My small business needs a loan. How do I know what type of loan to choose?

Business Financing

Business loans and lending has changed dramatically since the financial collapse of 2008. Stricter regulation and stricter lending guidelines have left lenders with well, LETS SAY FEAR IN THEIR HEARTS(OR POCKET BOOKS – NOT SURE HEARTS APPLY). Lending has loosened up some but many small businesses still are finding it very hard to secure the funding they need to grow, expand or open a new business. In this article, I attempt to give you as a business owner an overview on the types of loans available. I hope it helps you as you grow your business. If you have any questions I am always open to giving free advise or answer questions. As a small business owner I understand how important to ensure  all the decisions we make for our business are the right ones. ** Most of this article comes directly from the sba.gov site. I do add feedback and my thoughts.

7(a) Loan Repayment Terms(MOST COMMON TYPE OF SBA)

Maturity Terms

The SBA’s loan programs are generally intended to encourage longer term small-business financing. However, actual loan maturities are based on the ability to repay, the purpose of the loan proceeds and the useful life of the assets financed. However, maximum loan maturities have been established: 25 years for real estate, up to 10 years for equipment (depending on the useful life of the equipment) and generally up to seven years for working capital. Short-term loans and revolving lines of credit are also available through the SBA to help small businesses meet their short-term and cyclical working capital needs.(Note this type of loan is great for many needs of any small business as you can finance growth, expansion, real estate and equipment at LOW rates).This loan is also designed for start ups, so don’t fret if you get declined for a conventional loan, they usually require 3-5 years in business. This loan operates very differently and is designed to help start ups get funding.

Amortization

Most 7(a) term loans are repaid with monthly payments of principal and interest. For fixed-rate loans, the payments stay the same because the interest rate is constant, whereas for variable rate loans the lender can require a different payment amount when the interest rate changes.  Applicants can request that the lender establish the loan with interest-only payments during the start-up and expansion phases (when eligible) to allow the business time to generate income before it starts making full loan payments. Balloon payments or call provisions are not allowed on any 7(a) loan except SBA Express loans. The lender may not charge a prepayment penalty if the loan is paid off before maturity, but the SBA will charge the borrower a prepayment fee if the loan has a maturity of 15 or more years and is prepaid during the first three years.(The great news about this loan is you can pay it off early after a certain time, principal only – Most equipment leases do not allow any discounts to pay off loan early. So if you finance 5 years you will most likely have to pay the full 5 years principal and interest on a standard equipment lease). So if you are leasing a lot of equipment that you might want to pay off early a SBA loan might be your best choice.

Collateral

The SBA expects every 7(a) loan to be fully secured, but the SBA will not decline a request to guarantee a loan if the only unfavorable factor is insufficient collateral, provided all available collateral is offered.  This means every SBA loan is to be secured by all available assets (both business and personal) until the recovery value equals the loan amount or until all assets have been pledged (to the extent that they are reasonably available). Personal guarantees are required from all owners of 20 percent or more of the equity of the business, and lenders can require personal guarantees of owners with less than 20 percent ownership. Liens on personal assets of the principals may be required.   (liens are not always applied to personal assets, though all small business loans require a PG – This shouldn’t scare a business owner, it really is just showing you as the owner are signing as the business owner. Typically it doesn’t show up on your personal credit score).

Don’t Qualify for Conventional Business Loan? Understand Your Options

 Caron_Beesley, Contributor writes for SBA.gov, Much of this article was taken from the SBA.gov blog site.

If you’re looking to start or grow your business, unless you’re fortunate enough to have a reserve of savings or a benevolent angel investor, then you’re going to need a business loan.

So where do you start?

According to credit expert and SBA guest blogger, Marco Carbajo, a recent study (link is external) found that over 63 percent of business owners target banks as their first source of funding. Unfortunately, the success among these respondents of actually getting a business loan was a low 27 percent.  

The challenge of obtaining loans on Main Street

For a start, lending requirements are much tighter now than they were before the financial crisis and small businesses, particularly start-ups, are still considered a risky bet by many lenders. Likewise, many larger banks don’t even offer small business loans as part of their portfolio – they simply aren’t profitable enough.

Furthermore, while borrowing and lending conditions have recovered in recent years, data from the SBA Office of Advocacy suggests that the improvement has been more gradual for smaller firms. In 2013, the dollar value of small business borrowing was down despite the fact that bankers reported easing their standards and terms on commercial loans to businesses of all sizes.

Yet, despite the harsh realities of securing conventional credit, there are several alternative options for start-ups and growing small businesses, even those with bad credit. Let’s take a look:

SBA loan programs

While banks may look upon small businesses as a high risk investment, that doesn’t mean they have nothing to offer small businesses. Many participate in SBA’s lending programs. The SBA doesn’t make loans directly to small businesses looking to start or grow; instead, it guarantees a percentage of the loan, reducing the risk to its lending partners and making it easier for business owners to get the financing they need.

SBA loans are experiencing unprecedented growth right now (by the end of the 2014 fiscal year, SBA had increased the number of loans made through its flagship 7(a) program by 12 percent and 7.4 percent in dollar amount over the previous year).

Small businesses can apply for these loans through their bank or authorized SBA lender. Read more about these loans, how the funds can be used and how to apply in: SBA Loans Explained – A 101 for Small Business Owners.

Business line of credit

If you need short-term working capital, a business line of credit is another option. Unlike a business loan, you can apply for a line of credit before you need it and use it only when you need it. Repayments are only made as and when money is borrowed. Lines of credit can be used to fund inventory, purchasing new equipment, overcoming cash flow issues, etc. Of course, there are drawbacks – accumulated debt being one of them. Since there is no fixed payment requirement, businesses can be tempted to pay off only the minimum each month, much like a credit card.

Credit unions

Credit unions are very attractive options for small business owners. These member-owned, not-for-profit financial cooperatives offer a range of savings, credit and financial services that emphasize affordability. They also offer higher savings rates and lower loan rates than traditional banks. In fact, lending by credit unions is outpacing banks (link is external) by almost double. Credit unions offer their own term loans (many with flexible repayment schedules and the opportunity to pay down loans ahead of time without penalties), lines of credit, as well as SBA loan programs.

Equipment Leasing

There are many equipment leasing companies both private and through banks. These lenders lend on the collateral of the equipment, thus minimizing liens on the business. Depending on the type of lease it may keep your financials free  of debt. There are Fair Market Value leases, $1 buy out leases and Equipment Finance Agreements. FMV leases require you to notify bank of  your intention or send equipment back usually 30-90 before end of lease. The FMV is decided by the bank and could be up to 40% or more, so try to limit the residual they assign the lease and get it in writing. Many businesses stay away from the FMV unless they are sure they want to return equipment at the end of lease(Case in point computer hardware). $1 out and EFA’s you own the equipment and they are considered a capital sale for tax reasons, just like paying cash. (I’ll write more on this in another blog or you can go to my website, professionalfundingcompany.com and read more)

Got bad credit? Try alternative funding programs

If you’re struggling with bad personal credit, many banks will take into consideration other factors such as bank history, credit card sales, credit partners, and other assets.

Revenue-based loans, merchant cash advances, using a business partner as a credit partner to get lines of credit in the form of business credit cards – are all viable options for overcoming a personal credit challenge.

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