12 Smart Tips for Getting a Small Business Loan

In our conversation with Frederick Welk, Director of Business Education and Communications for the Community Economic Development Fund (CEDF) in Connecticut, we discussed several forms of business financing for entrepreneurs. These insights were shared earlier this week in the post, “Financing Your Business: Evaluating Sources of Capital.” Now we shift gears to focus on the loan itself. Frederick had some great advice to share about getting a small business loan. Below is a brief overview of his 12 tips, and readers can also download his organization’s booklet on this topic by clicking the link in the summary.

12 Smart Tips for Getting a Small Business Loan:

1. Be ready to show how you can pay it back. This is the most important thing lenders will want to know. As a new business owner, it can be difficult for you to prove your ability to repay or “service” the loan. Be sure to get your finances in order and provide thorough financial detail in your business plan. Don’t overstate your expectations, be realistic. If you’ve been in business for any length of time and can show that your profits exceed your expenses, have your proof on hand.

2. Expect to personally guarantee the loan. Entrepreneurs don’t always have enough suitable assets in their businesses to guarantee a loan. So the lenders will require a personal guarantee from the business owner and any co-applicants or additional guarantors. This means you (and perhaps cooperating partners, friends, or family who secure the loan with you) will need to pledge personal assets as collateral in the event you are not able to repay the loan.

3. Realize it’s not just about the business. Lenders will calculate “global debt service” which means your ability to pay all of your personal and business debts. If the business owner is already carrying a lot of debt, the role of the co-applicant becomes even more important.

4. Be candid and upfront about your financial condition. Not everyone has a perfect credit and financial history. Share details about any current or prior issues that could negatively impact your application. They are likely to be discovered in the process anyway. “Bad marks” don’t automatically disqualify your application, and it will be better to provide detail in the beginning rather than explain along the way. You will also convey your trustworthiness by being honest.

5. Be realistic about how much you need to borrow. A popular saying is, “There are only two reasons a company goes out of business: Either they borrow too much money, or they don’t borrow enough money.” Be sure you raise enough capital, either debt or equity, to launch your business and meet your early working capital needs, but not so much that you can’t afford the payments.

6. Accept that it’s not the lender’s job to provide you with enough money. In all cases business owners will have to use some personal finances, and they cannot rely on the lender for the entire support of the business. Make sure that you have access to additional sources of funding to face unexpected circumstances while continuing to repay your loan.

7. Understand the purpose of a business plan. There are many format variations of a business plan. What’s important is that you show that you understand your own operation and market, you can communicate the essentials of your business, and you have done enough research to provide realistic calculations to predict future financial results.

8. Realize the lender can’t help you create your business plan. Entrepreneurs can seek assistance with business planning from a variety of sources including SCORE mentors (you can find a free mentor by providing your zip code at SCORE.org), local Small Business Development Centers (SBDCs), certified public accountants (CPAs), and others. It’s also very important to continually update your business plan because circumstances change all the time. Whether your own financial circumstances, your industry, or the economy, shifts will impact your business and your business plan.

9. Arm yourself with at least basic financial knowledge. You don’t need to be a financial expert, but you do need to understand the finances of your business and be able to understand and explain your financial reports. Learn financial fundamentals through a variety of resources such as MOBI’s Accounting and Cash Flows session available on its website and in its free Starting a Business and Quick Start Entrepreneur courses.

10. Appreciate the differences in sources of business loans. As discussed in this week’s previous blog, each source of funding has its own pros and cons. Banks can offer low interest loans and lines of credit because they lend to credit-worthy organizations and they are regulated by the government. However, many new small businesses may not meet their qualifications. Banks also offer credit cards, however the interest rates can be much higher and can increase to 18-29% if cardholders miss payments. Find the best source of funding for your business and your financial position.

11. Let the borrower beware. Be sure you understand the effective interest rate of your loan. There are many new options available for small business loans, especially from internet or non-bank lenders. These organizations are not regulated and some use different methods to calculate a “factor rate.” While these rates can look very low at first, when you calculate how this translates to the equivalent of an annual percentage rate (APR), you see a very different number, often into high double digits or even three digits.

12. Community development financial institutions like CEDF are another source of lending for small business. Check with your city’s economic development office, your region’s SBDC, or the commercial lending department of your bank to learn which community development financial institutions are active in small business lending in your area. Many operate as nonprofit organizations and often can be more flexible in their criteria than a bank because they are mission-driven to improve their communities.

Summing Up

There are steps entrepreneurs can take to prepare for applying for a small business loan. Demonstrating that you understand your business and have done your research are two important steps you can take. Be honest about your financial situation, enlist co-applicants if your credit history is not strong or you don’t have sufficient collateral. Prepare a business plan, and continually update it based upon changing business and market conditions. Seek help from mentors or experts if needed. Lastly borrow the right amount, not too much or too little.

To download CEDF's full booklet on this topic click here.

About CEDF

The Community Economic Development Fund (CEDF) is a mission-driven 501(c)(3) economic development organization formed in 1994. Our purpose is to provide resources and assistance to serve the economic needs of the small businesses in low-to-moderate income towns and cities throughout Connecticut. For more information visit https://www.cedf.com/.