Every small business needs to borrow from time to time – and these small business loans can mean the difference between success and liquidation. Hardly surprisingly, given their importance, business loans have started to attract quite a number of myths and legends.
In this article, we’ll bust a few of the most common, before going on to explain the best way of getting the finance you need.
1 Lenders don’t like small loans
It’s surprising how this one has taken hold and how many small businesses think banks and other lenders simply won’t be interested unless they’re seeking a substantial five- or six-figure sum.
In fact, most lenders are more confident in dealing with a business that is realistic about what it needs and can afford to repay, as opposed to companies that think far too big and then can’t meet their repayments.
2 A perfect credit score is essential
Whilst it’s perfectly true that the closer you get to 850 (the best credit score there is) the greater your options and the lower the interest you pay, this doesn’t mean that an average score will prevent you from getting credit.
In fact, the major credit bureaux freely admit that there is no financial product out there requiring the full 850, with a score of around 750 being good enough to get the very best deals. However, if you’re under 600, you should consider taking steps (such as repaying credit card debts whilst keeping the accounts open) to build your score.
That said, alternative lenders tend to place much less emphasis on credit scores than banks, which brings us onto another important point.
3 If the computer says no, it’s all over
Most small businesses, quite understandably, turn to their bank as their first source of finance. Yet most banks, following the financial crash of 2008, have significantly tightened their lending criteria and now use computerised algorithms to approve or deny small business loans rather than giving relationship managers discretion.
However, if your bank says no then there’s every chance an alternative lender will say yes, applying quite different criteria to assess your suitability as a borrower.
4 The application process is bound to take ages
With a bank loan, this can actually be true. Banks will often ask to see a ream of documents – articles of incorporation, a fully costed business plan, three years’ profit and loss statements, three years’ tax and VAT returns, even CVs for the management team – before considering an application, and you’re likely to receive their decision later rather than sooner.
However, with alternative lenders you may not need an armful of paperwork and you could have the money inside your account within 24 hours if you’re facing a sudden cash flow crisis.
5 If I’m approved, I’ll have huge payments each and every month
With traditional bank loans, your payment is likely to be the same every month, with some portion being interest and the remainder capital. On one hand, this makes the loan predictable and enables you to budget, but on the other it can mean having to find a substantial sum if your business encounters a seasonal slowdown.
However, with a merchant cash advance, you repay the loan via a fixed percentage of your daily sales, and with a short-term loan you can pay back all the money in as little as three months – making sure, of course, that you take out the business loan at the start of your busiest season.
6 New businesses never qualify for a loan
New businesses are at the very bottom of the pile when it comes to a credit score. They don’t have one at all. As a result, it can be difficult for them to obtain credit, though by no means impossible.
One option is to offer a personal guarantee, though it’s important to remember that this means your home and other private assets are at risk if you default. Alternatively, some alternative lenders are comfortable dealing with start-ups, though they may be charged significantly more interest.
7 Your business plan is the most important document you can present
Whilst banks usually ask to see a business plan before granting a small loan, this generally isn’t the case with alternative lenders. Of course, drafting a detailed business plan makes sense anyway: it will focus your mind, stimulate you to make accurate projections of income and expenditure, and clearly highlight any potential problems with your business idea. In fact, if you don’t have one you could find yourself blundering around in the dark.
8 If you’re offered more than one loan, you should base the decision on the interest rate
Interest rates are certainly an important factor, shaping how much you will have to pay in addition to repaying the capital. Bear in mind that you should ask each lender to provide you with an APR, which is actually a legal requirement for banks, as a simple interest rate can differ wildly from its compounded version.
However, minimising your repayments shouldn’t be your only consideration: a more expensive but more flexible loan may be a better bet if you have a seasonal business or one likely to encounter some sudden cash flow pitfalls.
9 Online lenders are expensive and untrustworthy
It’s odd how this particular myth survives in the internet age, but there are still entrepreneurs who react to online lenders like a vampire to garlic.
Whilst online lenders can indeed be comparatively expensive – their modus operandi is often to service those customers who can’t obtain conventional bank loans – there are plenty of reliable companies specialising in small business finance.
Many online lenders these days are backed by venture capitalists and hedge funds, and they’re every bit as professional and reliable as a high street bank.
10 Lenders don’t like my business sector
It’s perfectly true that some lenders don’t like to lend in particular business sectors because they’re inherently risky, because they’re suffering a cyclical downturn, or simply because they’ve got their fingers burnt before.
However, alternative lenders will frequently take a more flexible view or even specialise in those sectors that banks choose to neglect. For instance, at Cashsolv we are not particularly concerned about your sector, business plan, history or credit score – we simply look at your ability to repay, and can offer a number of innovative solutions where it appears that this might be a problem.
Ten steps to get the business loan you need
Having put a few myths to bed, let’s look at the steps you’ll need to take to obtain the small business loan to power your company’s growth.
1 Understand the loan type that suits you
Conventional business loans, with fixed monthly repayments, are just one way to borrow. We’ve already mentioned merchant cash advances, where you repay the capital via a fixed percentage of your daily credit card sales.
Alternatively, you could take out a business line of credit, which operates rather like an overdraft – you have a fixed borrowing limit and agreed interest rate and can draw down and repay capital whenever you want, with interest being levied monthly on what you’ve actually borrowed.
Meanwhile, with invoice factoring and discounting, you can borrow against the value of your invoices the instant you issue them, with repayment being made when your customers pay you.
At Cashsolv, we offer up to 85% of your invoices’ value, and with factoring will assign experienced credit control professionals to secure early payment whilst with invoice discounting you continue to deal with your own debtors.
2 Research all the available lenders
Be sure not to consider your bank the only potential source of finance, as banks are not currently noted for their flexibility (or their streamlined application process). That said, don’t immediately discount your bank either: if you have a solid credit score and all the paperwork you need, you may find they offer you the best deal.
3 Repair your credit score if it’s damaged
As already discussed, you don’t need a perfect 850 to get the best possible deals, but if you’re down in the 300s or 400s you will find yourself struggling. First, you should obtain your credit file from one of the bureaux and ensure they correct any mistakes.
Secondly, do whatever you can to improve your score, settle any overdue payments, pay down credit card debt (whilst keeping the accounts open) and be sparing about making loan applications, as multiple applications within a short period can imply desperation and reduce your score.
4 Assemble all the documents you’ll need
If you’re going down the route of a bank loan, you’ll need to have plenty of documentation to show them, including your business plan, cash flow projections, articles of incorporation, balance sheet, profit and loss statements and tax returns.
Compiling this information is a time-consuming distraction from running your business, but unless you’re prepared to do it you can probably discount banks as a source of finance.
5 Understand the repayment schedule
With bank loans, it’s usually quite simple – you pay the same amount every month, which will initially comprise lots of interest and some capital, then towards the end of the loan lots of capital and some interest.
However, it’s also possible to pay the same amount of capital each month plus interest as it arises. This means that you’ll pay more each month at the start of the loan but will repay the capital much quicker, thus saving yourself quite a bit of interest.
Alternatively, some products, such as merchant cash advances, tie repayments to your turnover and others, such as overdrafts, credit cards or lines of credit, require no structured repayments at all.
6 Consider whether you can offer security
Secured loans are much less risky for lenders than their unsecured counterparts, so they’re generally far cheaper. For this reason, you should consider whether you have business assets to offer as security or if you can’t get a small business loan otherwise, whether you should offer a personal guarantee.
However, remember that secured loans are much riskier for you: your lender can simply seize the collateral if you don’t repay, whereas with unsecured lending they need a court order before they can touch any of your assets. This is particularly important if you put personal assets like your house on the line – if the business fails, you’re both unemployed and homeless.
7 Get your lenders to express the cost as an APR
As already noted, the most meaningful figure to compare different types of loan is the APR, which factors in compound interest and any fees. Banks have to give you this figure, but the rules are different for alternative lenders, so you should insist that this crucial information is supplied.
However, there’s one exception: where a loan attracts a factor rate rather than an interest rate. In simple terms, a factor rate of 1.2 on a loan of £50,000 means that you would repay £60,000 – the £50,000 capital plus £10,000 interest.
8 Check for early repayment penalties
Some small business loans are comparatively flexible and allow you to repay early without penalty if your business performs better than expected. Others hit you with a hefty penalty for doing so. With a factor rate, the entirety of the interest is charged upfront, so there’s no point whatever in paying early as you won’t save a penny.
9 Consider innovative solutions as well as loans
If you’re borrowing to protect yourself against cash flow problems rather than to invest in growth, a structured loan may not be what you need. Invoice factoring and discounting can tame a troublesome cash flow for good, by enabling you to borrow against your invoices as soon as you issue them, thus minimising the problems caused by late paying customers.
10 Don’t forget to talk to Cashsolv
Cashsolv are the specialists in small business finance, and we’re here to help you get ahead. Whether you need an emergency loan (with cash in your account in under 24 hours), asset-based finance or invoice factoring or discounting, you’ll find we apply quite different criteria from banks and will frequently say yes when they turn you down. To discover what we can do for you, please visit our business finance page.