The Basics of Business Loans: A Guide for Beginners
Starting a business can be an exciting and scary experience. There are many steps to take, and it’s not always easy to know where to start. One of the first things you should do is figure out how you’re going to get your startup capital. A business loan might sound like the best option, but they come with their own set of challenges.
This article will help you understand what a business loan is, how it works, and if it’s the right choice for you. It will also talk about some of the different types of loans that are available, so you can make an informed decision about which one might work best for you.
What is a business loan?
A business loan is a type of personal finance that’s specifically designed for business owners. It allows you to borrow money from either a bank or a credit union, and it can be used for almost any type of business expense.
Business loans are available to both new and established businesses, but they are most often used by startups. They are one of the easiest ways to get startup capital, because it’s easier to secure a large amount of money with little collateral than it is with an investment loan.
How does a business loan work?
A business loan is a type of debt. When you take out a business loan, you borrow money from someone else and agree to pay them interest on the loan. Theoretically, this should make your business more profitable—but it’s not always that easy.
The person giving you the loan (the lender) will want some kind of collateral against your promise to repay the money. You can offer up physical assets like equipment or property, or you might have to pledge something else in return for the loan. This is called an equity stake in your company. But what happens if things don't go as planned? If your business fails, the lender can come after any collateral that was offered up when they extended the loan in order to get their money back.
Who can apply for a business loan?
A business loan can be a great way to fund your startup. The best candidates are those who have good credit, reasonable debt, and stable income.
If you’re just starting out, it might be difficult for you to qualify for a business loan. This is because lenders want to know that you have the ability to repay the money given to you. They also want assurances that they will get their money back in due time. That being said, if you have an established track record of success, then this might not be as much of an issue.
If you don't yet have any experience with loans, borrowing small amounts from friends or family members may be one way for you to build up your credit score so that lenders are more apt to work with you down the road.
The types of loans available
Banks often offer business loans, but other places might be willing to give you one too. For instance, angel investors might be interested in your idea and offer you an investment loan. This is a loan that can be repaid with shares of stock in your company.
Business loans are usually considered the safest option because the business owns the assets that are being used for collateral. You may also qualify for a line of credit that you can tap into whenever you need it.
A factoring loan is another type of loan available to businesses. Essentially, this type of loan allows you to borrow money to cover certain costs before they’ve been paid by customers or clients. The funds are then applied against those expenses when they come due.
Before we get into the details of business loans, let’s first discuss the application process.
If you believe a loan is right for your business and want to apply, there are a few things you should know up front about the process. For one, many banks will need more information than just your financial history before approving a loan. They might also ask for information on your company’s projected revenues and expenses, as well as other pertinent details like your personal credit score or how much you earn.
You may also be asked to fill out paperwork and provide documents, such as tax returns and financial statements, which can take some time to gather.
In general, it’s important to be prepared and follow these steps:
1) Find out which type of loan might work best for you by considering what kind of funds you need.
2) Fill out preliminary paperwork with information on your company's projected revenues and expenses that includes projections from the next 12 months.
3) Provide documentation that proves you have personal creditworthiness as well as financial records from within the last 12 months that show your finances are stable enough to cover loan payments over a period of several years
Getting Your Financial House in Order
Before you apply for a business loan, make sure your financial house is in order. This means tracking your assets and liabilities, researching your borrowing history, and gathering collateral.
What are assets? Assets are anything you own that has value. Cash on hand, an investment portfolio of stocks and bonds, property, equipment—all of these can be classified as assets. What are liabilities? Liabilities are amounts that you owe to someone else. These include personal loans, credit cards or lines of credit, mortgages, car payments or leases.
You should also research your borrowing history so you know how much debt you have had in the past. If you have had more than one loan in the last two years or if your total debt-to-income ratio is greater than 50 percent, then it might be difficult to get approved for a business loan.
Collateral can be any type of asset that can be pledged against a loan in case you default on payments (e.g., real estate properties). It's important to gather enough collateral in order to provide security for your lender in case things don't go as planned with the loan repayment terms.
Know the Details of Your Current Financing
Business loans are not the only form of financing available for your business. Savings, current assets, inventory, equipment, and property are all viable options.
You should consider what types of financing you currently have before applying for a business loan. If you have substantial cash or equity in your company, any investment opportunity might be better than taking on debt by borrowing money from a bank.
In addition to considering your existing sources of funding, it is important to note that banks often do not offer long-term loans with low interest rates. So if the interest rate on the loan exceeds 4 percent or is an adjustable rate loan, it can be more expensive than other forms of financing.
Prepare for the Application Process
Before you apply for any loans, it's important to be prepared. Prepare your assets, liabilities, borrowing history and business plan.
An asset is an item of value that belongs to your business. Assets can include cash, accounts receivable (money owed to your company), inventory (goods on hand), equipment, buildings and land. A liability is money owed by the business to other parties, like credit card balances or other loans.
A borrowing history includes information about how much you've borrowed before and what the terms were (i.e., interest rate). It also includes whether you've paid back those loans on time or not.
A business plan contains critical information that will help provide a framework for your loan application process including projections of taxes, cash flow statements and more.
Gather all your financial information
Before applying for a business loan, it is important to compile all of your financial information. This will include:
A list of all your assets, such as property and vehicles
A list of all your liabilities, such as credit cards and personal lines of credit
Your current balance on each liability
The total amount you owe on each liability
A list of any previous business loans that have been applied for or received in the past five years
Establish your business plan and budget
Before you start shopping for a loan, you should have a clear idea of what your goals are and how to get there. Set goals for your business and define deadlines for when you would like to accomplish them.
This is also the best time to draft a budget that will include the cost of any investments you’re considering, such as a new piece of equipment or marketing initiative.
The point is: before you submit an application for a loan, know what it’s going to be used for and how much it will cost. This way, you can see if these purchases are possible with the funds from your loan and if so, whether or not they make sense financially.
Become familiar with loan requirements
The first step in applying for a business loan is knowing what it takes to qualify. The requirements will vary depending on the type of loan you're applying for and the lender. However, there are a few items that may be required of all borrowers:
-A business plan
-Business credit history
It's not enough just to have a good idea for your company. You have to take the time to prepare yourself financially before you apply for a loan. In addition, once you know how much money you need, you should start researching different sources of funding so that you can pick the one that is best for your company's needs.
The Importance of a Good Credit Score
In order to qualify for a business loan, you'll need a good credit score. For some types of loans, your business will be liable for the debt if you don't make your payments. This is why it’s important to maintain a good credit score by paying on time and not maxing out your credit cards.
If you want to improve your credit score, here are some steps you can take:
- Review your records for errors or mistakes
- Pay all of your bills on time
- Avoid new debt obligations
- Consider a secured personal line of credit
A business loan can be a great way to help your business grow—but you have to be ready for it.
If you want to avoid the common pitfalls of applying for loans, it’s important to take the time to prepare. Knowing the details of your current financing, gathering all your financial information, establishing your business plan and budget, and getting familiar with loan requirements are just a few of the things you’ll need to do—and you’ll be thankful that you did when it comes time to apply.