Business Loans: Everything You Need to Know for Opening Your Small Business
By: iThink Financial | Oct 01, 2022
Currently, there are 32.5 million small businesses in the United States. If you want to join their ranks and have an idea for a new company, you're likely excited to start. But before you do, you must secure funding for your business.
Business loans are one of the most common ways to fund a new company. If you're interested in learning more, keep reading! We cover everything you need to know about taking out a small business loan, including why you should, how to get started and critical information you need to guarantee your success.
Do You Need a Business Loan?
As you begin taking steps toward launching your new company, one factor you must consider is how much money you will need for startup costs. There's no getting around the fact that starting a new business costs money, but how much it costs depends on several factors, such as the industry and the scale.
We'll cover the many different costs that business loans can cover later, but for now, let's go over some funding options.
You have a few options regarding funding your business. What works for one entrepreneur may not be the best solution for you, as each individual has different financial needs. For instance, an e-commerce company that doesn't have a physical location and sells only digital products will have vastly different needs than a brick-and-mortar company.
The first step is to calculate your startup costs. Doing so enables you to estimate your profits, attract investors, save more with tax deductions, and secure loans.
You have three options for funding: self-funding, investors, and business loans.
Self-funding or bootstrapping involves leveraging your financial resources to launch your business. Examples include:
- Taking money from your savings.
- Tapping into your 401(k).
- Borrowing from family and friends.
Self-funding is fine for smaller operations but also has certain downsides. For one, you take on all the risks yourself, even if you retain complete control of the company. It's also risky to pull from your 401(k) early, especially if you can't repay it back in time.
Investors can give entrepreneurs funding through venture capital investments. The tradeoff is that they will retain an ownership share and have a say in how the company conducts business.
Venture capital usually focuses on high-growth companies, so it's hard for new entrepreneurs to secure this type of funding. Venture capitalists also often want a seat on the board of directors, which means giving up some control of the company.
Crowdfunding is another way to launch a business. Crowdfunders aren't technically investors in that they don't want to play ay, but they may expect certain perks, such as a mention on the website, access to the latest updates, and so on.
Small Business Loans
Small business loans are the best bet for those who don't have enough funds to launch a business themselves and want to maintain complete control.
It's much easier to secure a business loan than to appeal to investors, and you can take certain steps to increase your chances of approval. For instance, preparing an expense sheet and business plan with financial projections for the next few years.
You can obtain a loan from banks and credit unions. Business loans are ideal for funding big projects and covering operational expenses, while personal loans are helpful as financing for both business projects and personal funding.
What Business Loans Can Cover
Business loans help with any business-related expenses and are invaluable to budding entrepreneurs. Here are a few of the many costs that this type of loan can help cover.
- Office space
- Licenses or permits
- Lawyer and accountant fees
- Printed marketing materials
- Website fees
- Employee salaries
- Marketing and advertising fees
Generally, the first step should be calculating your estimated expenses. For instance, you might operate your business from home, but you might need to pay for storage for inventory or fees related to your business website, such as hosting.
The reason so many new businesses don't make it is due to a failure to prepare and account for these expenses. It's easy to underestimate how much it will cost to launch and run a company, even an e-commerce business.
You must make a business plan, even a basic one. Your plan should include startup costs, operating costs, and financial projections. A business plan will also make it much easier to qualify for a loan.
After making a full list of expenses, it's time to separate them into one-time business costs and monthly costs. One-time expenses include purchasing major equipment, paying for permits or licenses, hiring a logo designer, etc. Monthly fees include website hosting, equipment rentals, office space fees, utility bills, etc.
Additionally, you can break expenses down further to include quarterly costs. For instance, self-employed individuals must plan for estimated quarterly taxes to avoid penalties and additional fees.
What You'll Need to Qualify for a Loan
The next step is to apply for a business loan. You can increase your chances of approval by taking a few steps beforehand. Here's what you need to do before applying for a loan.
A Credit Score Analysis
Your credit score is arguably the most important factor that lenders consider before agreeing to lend you money. Banks and other lenders need to know that you'll pay the money back, and your credit score is a good indicator of how big a risk you are.
There are two different credit scores to consider here: your personal and business scores.
When you launch a business and file taxes, you should have an Employee Identification Number (EIN), which begins a business's financial history, including the business credit score. If you're a budding entrepreneur and have never filed taxes for your company, you might not have one yet.
Your personal credit score is a number built on your credit history. This number ranges from 300 to 850, and it determines your creditworthiness. The higher the score, the more likely you will obtain a loan.
Individuals with scores below 640 are generally considered subprime borrowers or higher-risk borrowers. Those considered subprime usually can only obtain loans with higher interest rates.
The FICO Score range is as follows:
- Excellent - 850-800
- Very good - 799-740
- Good - 739-670
- Fair - 669-580
- Poor - 579-300
Your personal credit score is affected by your credit history, debt levels, number of open accounts, repayment history, and more.
The three main credit bureaus are Experian, Equifax, and TransUnion. You can request a free credit report from these major bureaus by visiting AnnualCreditReport.com.
We discussed earlier how calculating your expenses would help keep you on track and improve your chances of securing a loan. Creating an expense report makes you look more professional and responsible to lenders, even if you don't have that many costs.
You can use expense-tracking software or create a simple spreadsheet. Present this list of expenses when discussing a loan with your bank.
Writing up a business plan will keep you on track, prevent overspending, and determine if you're on the right track toward meeting your goals. It guides you through each stage, from launching a company to managing it and beyond.
Essentially, the business plan is a roadmap that enables entrepreneurs to run, manage, and grow a company.
If you're not looking for investors, a simple startup plan will work fine for now. It should include the following:
- Deadlines for each month
- Product goals
- Profit and loss statements
- Financial projections
- High-level and long-term goals
- Executive summary
- Market analysis
- Competitive analysis
- Product and service descriptions
- Marketing plan
- Sales strategies
- Request for funding
Corporations can have business plans of upward of 100 pages, but for a new startup, a concise plan is fine. You should regularly check and update your business plan, especially when expanding.
Applying for a Business Loan
Finally, you can apply for a business loan. You'll need to calculate the payments you can afford and determine what type of loan you plan to request.
Examine your business cash flow. Ideally, the total income should be a minimum of 1.25 times your total expenses. That should include the new repayment amount for your loan.
The next step is determining the type of business loan you plan to pursue. There are term loans, SBA loans, business lines of credit, and more.
Term loans mean you'll receive a lump sum upfront, and you'll repay the amount over a set period with interest. This type of loan may require a type of collateral or a guarantee.
Banks and lenders offer SBA loans. Repayment periods vary, depending on your plans for the money. SBA loans have low rates and allow businesses to borrow up to $5 million.
Get Your Business Loan Today
Starting a business is a challenging and sometimes daunting task, but securing business loans can make running and funding your company much easier. Use these tips to prepare, and when you're ready to apply, you can rely on us at iTHINK Financial.Make an appointment today to open a business account and discuss the loan options available to you.