Remember the old advice that heeds to “look before you leap”? When it comes to small business loans, you can translate that to “ask before you apply,” and it’s a crucial step for any entrepreneur considering financing. You’ve probably already thought of common questions like, “What will my interest rate be?” and, “How long is the term on this loan?” While these questions are important, they come later. First, you need to be introspective to determine whether or not a small business loan is the right solution for you and whether you have everything you need to begin the application process.
In fact, before you ever start a business loan application, you should ask yourself these five questions.
How will I use this business loan?
Answering this question with a general “to grow my business” isn’t enough. You should have concrete plans for how you’ll use your loan, whether it’s to hire new employees, increase your marketing reach, or add more stock. If you don’t have a clear answer for how a loan will help you grow your business, you probably shouldn’t apply for one just yet.
Your answer should directly inform what kind of funding you get. If you have cash flow issues, a business line of credit might be a good option. If you’re making a large one-time purchase, though, you’ll probably want a traditional term loan. Likewise, your answer will help you decide how much money you need, which brings us to the next question.
How much money do I need?
Note that this question asks how much money you need, not how much you want. It can be easy to give in to the impulse to apply for the biggest loan you can possibly get, but you’ll find a few problems with that method.
First, if you’re applying for the maximum loan amount a lender offers, you’re more likely to get rejected (or at best, approved for a smaller loan than you asked for). After all, lenders tend to reserve the larger loans for top-tier applicants.
More importantly, you have to repay every dollar you borrow and then some. Small business loans often come with high interest rates and a lot of fees that you must consider in your cost. Most lenders calculate their fees based on your loan size, so you’ll have bigger fees on a bigger loan.
Plus, a larger loan could stick you with too-high monthly payments that take over your budget. It’s better to apply for the amount you actually need. You’ll come off as a better applicant, and you’ll have confidence in your ability to repay your loan.
How does my application look?
This question requires you to look at yourself as a lender will, which can be difficult. Still, you don’t want to waste your time applying for business loans you’ll never qualify for. Be honest with yourself: Do you have a solid application?
Most lenders look at a number of factors when determining your funding eligibility, from your personal credit score, to your startup’s revenue, to how long your company has been around, and its projected future revenue, to name a few. If you’re confident that you have a strong application, then you can move on to the next question. If you’re less sure, take some time to consider your options.
For example, you might want to apply to an alternative lender that looks just at your business bank account rather than your credit score (Kabbage and FundBox both operate this way). Alternatively, you could postpone your loan application until you’ve beefed up your credentials a bit. You could build your business credit by getting a business credit card. The process could take a few months (or even a year or two), but in the end, you’ll be a better applicant who can qualify for better loans.
How confident am I in my business?
Applying for and getting a loan is just the beginning; this question asks you to look at what comes next. Are you sure that your business will do well enough that you’ll have no issues repaying your loan? Everyone wants their business to succeed, but that doesn’t mean they all will.
In fact, 1 in 12 businesses shutter each year, mostly because of cash flow issues.
At the very least, you should think long and hard about what will happen if you default on your loan. If you get a collateral-backed loan, for example, you’ll obviously forfeit your collateral if you can’t pay. Are you willing to give up that collateral, whatever it may be? Even if you don’t have to offer collateral, many loans require a personal guarantee. That means your lender could come after your personal property if you default on the loan. Can you live with that?
Hopefully your business has a bright enough future that you’ll never need to worry about these what-ifs becoming realities. Even so, you should give them some consideration.
What’s my contingency plan?
Speaking of possible realities, what happens if you go through the loan application process only to get denied any funding? It happens.
One study suggests that 20 percent of business owners who apply for funding get denied.
Sure, you’ve probably been up against worse odds, but take some time to mull over what happens if you’re the one in five—or even if you get approved, but for a lower amount or at a higher interest rate than you expected.
Of course, you can always apply for funding with a different lender. You can also try different types of funding. Some, like invoice financing or merchant cash advances, are much easier to get than term loans (though you’ll pay more for them).
Without any plan in place, you might find yourself up a creek without a paddle—or in a tight financial spot without a business loan, as it were. You’ll feel the sting of rejection and worry about the future. Better to come up with a contingency plan beforehand so that a “no” on your application is a disappointment, not a disaster.
It never hurts to ask
As you ask yourself these questions and then give yourself honest answers, you’ll find yourself better prepared to successfully apply for a small business loan. You’ll not only be able to present yourself as a good investment to a lender, but also feel more peace of mind knowing that you’ve prepared yourself for the funding process.
Look before you leap, ask before you apply, and go forth feeling confident in your funding decisions.