How To Apply For — And Effectively Manage — A Small Business Loan

During the current pandemic, small business loans have assumed even greater importance. Between April and July of 2020, almost 5 million businesses received emergency funding via the Paycheck Protection Program (PPP) sponsored by the Small Business Administration (SBA). Although that program has ended, small businesses across the U.S. have continued turning to lenders to secure working capital.

Whether you currently own and operate a small business, or are contemplating starting one, read on to learn more about the financing options available to you.

Small Business Loan Basics

If you’ve ever taken out a home mortgage or borrowed money to purchase a vehicle, you’ve used a term loan. A term loan provides a lump sum of capital upfront. This principal, plus any interest accrued, is repaid at fixed intervals over the life — or term — of the loan. The technical name for this repayment method is amortization.

Most small business loans are another form of term loan. However, their terms can vary widely. Some short-term loans must be repaid within 3 to 4 months, while some SBA loans follow an amortization schedule that can span 25 years.

Although some lenders offer unsecured business loans, most loans require that the business owner put up some form of collateral. Existing property, existing inventory, and future receipts (sales, invoices paid, etc.) can all serve as collateral assets. Whatever the case, secured loans typically feature more borrower-friendly interest rates and terms.

Finally, the majority of small business loans are designed for established businesses. In this context, “established” typically translates to “can demonstrate two years of operating experience and expenses.” Also, due to the dollar amounts involved and the fact that funds are usually delivered in a lump sum, small business loans are often earmarked for growth investments rather than day-to-day operating expenses.

Types Of Small Business Loans

Small business loans can take many forms. It would take a series of articles to cover all the available options. However, we can sort the most popular small business loans into a few broad, purpose-based categories.

• Business acquisition loans.
• Equipment loans.
• Commercial real estate loans.
• Credit accounts.

Most, but not all, of these loan types are available both from private lenders and through programs administered by the SBA.

Business acquisition loans provide the capital borrowers need to purchase an existing business or start a franchise.

Equipment loans provide the capital borrowers need to build out their business’s infrastructure. Common items purchased using this type of loan include office furniture, mechanical equipment (e.g., forklifts), business software — such as accounting, point of sale (POS), and enterprise resource planning (ERP) systems — and commercial vehicles.

Both business acquisition and equipment loans can be quite generous, with amounts often topping out at $5 million.

Now, let’s take a deep dive into the types of loans with which Guaranty Bank & Trust’s business bankers have extensive experience: commercial real estate loans, SBA loans, and business lines of credit.

Commercial Real Estate Loans

A commercial real estate loan issued to a small business is a special kind of mortgage, one secured by a lien on commercial property. Here, commercial real estate (CRE) refers to any income-producing real estate used for business purposes. That includes offices, warehouses, retail, restaurants, self-storage, lodging (hotels and motels), rental properties (apartments, duplexes, condominiums, single-family homes, etc.), and vacant land that will be developed for commercial use.

Businesses can also take out commercial real estate loans to purchase existing buildings or cover the costs associated with new construction.

Commercial real estate loan amounts can total as low as $250,000 and as high as $5 million. A wide variety of factors affect the interest charged on these loans, including but not limited to:

• The property’s location.
• The property type.
• The property’s appraisal value, as expressed in a loan-to-value (LTV) assessment.
• Your business’s cash flow and overall financial stability.
• Whether your business will be occupying the property (also known as an owner-occupied project) or transforming it into a revenue-generating investment.

That said, interest rates in the range of 3.5 to 4.25 percent are generally considered low for this type of loan.

Finally, commercial real estate loan terms tend to align with residential mortgage terms: between 15 and 30 years.

SBA Loans

The SBA does not make loans directly to small businesses. Instead, the SBA guarantees a sizable portion — sometimes up to 85 percent — of each loan. This federal backing partially shields lenders from the risks they face should a business fail, declare bankruptcy, or otherwise default on its loan. By creating this incentive for partner institutions to carry its lending products, the SBA makes it easier for small business owners who might not ordinarily qualify for a loan to gain access to working capital.

SBA loans can be more time-consuming to apply for, but they do offer some key advantages over most traditional loans. Those advantages include lower interest rates and longer terms.

The two most popular types of SBA loans are 7(a) loans and 504 loans.

SBA 7(a) Loans

SBA 7(a) loans are available in amounts ranging from $50,000 to $5 million. Businesses may use these funds for any of the purposes listed above (commercial real estate purchase, new construction, equipment, business acquisition) or simply to cover operating costs.

However, the business’s purpose in requesting the loan will affect its term. On average, 7(a) loans for discretionary funds and equipment purchases reach maturity — that is, must be repaid — in 7 years. Real estate loans typically mature in 25 years.

SBA 504 Loans

The SBA describes its 504 loan program as one that provides “approved small businesses with long-term, fixed-rate financing… to acquire fixed assets for expansion or modernization.” Such assets include land, existing buildings, ground-up construction, and equipment. Businesses primed to open new offices or retail locations, upgrade their manufacturing facilities, or add industrial capacity might want to consider applying for a 504 loan.

504 loan amounts are larger than 7(a) loan amounts — starting at $250,000 and maxing out at $15 million. Terms are longer, too, with most 504 loans reaching maturity in 25 years.

That said, 504 loans are not for all small businesses. Borrowers must report a net worth of more than $15 million and a business income of $5 million to qualify. Your business will also need to be able to demonstrate that, by undertaking capital improvements, it will promote both local economic growth and job creation.

If your business does qualify for a 504 loan, it will be able to take advantage of several attractive features.

• Generous financing (up to 90 percent of a project’s cost).
• Historically low fixed interest rates.
• Amortization schedules that eliminate the necessity for an end-of-loan balloon payment.

Business Lines Of Credit

A business line of credit (sometimes referred to as a LOC) combines some of the features of a conventional loan with those of a credit card account. Consequently, lines of credit tend to offer business owners flexibility that neither a loan nor a credit card can on its own.

First, business owners have more discretion about how they use the funds available via a business line of credit. Businesses can draw from a line of credit to cover a range of operating costs, purchase inventory, invest in marketing, make up for fluctuations in seasonal sales, or pay a surprise bill.

Secondly, business lines of credit are revolving. Instead of managing a lump sum payment, businesses can borrow up to a specific limit. As the business repays that outstanding balance — plus interest — its credit replenishes, and it can continue borrowing against its credit limit.

Finally, business line of credit accounts are typically activated much more quickly than either privately-issued or SBA loans. In some cases, it can take weeks for a conventional loan to payout. Once approved, you may begin using your line of credit account within days.

Proving Your Creditworthiness

All borrowers — individuals and businesses alike — accrue credit scores. But is a good personal (or consumer) credit score equivalent to a good business credit score? Although FICO calculates both scores, it uses a different formula to determine the latter: the FICO Small Business Scoring Service (SBSS).

Unlike the consumer credit score scale, which ranges from 300 to 850 points, the SBSS scale ranges from 0 to 300. SBSS scores factor in not only the business’s ability to manage its debt but also each business owner’s personal credit history.

Moreover, other credit bureaus operate their own business credit scoring scales. For example, Dun & Bradstreet’s Paydex score ranges from 0 to 100. Equifax and Experian similarly measure a small business’s creditworthiness according to a 0-to-100 scale. To verify your business’s creditworthiness, you may want to purchase credit reports from each of these providers.

Most borrowers must achieve an SBSS score of at least 160 and a personal credit score of at least 680 to qualify for a small business loan. The best way to increase your business credit score is to make on-time payments on any existing loans.

Applying For A Business Loan

The first step to applying for a business loan is to gather the appropriate documentation.

First, you will need to show proof that yours is a legitimate business. You can do so by making copies of your articles of incorporation, registrations, licenses, and permits, where applicable. You will also need to include your IRS-issued Employer Identification Number (EIN) or Federal Tax Identification Number (TIN) in your loan application.

Next, draft a solid business plan. This document should clearly state your business’s needs, specify the amount of capital required to meet these needs, and detail how capital investment in your business will produce measurable returns. Your business plan should also provide supporting evidence for your request in the form of industry- or sector-specific market research.

With your business plan finalized, you’ll need to give your potential lender insight into your business’s finances. To do so, you will need to gather:

• Credit reports.
• Bank statements.
• Tax returns.
• Balance sheets.
• Profit and loss statements.
• Cash flow statements.
• If applicable, information about your other business loans, both past (paid off) and current (in repayment).

As noted, many lenders also require that prospective borrowers demonstrate proof of their ability to repay their loans in the form of collateral. Document your business’s current assets, such as real estate or other property that is of equal or greater value than the loan for which you’re applying. This guarantee that you can repay the loan may be the deciding factor in whether the lender approves your application.

Finally, outline your specific plans for repaying your business loan. Even if you have never applied for a loan before, you should be able to provide projections for repayment. For your loan application to be successful, you need to convey to the lender that you understand the seriousness of your financial obligations to them and have thoughtfully considered what assuming debt means for your business.

Repaying Your Business Loan

Once your application has been approved and you’ve received your loan, the process is relatively straightforward. You repay the loan according to the payment (or amortization) schedule set by the lender and at the interest rate detailed in your loan agreement.

It is possible to repay your loan ahead of schedule by increasing your monthly payments or paying off the entire outstanding balance. But it’s important to check with your lender to determine whether doing so would incur a prepayment penalty — especially if you are paying off a commercial mortgage or commercial real estate loan.

Properly Managing Your Accounting

After you’ve secured your small business loan, it’s vital that you accurately track your company’s financial performance. Doing so will ensure the appropriate use of any borrowed funds. Good bookkeeping habits also support timely loan repayments.

At one time, an electronic spreadsheet may have been sufficient for your accounting needs. However, as your business grows, consider investing in financial management software or hiring a professional accounting firm.

What To Do If Your Business Loan Application Is Denied

You’re not at a complete loss for funding should your loan application be denied. Consider the following possibilities.

• Talk to a business mentor. A business mentor can help you reformulate and firm up your business plan. You can find mentors through former employers, professional associations, and online networking events. You may also be able to connect with a business mentor via the non-profit organization SCORE.
• Apply for a personal loan. You can leverage your good-to-excellent personal credit score to take out a personal loan. Before doing so, confirm with your lender that you may use these funds to cover qualified business expenses.
• Apply for a business credit card. A business credit card may be easier to secure than a small business loan. However, be aware that any given business credit card’s variable interest rate will likely be much higher than a small business loan’s fixed interest rate. Make sure you understand the card’s terms before applying, especially as they relate to cashback rewards. Once you begin using your business credit card, avoid carrying large balances month-to-month, and be on the lookout for sudden interest rate changes.
• Apply for a small business grant. Government agencies make a number of grants available to small business owners. If, for example, your company engages in scientific research and development, you may qualify for federal assistance via the Small Business Innovation Research and the Small Business Technology Transfer programs.
• Seek the assistance of a local business incubator. These organizations offer both mentorship and financial support to small businesses. Created by Texas Governor Greg Abbott, the Product Development and Small Business Incubator Fund (PDSBI) provides loans to “businesses which may be unable to obtain full financing or financing on workable terms in traditional capital markets.” Many colleges, universities, and non-profit organizations also operate (or sponsor) their own incubators and business accelerators. The Office of the Governor’s Texas Startup Resources Directory contains additional information about the incubators located across the Lone Star State.

If you’re ready to apply for a small business loan, we hope you consider making Guaranty Bank & Trust your lender. No matter what your growth goals may be, our friendly, caring, and knowledgeable bankers can help you achieve them. After all, we’ve been backing prosperous small businesses across the Lone Star State for over 100 years — and we have success stories to tell that prove as much. Request an appointment today to learn how your business can partner with one of the oldest and most respected community banks in Texas.