Applying for a business loan can take time and effort. This article aims to equip entrepreneurs with a step-by-step guide on applying for a business loan and essential things to which a loan applicant should pay attention. After reading, this article will help business borrowers improve their loan approval success rate.
What Are the Requirements When Applying for Business Loans
Generally, these are the requirements when a business owner applies for a business loan:
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- Business Plan
This information provides insights to lenders on the company goals, financial performance, forward-looking projections, key objectives, marketing strategies, and other critical action plans. Through this, lenders can better understand how their funding could help the business achieve its targets and help the lender assess the company’s bankability. After all, a lender’s interest is also tied to the borrower’s success. Bring a detailed business plan to the lender to help convince them.
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- Personal Credit Scores
While borrowing via the company, the business owner’s credit strength is one of the most critical factors when granting a loan. Hence, always keep a good credit score by paying outstanding bills on time and avoiding excessive personal indebtedness.
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- Personal Tax Filing
The document depicts the annual income of business owners and ensures their compliance with tax obligations.
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- Business Credit History
This is more applicable to established businesses. Strong discipline in prior borrowings will provide significant comfort to the lenders on repayment capability, as they directly indicate a business’ ability to manage debt and repay loans on time.
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- Business Tax Returns
Like personal tax filing, this is another due diligence method to examine the company’s discipline.
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- Financial Statements
Banks typically request audited financial accounts to scrutinize the business balance sheets, income statements, and cash flow statements. Quantitative information provides insights into the business’s financial health and performance through words.
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- Debt-to-Income Ratio
Banks may also scrutinize the debt-to-income ratio, which compares the monthly debt obligations to monthly income. A lower ratio indicates a better ability to handle additional debt. Other ratios that could be considered include projected EBITDA-to-debt obligation or monthly free cash flow generation.
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- Collateral
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- Lenders may require collateral depending on the type and size of the loan. Collateral is usually in the form of assets such as real estate, equipment, inventory, or accounts receivable. It acts as security for the lender in case of default.
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- Industry Experience and Management Team
The saying e fate of a business is in the hands of its management” is not without merit. Banks may consider the expertise and experience of the business management team, mainly if the business is relatively new. Being a subject matter in the industry and entrenched experience can instill confidence in lenders.
How to Apply for a Small Business Loan
Step 1: Decide which type of loan to apply
Business owners should ask themselves why they want to apply for a business loan. There are various reasons to do so, such as expanding the warehouse, replacing obsolete machines, getting that new office, or for other working capital purposes. The purpose of the loan should be communicated, given that specific loan products may be more suitable to cater to different needs.
Standard business loan products that the banks offer.
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- Equipment financing. Some banks offer loans to acquire machinery or office furniture; typically, the loan is secured against the equipment. In the event of default, the lender will seize the equipment to recover its losses.
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- Cash flow-based financing. Contrary to equipment financing backed by assets (balance sheet item), a bank’s lending decision for cash flow-based financing will emphasize the business cash flow more. This type of financing product is suitable for asset-light businesses but enjoys better cash flow liquidity. To support the decision-making process, lenders will evaluate historical and projected cash flow to assess the likelihood of repayment. Typically, cash flow-based financing has a higher interest rate than equipment financing.
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- SBA loans. This is a business loan catered for small business owners. The U.S. Small Business Administration (SBA) has a microloan program that allows qualified applicants to borrow up to $50,000 for an affordable business loan interest rate. While the actual lender is a bank, the loan granted is guaranteed by the U.S. SBA, hence the lower interest rate on the small business loan.
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- Term loan (secured or unsecured). Term loan typically goes up to 7 years in tenure and has more flexibility in using proceed utilization.
A secured term loan requires the borrower to provide collateral as a security to the bank in the form of properties, inventories, equipment, or account receivables. Similar to equipment financing, failure to pay will confiscate the security. The benefits of applying for a secured term loan are higher borrowing limits and lower interest rates than an unsecured term loan. The downside is that the collateral will only be released by the bank after borrowers have fully repaid the loan, which makes disposal or modification to the collateral cumbersome or, sometimes, impossible.
An unsecured term loan does not require any collateral for loan application but is more likely to have lower borrowing limits and higher interest rates. This is due to a bank’s limited recovery avenue in the event of business default. For unsecured term loans, the business owner’s credit score is one of the critical determinants of the loan’s approval.
Secured and unsecured term loans involve a structured repayment plan, usually with fixed monthly installments over the loan tenure. Interest rates for term loans can be fixed or variable, depending on the agreement between the lender and the borrower.
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- Working capital loan. Short-term financing to cover day-to-day business operations, such as operating expenses, salary disbursement, invoice payment, purchase of inventory, rental of business premises, and other costs. Essentially, this type of financing is specifically designed to meet a company’s short-term operational needs.
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- Business line of credit or business credit card. Suitable for business owners who do not know the exact amount to apply for a business loan. Business lines of credit and cash advances from business credit cards allow for on-demand loan withdrawal up to a certain amount (fixed by the bank) when needed to cover unforeseen circumstances such as sudden liquidity shortages.
Step 2: Eligibility check
Most banks have specific criteria for loan eligibility, which mainly revolve around minimum business time and annual revenue. Fret not; this guide is similarly applicable to small business owners looking at how to apply for a small business loan. Generally, a company duration of a minimum of 2 years is preferred, but there may be exceptions depending on individual banks. In addition, some banks require the founders to hold a majority shareholder in a small business.
In some instances where a business has a limited track record, or the founder has a weak credit score, a co-signer may be required to apply for the business loan (someone who agrees to repay the loan if the borrower fails to meet payment obligations).
Step 3: Look for banks that offer small business loan
Before we even get to “how to apply for a business loan,” finding out which banks provide business loans is helpful.
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- Online research: This is the easiest way to start looking for banks that offer small business loans. The Internet could provide a preliminary understanding of specific banks that focus on small business financing. Look for banks with a strong reputation and positive customer reviews. Typically, the upside of online research is easily accessible information at your fingertips. However, business owners may be overloaded with information, especially when some information included in the search result is obsolete.
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- Call the bank. Make a note of essential information before calling a bank. Speaking to a loan officer or small business loan specialist is an easy way to understand if the bank is suitable for its intended purposes and answer any questions a borrower may have.
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- Visit bank branches. Based on the online findings or conversations with the business loan specialist, business owners should also consider visiting local bank branches. Local community banks often have a vested interest in supporting small businesses within their community and may offer competitive loan options.
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- Seek recommendations. Reach out to other small business owners, entrepreneurs, or industry experts who have applied for business loans. They may be able to provide recommendations based on their own experiences.
Even with the above, speaking directly to bank personnel is often more straightforward as it provides a more direct communication path with instant feedback on the latest product information. Wheeler Group delivers the convenience of one-stop services to facilitate the application for small business loans by liaising with loan officers or making a trip to local bank branches on behalf of the Group’s clients.
Step 4: Preparation of required documents
Below is a list of general documents needed for a small business loan application. Wheeler Group collaborates with clients to gather the required documentation for assembling a comprehensive loan package that will be submitted to banks and non-traditional lenders.
Personal information
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- Homeownership
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- Liquid assets and other forms of savings
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- Investment assets
Business Information
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- Business name
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- Registered address
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- Articles of incorporation
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- Business licenses
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- business tax returns, Personal and
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- Business plan
Business Financials
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- Profit and loss statements
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- Supporting documents of cash and cash equivalents, such as bank statements
Proforma Budget Model
Wheeler Group also assists clients in formulating the budget model and constructing a compelling narrative that effectively presents the opportunity to banks and alternative lenders.
The following table is an example of a 3-year forecast that could be used to enhance the approval rate of business loan applications.