By Meredith Wood of Fundera
According to the Bureau of Labor Statistics, only 19.5 percent of businesses survive past their second decade of operation. A key culprit of failure is a shortage of cash: one small business survey conducted by Babson College found that owners were four times more likely to seek funding from large financial institutions, applied for a median of $100,000 in capital, and only received an average of 40 percent of their desired amounts.
Obviously, any small business needs capital to survive. But too many small business owners who borrow from friends and family end up damaging their closest relationships. That’s why a small business loan is often the most attractive option.
The Small Business Administration lent out $28.9 billion as of October 2016. With that kind of generosity, securing a loan is really just a matter of planning and research.
Understand your needs
No one will understand your business needs better than you do. That being said, it pays to understand what you intend to use loans for because different loans have different criteria.
For instance, the SBA offers CDC/504 loans, intended to finance purchases of equipment or real estate, or the construction or renovation of existing facilities.
Before you consider loans, you also need to keep in mind your long-term financial health, your credit scores, and your ability to repay, which will greatly impact the type of loan you apply for. One huge factor that’s rarely mentioned is the debt-to-equity ratio, which is the amount of personal money you have invested, versus the amount of money borrowed.
Know your loans
Next, you should understand the different types of loans out there, and whether they are right for your business. Note that some loans are general purpose, while others are for a specific task or project, with assistance for specific sectors like manufacturing.
Business revolving line of credit
A business line of credit is a flexible loan that has many advantages: applicants can have poor credit scores, will only pay interest on any funds withdrawn, and can even work on restoring their credit with this type of loan. A line of credit is not perfect, as it does require collateral to be held against the loan (such as real estate or cars), and can result in higher interest rates for those with bad credit.
Business term loan
The most traditional option, business term loans are lump sums that are paid back over a specific period of time with a preset interest rate. Term loans are the Toyotas of the loan world: reliable, with no surprise built into their structure; versatile, as they can be used for any number of improvements; and affordable, thanks to straightforward repayment plans.
Tax Exempt Bonds
Because tax exempt bonds come from local and state government treasuries, they require applicants to demonstrate how their project will create employment and improve the local economy. However, while bonds have higher sums (usually over $1 million), the interest on these bonds is much lower than comparable loans, and have longer-term payment plans.
There are many more types of loans, including those issued directly by the SBA. Be sure to look carefully into the different types of loans, from microloans for small, short-term amounts to the common 7(a) loan program, which can be used for purposes ranging from renovations to acquisitions.
Be prepared with your paperwork
Compared to evaluating which loan works best for your business, paperwork is probably the biggest obstacle. It pays to be prepared: an estimated 80 percent of small business loans are rejected by lenders.
Thankfully, the SBA has loan application checklists that are a good guideline for what to expect when applying to most lenders. For instance, the checklist for 7(a) loans are very hefty, including a projected financial statement, profits and loss statement, and even a personal background and finances statement.
Government loans are much more thorough,but if you can put together a comprehensive SBA loan application, chances are you can do the same for a private sector loan as well.
In short, first-timers should consider three things: the needs of their business, the strengths and weaknesses of different loans, and how to prepare the proper paperwork. It certainly helps to be persistent and follow up often, too.
Meredith Wood is the Editor-in-Chief at Fundera, an online marketplace for small business loans. Prior to Fundera, Meredith was the CCO at Funding Gates. Meredith manages financing columns on Inc, Entrepreneur, HuffPo and more, and her advice can be seen on Yahoo!, Daily Worth, Fox Business, Amex OPEN, Intuit, the SBA and many more.
The views, opinions and positions expressed within this guest post are those of the authors alone and do not represent those of CBS Small Business Pulse or the CBS Corporation. The accuracy, completeness and validity of any statements made within this article are verified solely by the authors.