A small business loan can help your business get off the ground, get through a slow sales season or get to the next level of success. Obtaining a business loan can be challenging, but making the right moves can boost your odds of success. Here are 10 business loan mistakes to avoid, including not researching loan options, not checking your credit score and not shopping around.
1. Not Calculating How Much You'll Need
Borrowing too much could make it difficult to repay your loan. Borrow too little, and you may run short of money. Lenders want to know you've thought through how much money you need and how you'll use it. Asking for a random amount could cast doubts on your financial know-how.
Carefully consider why you need the loan, how you'll use it and how it will benefit your business. Will you buy new equipment, helping your business serve more customers? Will you expand into a new product line or market? Create sales and cash flow projections to show the positive effect the loan will have and demonstrate your ability to pay it back.
2. Not Researching Your Options
There are many small business loan options available. Do some research to choose the one that fits your needs.
- Term loans, which provide a lump sum you repay over time, are installment loans available from banks, credit unions and online lenders. Some are short-term, typically repaid over six to 24 months. Others are long-term, usually paid back over three years, 10 years or more.
- SBA-guaranteed loans are bank loans of up to $5.5 million, partially guaranteed by the Small Business Administration (SBA).
- Microloans are small loans ranging from $500 to $50,000, available from community organizations, nonprofits and the SBA.
- A business line of credit allows you to borrow money up to your credit limit, repay it and borrow against the credit line again without reapplying for credit.
- Equipment loans use equipment you're buying as collateral, similar to an auto loan. You can get them from banks, equipment financing companies and manufacturers.
Choosing the business loan that matches your purpose can increase your chances of approval. A short-term goal (such as buying retail inventory for the holidays) demands a short-term loan, such as a business line of credit. A long-term goal (such as buying a building) calls for a long-term loan, such as an SBA loan.
3. Ignoring the Loan Requirements
Different lenders may have different criteria, even for the same type of loan. Once you know what type of loan you're seeking, review the lender's loan requirements to see if your business meets them.
For example, SBA-guaranteed loan applicants must meet SBA size standards, have put their own money into the business and show that they've tried other financing options. Online lenders typically have less stringent requirements, but you'll still need to meet their requirements for annual revenues, time in business and credit scores.
4. Neglecting Your Credit
Business lenders consider both your personal and business credit scores. Good credit can make it easier to get financing. Check with the three major business credit reporting agencies—Experian, Dun & Bradstreet and Equifax—to see if your business has a business credit score. A new or very small business may not have one. Begin building business credit by getting a business credit card or asking vendors to extend credit. If the vendor or credit card company reports to business credit bureaus, making timely payments will help build a credit history.
Even if your business is established, your personal credit score plays a role in getting a business loan. Generally, banks require a personal credit score of 650 or higher. Online lenders may accept a personal credit score as low as 500, but a score of 600 or higher usually garners a lower interest rate. Before applying for a business loan, check your personal credit score and take steps to improve it if necessary.
5. Not Considering Collateral
Business loans can be secured or unsecured. When you secure a loan with collateral, the lender can take your collateral if you don't repay the loan. Because secured loans are less risky for lenders, collateral can offset a less-than-perfect credit score and help you get a lower interest rate.
Evaluate assets you could use as collateral. Business assets include inventory, real estate, equipment, machinery or outstanding invoices. Personal assets could include fine art, jewelry, vehicles, retirement accounts or your home. Ideally, use business collateral to avoid putting personal assets at risk. Regardless, don't put up any collateral you aren't willing to lose.
6. Submitting an Incomplete or Inaccurate Application
Having a loan application rejected due to missing or incomplete information is surprisingly common. Before filling out an application, find out what information the lender needs and gather your documents. Requirements can vary from one lender to another. Banks typically ask for a lot of documentation, sometimes including a business plan, while online lenders generally have lesser requirements.
Lenders may want to see:
- Business financial statements
- Business bank statements
- Business tax returns
- Personal tax returns
- Outstanding business debts
Review your application carefully before submitting it.
7. Waiting Until the Last Minute
Don't wait until you're desperate for cash to seek a loan. Some loans take weeks or months to approve. Using cash flow projections will help you spot potential cash flow problems ahead, giving you time to research loans and apply for financing.
Do you have expansion dreams? Build financial projections into your plans and start investigating financing sources early on. That way, you'll be prepared when the perfect growth opportunity appears, instead of scrambling for a loan.
8. Failing to Make a Backup Plan
Always be prepared with a Plan B (and C) in case your loan application is rejected. Consider these alternative financing sources:
- Crowdfunding can raise money for a new product.
- Merchant cash advances can provide short-term loans for businesses with substantial credit card sales.
- Invoice financing is an option for companies that invoice customers.
- Business credit cards can pay for inventory, equipment or other short-term needs.
9. Not Comparing Loan Offers
It's tempting to jump at the first loan offer you get, but take some time to shop around and weigh your options. Once you've narrowed down your alternatives to a few lenders, see if you can prequalify for a loan. You'll submit some basic information to receive an estimate of how much you can borrow, interest rates and terms.
Once you complete a full loan application and get a final loan offer, carefully compare loan details. Look at the annual percentage rate (APR), fees, monthly payments, loan term and any penalties. Also consider how much money you're offered and how fast your loan will fund.
10. Not Asking for Help
Small business lending can be complicated. Fortunately, there are plenty of places to get free assistance. The following resources can match you with experts who'll help you find the right loan and prepare your application.
The Bottom Line
A business loan can benefit your business in more ways than one. Making timely loan payments can help build your business credit history, improve your business credit score and pave the way for future loans—and greater business success.