll be paying some kind of interest rate, but that interest rate is variable based on your credit history, the type of loan, the terms of the loan and various other factors. The lower this interest rate, the better, but you may have special circumstances that allow for a higher interest rate in exchange for another benefit (such as a higher amount of capital to be lent).
- The terms. You’ll also want to check out the terms of the loan—basically, how long the loan will last. If you only need a temporary boost in capital, shorter terms are more favorable, while something like a line of credit will need to last you for several years. You’ll also want to examine how the interest rate is compounded (monthly, quarterly or annually).
- Conditions for paying the loan back. Your business loan may also come with special conditions for how your loan can and should be paid back, and what happens if it isn’t paid back on time. For starters, loans will either be “secured,” with a piece of equipment or something similar to be used as collateral, or “unsecured,” where no collateral is necessary. If you fail to pay back a secured loan, the lender has the right to seize the secured asset. If you fail to pay back an unsecured loan, depending on the terms and conditions, you may be held personally liable for the balance. You may also face penalties for things like early payment, so be aware of the conditions here.
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With these five points in mind, you should be able to come to a decision about which business loan is best for your business. Keep in mind you may still need to go through a formal approval process, especially if you’re requesting a sizable loan amount. If your business already exists, banks want to see a healthy, consistent trend of profitability, relatively liquid assets and low existing debt. If you’re just starting out, you’ll also need a strong personal credit score and a good business plan to win a lender’s favor.
If a business loan doesn’t work out, you can always opt for a personal loan, or return to seeking investment from venture capitalists and angel investors.
