About the Author: Meredith is Editor-in-Chief at Fundera. Specializing in financial advice for small business owners, Meredith is a current and past contributor to Yahoo!, Amex OPEN Forum, Fox Business, SCORE, AllBusiness and more.
Starting and growing a business is an expensive endeavor, and as the old saying goes, you need to spend money to make money. Sometimes this means investing in a loan product to expand your company’s horizons.
But with a growing plethora of loan products available to small business owners, how do you figure out which business loan will best meet your needs? Follow these steps to find the best business loan for you.
Know Why You Need a Loan
This may sound overly simple, but it is critically important: Why do you need a business loan, anyway? How do you plan to use the funds?
There are a wide variety of worthy answers to this question. Is it for a construction project, or to purchase equipment? Do you need working capital to stock up on inventory in preparation for your busy season? Your answer here will help you determine whether the investment you make using your business loan will generate enough return for you to not only pay your loan back on time and in full, but also generate a profit.
Decide How Much You Need AND Can Afford
Most every business owner starts with a “pie in the sky” number in mind in terms of their ideal business funding. After all, the more money you have to invest, the more you can do to grow your business! But along with considering what you need, it’s also critical that you consider what your business can realistically afford. Remember, you’ll be required to make monthly, weekly, or even daily payments on the money you borrow, along with interest on those funds.
To determine how much capital you can realistically afford to borrow, use the debt service coverage ratio formula by dividing your net income by total debt owed, expressed as:
Annual Net Operating Income + Depreciation & Other Non-Cash Charges
Interest + Current Maturities of Long-Term Debt
You should be able to pull these figures from your most recent balance sheet or profit and loss statement to calculate your ratio. In general, most lenders will require a DSCR of at least 1.25, but the higher your ratio is, the more comfortably you’ll be able to repay your loan on time, every time.
Review Your Credit History
Even though you’re applying for a business loan, lenders will look to your personal credit score as an indicator of how trustworthy you’ll be as a business borrower—so knowing your FICO score is key. Check your credit report from the three major bureaus—Experian, Equifax, and TransUnion—to make sure they’re accurate, and if you find any errors, request corrections in writing.
A credit score in the 700 range or higher is considered excellent. If your score over 620, you should also have plenty of loan options. A score of 520 or above will still give you some options, but they will be more limited and come with higher interest rates. If your credit score is under 500, you may have a harder time finding a business loan.
Choose the Right Loan Product for You
The good news about recent growth in alternative lending is that there is now a specially tailored loan product for virtually every business need. Researching your options to find the right loan product can help you to maximize the potential of your funding while minimizing costs.
Do you need funding to purchase machinery or computers? Consider an equipment loan. Are you searching for short-term cash flow relief while waiting for clients to pay their invoices? Consider invoice financing. As you learn about your various options, consider things like how much funding you need, how you plan to pay it back, and whether you can put up collateral on a loan to determine which will be the best business loan for you.
Work With a Reputable Lender
Particularly within the alternative lending market, where lenders aren’t subject to the same FDIC regulations as traditional banks, it’s critical that small business owners do their homework to make sure you’re working with a reputable lender.
Check with the Better Business Bureau and even review sites like Yelp to make sure the lender’s reputation is solid, and shop around with multiple lenders to make sure you get the best available price on your loan.
Look out for common red flags of lending scams, such as the lender not having a physical business address, or not being able to speak to a representative on the phone. And if you’re at all concerned about the quality of lenders you’re working with, talk to an experienced business loan broker who can point you in the right direction.
Understand Your Borrowing Rate
When you’re comparing various business loan products, not all interest rates are necessarily created equal. To make sure you’re comparing apples to apples, calculate and compare the annual percentage rates (APR) for each loan to reveal the true price you would pay for each product over time.
Most reputable lenders will give you the loan’s APR if you ask, but if not, you can calculate it for yourself using an online APR calculator.
Prepare a Stellar Loan Application
Just like most things in life, a good loan application takes time. Be sure you carefully complete all portions of the application, providing all the paperwork your lender requests. This may include bank statements, accounting documents, personal and business tax returns, and any legal documents verifying that your business is in good standing with the state and federal government. Double and triple checking your application for accuracy before submitting will help to ensure you’re approved for your dream business loan on the first try.
Following these simple steps will guide you toward the best business loan for you and your company. Once you have the perfect small business loan for your needs, protect the business you’ve worked so hard to build with general liability insurance. Remember to be diligent about your payments so that you’re seen as a responsible borrower and can explore even more financing options as your business continues to grow!