Landing a Small Business Loan: The Least You Need to Know, Part 1

Do you own a small business? Any business owner can tell you how incredibly stressful it is keeping up with a small business’ demands for capital. Cash flow is often a problem for a small business, and it may be necessary to infuse the business with cash that the normal operations of that business simply aren’t bringing in at the moment. Your business could be operating in the black until an expense or other unexpected investment comes up. When that happens, it may be time to look for a small business loan. But there is a lot the typical small business owners should take the time to understand before seeking such a loan. Small business loans have both advantages and disadvantages.

Bradley James Bryant, writing for Demand Media, explains, “Businesses have two ways to raise capital: debt and equity. Equity represents an ownership stake and does not need to be paid back, however, the owner may have to share decision-making authority with those that provide capital. Debt, on the other hand, represents a claim on the future earnings of the business. …Once the debt is paid off, the lender has no say in business operations or claim on future earnings. Although debt financing may seem like the preferred way to raise capital, especially for independent, entrepreneurial types, there are a few cons to be mindful of before making a final decision. …While debt provides the small business owner with more flexibility over time, bankers usually create rules about how much additional debt the business can take on and how much the business can spend on inventory or other investments. These rules are referred to as covenants in the banking world and the more money a bank lends to a small business, the more covenants they are likely to place on the loan to ensure the payback of funds. …The terms and conditions of the loan can also create a great deal of inflexibility in business operations. You are required to make all payments on the agreed-upon dates in which the amount is due. This is true even if your business is experiencing hard times. In fact, the bank may even decide to “call in” the loan early if they believe bankruptcy or extreme financial distress is imminent. …Rarely do banks give away money for free and the cost of money is referred to as the interest rate. This rate will usually be higher for small businesses than larger, more established businesses as they are deemed riskier. This interest is a real cash expense that affects the bottom line. The higher the interest rate on the bank loan, the less money you have to pay back the loan, which has the potential to create a cycle of debt…” explains that some unsecured small business loans may be worth considering, but with caveats in place. “With unsecured business loans, there’s may need to present collateral to the lender. That means there’s no risk to existing assets like a home, vehicles, other commercial property, or long-term assets like a 401k or IRA. Some small business owners who take out secured loans tied to their assets get worried about what happens in a default situation. Because the borrower doesn’t need to document their assets in an unsecured business loan, some parts of the loan underwriting process may be easier. …Because unsecured business loans are based on nothing but the borrower’s credit, interest rates can be much higher than those for secured loans that are tied to assets. It’s important to keep an eye on the interest rates that lenders offer and think about how easy these will be to repay in the future. For those without squeaky clean credit, unsecured business loans can have a particularly high debt load. Some lenders won’t contemplate customers with subpar credit, and others will lend at usurious rates that can trap a start-up company in eternal debt. Lenders that offer unsecured business loans need to really go over their potential borrowers’ balance sheets with a fine toothed comb. This can take time and effort, and some who apply for unsecured business loan opportunities can be aggravated by the bureaucracy of the process. These days, lots of lenders are fairly skittish about their unsecured business loan offers. It may seem to borrowers as if the lender is paranoid or unfair, but these companies who offer unsecured capital to businesses are just paying attention to their and bottom line. Because the lenders have the money, the lenders make the rules, but some unsecured loan situations can become combat and troublesome, where the borrower may have been able to prevent some headaches by doing more to control her costs to avoid financing of a business.”

One alternative to a small business loan is a small business credit card. According to Investopedia’s Katie Adams, “Small business credit cards provide business owners with easy access to a revolving line of credit with a set credit limit, in order to make purchases and withdraw cash. Like a consumer credit card, a small business credit card carries an interest charge if the balance is not repaid in full each billing cycle. Small business credit cards are marketed as an attractive alternative to a traditional line of credit, but there are some important differences. The first and most obvious difference is that a credit card provides you with a revolving line of credit for your business whereas a loan or line of credit is fixed. That means that you can continue to borrow or charge up to your credit limit as you repay your monthly bill when you use a credit card, compared to a fixed line of credit which requires that you apply for a new loan once you have used and repaid your first loan. Another important difference is the amount of money you can access and the amount of interest charged. Traditional small business loans or fixed lines of credit typically provide a larger amount of financing, which is necessary for more substantial purchases such as equipment leasing and facility costs. These loans cost less because they charge a lower rate of interest. Lastly, unlike most loans or fixed lines of credit, small business credit cards do not require that the card holder put up collateral to qualify for the line of credit. Credit cards represent an unsecured line of credit, meaning that the money is not secured with an asset. Instead, the card includes a requirement for the card holder to sign a personal guaranty, meaning that she or he is personally and legally liable for repaying the money borrowed on the card.”

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