Why Your First Business Loan Is so Important
It is common knowledge that all businesses need to secure financing in order to succeed. Loans allow businesses to capitalize on opportunities and multiple their profitability, as well as to take care of essential expenses such as wages and rent. But few businesses consider how much the first loan counts towards their future success.
It is vital to start off well and not get locked into a long-term loan that does not suit. Failure to repay a loan on time can destroy a credit rating, which takes a long time to build up again. Presently, banks still account for 47% of total small business loan applications.
However, online providers are increasing in prominence and in advantages, currently accounting for 24%. Additionally, approval rates are higher with online lenders and applicants typically acquiring the full amount in a shorter time frame compared to standard bank loans.
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Selecting The Right Loan
A key point to keep in mind is that you should not take out a loan if the fundamentals are not right – this will exacerbate the problem. Loans should be taken out when necessary to assist the core business model. Like technology, money does not solve all issues. It has to be correctly used with a goal in mind. If your business is generating a net loss, more money simply means a larger net loss if you expand, all things remaining equal.
Before choosing a loan, you must clarify what you need it for. A loan designed to increase credit rating will be different from a loan needed to pay for general expenses. The next step it to determine how much you need and how long you expect to have in terms of paying it off (the longer the time, the greater the overall repayment).
Once you are clear about why you need the financing and how much you need, it is time to get the right one. A loan taken out for invoice financing is not the same as a loan designed for trade finance, and will have distinct terms and conditions. Seasonal business models require a completely different kind of loan compared to consistent income companies.
A good rule of thumb is that the expected profits from the loan should exceed the value of the loan itself. Obviously, this only applies to loans seeking to capitalize on a profitable opportunity, not loans to cover expenses such as payroll or rental costs. Additionally, your business should have enough cash-flow to easily make the loan repayments. Never gamble, just play the math.
Still, the most common reason that small businesses to take out loans is for expansion and growth. 60% of small business owners state this as the primary reason for the loan as per the 2017 Small Business Credit Survey.
Different Loan Options
There are many different types of loan options available. One common loan is the SBA (7)(a) which is designed to assist small businesses acquire funding in the USA. While this might have been a good idea a few years back, it is now notoriously difficult to attain this kind of loan. It has increased in complexity (requiring an onerous amount of documentation) and it can take months to successfully complete the process, only to be told that your loan application has been rejected. The SBA (7) (a) is still a great option for small businesses with a stellar credit rating and time to wait for a response, as it typically offers the best terms and conditions.
If you want to take a out a large loan at a future date, it could be a good idea to start with a short term loan initially to build up credit. Business loans for bad credit are available, but they are generally much more expensive and have significant restrictions. If you need it for equipment, there is equipment financing, where the equipment itself often serves as the collateral for the loan. An unsecured business loan is an option for those without any physical collateral, but tends to have higher repayment rates and strict terms and conditions.
A business line of credit offers advantages above and beyond standard small business loans. Borrowers have the capability of taking out finances (up to a certain max limit) and only pay interest on what is borrowed in a given time period. It is one of the most flexible options available. Lenders will require a high credit rating or alternatively high interest rates to offer a business line of credit. According to the SBA, 75% of new business financing is provided by credit cards, business lines of credit, and business loans.
Loan Provider Comparison
There are various online loan service operators who can provide reasonable first time loans to businesses starting out. Each of them will have distinct characteristics which make them suitable to a particular business model. Four of the biggest names in the USA include FundBox, OnDeck, Kabbage, and Lending Club.
FundBox are geared specifically towards loans for small businesses, offering business lines of credit. The fees are transparent and they have a very intuitive application process. At the current time, they have an outstanding 9.7 rating on TrustPilot from over 1,300 reviews. Businesses can have a line of credit within hours of applying.
OnDeck bears many similarities to FundBox, offering business lines of credit and term loans to small businesses. The application process is automated and streamlined and they have a 9.8 rating on TrustPilot. Both operators are perfect for businesses that do not have a strong credit score, though the rates offered can be high.
Kabbage is one of the most well known providers for small businesses, delivering a fast turnaround time to applicants. It offers larger lines of credit and longer terms than either FundBox or OnDeck. However, the fees are a little higher and the requirements are a little stricter. For example, with Kabbage, businesses must be at least a year old while with FundBox, invoice financing is available within 3 months.
Lending Club is an entirely different model from the three providers listed above. It is a peer-to-peer lending system for business loans up to $40,000, essentially an online platform that connects lenders and borrowers in a free market loan system. The minimum personal credit score is 620 and applicants needs $75,000 in annual revenue as well as a minimum of 2 years in business. Term loans are offered on this platform, not business lines of credit.
Find the right funding for your business
Why is the First Loan More Important Than Others?
Taking out the wrong business loan can have long-term implications. First, a failure to repay could lead to a bad credit score. Credit scores are ‘sticky’ – you really need to work at them over time to raise your ratings.
Once you take out a loan, that is it until it is repaid. So if you take out a 5 or 10 year term loan, it can really be a disaster situation. You still have options, such as loan consolidation, but you will be losing money. It is always a good idea to start off with a small short term loan and work from there. Between $10,000 – $35,000 is a good range.
Most new business owners make the mistake of taking out a loan that they do not need, taking it out for the wrong purposes, or (most commonly) taking out loans with the wrong terms and conditions. Another common situation is that an unaffordable loan is taken on on an apparently profitable business venture, that turns out to be not so profitable. The end result is late repayments, increased debt, a bad credit rating, and a business that is behind where it should be.
But a loan is still absolutely necessary. According to Jessie Hagan of US Bank, 82% of businesses fail due to cash flow issues while 79% fail because they started out with too little money. Financing is essential to any successful business endeavor. And of course, finance is the whole point of the business endeavor itself.
Get the first loan right by understanding your own business model and what you need the loan for. It will set your business up for success financially and psychologically. This is why a small short term loan is a good option. It is a quick win that increases credit score and solves a tangible financial problem. Additionally, it can be easy to qualify and quick to attain with a good online lending platform.