There are two ways to fund a business – debt funding & equity funding.
Equity funding is when you receive funds in exchange for a portion of the company – the investor may or may not want to be an active partner and make business decisions alongside other shareholders.
You are not required to repay the investor however they will be entitled to a certain percentage of all future profits. Debt funding is simply a loan from a bank or other provider which you are required to repay by making monthly instalments – with interest. If you're business is not currently turning a profit chances are you're not going to get equity financing from investors and if you're not interested in sharing ownership of the business you can take equity financing off the table. In this case you're going to have to look into debt financing – or a business loan.
If you're looking for a business loan – whether to start a business or expand an existing one – taking out a business loan makes a lot of sense. Understanding the key aspects of financing and improving your own personal financial knowledge is crucial to ensuring you make the best possible decision for you and your business. There are a number of alternative zero-interest methods to finance a business and we will assume you’ve looked into these prior to considering a loan.
Some lenders specialise in providing loans to start up businesses while other, generally more conventional providers, specialise in providing loans to small to medium sized businesses. The distinction between the two must be made because it will ensure that you choose the most suitable provider. Securing any type of business funding for a start up is definitely more challenging than for an existing business, where there is sound financial history to provide a picture of where the business stands.
Some lenders have flexible interest rates while others have fixed interest rates, some are long term while others short – so the loan term may vary from 6 months to 5 or even 10 years. A working capital loan is a short term loan and an equipment loan is a long term loan where the equipment itself can be used as collateral. All service providers will try and sell you their products so they do tend to mislead borrowers in some cases – and that’s why you should strive to understand how business loans work and what you should be looking for before approaching any providers and more notably, whether you should be looking at traditional banks or alternative lenders.
Different providers each have a different list of requirements for loan approvals and businesses should always aim to make more than one application however, there are certain requirements that must be met across the board. One of the main thing lenders look at is whether the loan will be used for a sound purpose – if you're just starting out you need to ensure that you pick an industry that isn’t considered to be difficult to enter into or what is considered to be a highly risky one. Your idea should obviously valid and you business plan should demonstrate this validity. Many start ups and existing businesses are looking to alternative lenders either because their credit scores are too low or they simply have no collateral where collateral is required. Alternative lenders tend to approve loans faster than banks and for many that may be worth the extra interest they’ll incur from these non-traditional lenders. Additionally private or alternative lenders have a much less strict criterion for determining eligibility than banks do. Banks also have very strict payment rules and hefty penalties for non-compliance whereas alternative lenders can sometimes provide more flexible options.
Starting a business is a very big undertaking because you're almost always going to bear a very high degree of risk – particularly if you have no previous experience starting or running a business. Financing is a major barrier to start up’s and because it’s well known that the majority of start up’s fail within the first year – lenders are cautious which is the reason that getting a loan for a start up isn’t easy no matter how good your business idea may be.
If you have savings that you could use to start the business – you may want to use these savings to avoid getting into debt but, if the business fails you'll have no money to fall back on to carry you forward – a bad situation for anyone to be in. This is probably the reason that many people prefer taking out a small start up loan to get their businesses up and running rather than digging into their savings. Some start-ups such as non-profit organisations and charities may even be eligible for a grant – however the competition for these grants is fierce and most start ups simply don't qualify – and this is where people turn to business loans to get started. A start up loan is essentially a personal loan so the loan application focuses a lot more on you as an individual than on the business but a sound business plan will still go a long way in helping you get approved. You also don’t need a business bank account for a personal loan.
As with all personal loans, the interest rates are usually higher and the less you borrow the higher the interest you'll need to pay. This is generally the case with most traditional lenders, which brings me to a very important point – applying to more than one lender. This is important for many reasons, the first obviously being that should one reject you, you'll still have another option. Multiple applications will obviously save you a lot of time and spare you from the frustration of having to start the whole application process all over again. The second reason is that you will have more options to choose from and you can easily compare them to determine which is the best deal or the one that suits you and your business needs best. For instance, some lenders may have an early repayment charge which means that you'll be charged for overpaying or paying-off the loan early – and this simply won’t do for some who place getting out of debt high on their priority list. Additionally, some lenders that cater specifically to start ups may have a package or product better suited to your needs than a traditional institution. Alternative lenders who cater to start ups also provide a wide range of support and development services that can help you get your business going. Some non-conventional institutions will even place more focus on the business plan and how realistic and achievable your cash flow projections are rather than solely on your financial standing as an individual. The business plan will essentially provide a guide to how you intend to run the business – and pay the loan back so it need to be accurate, realistic and clear. Start up loans rarely go beyond £25,000 – and average around £7,000. To be eligible for a start up loan most lenders will require that you’ve been in business for no longer than 12 months (some 24 months) and will require that you have a good credit rating. You will need some type of collateral – the stronger the collateral the more likely you are to be granted a loan.
Payment terms will also vary from one institution to the next. You may be required to begin repaying the loan a month later or you could have the first repayment deferred to 3 or even 6 months after the loan has been granted – so ensure you understand all the terms of the loan before accepting any offers.
Lenders generally tend to advertise new products by placing an emphasis on the low interest rate of that particular package but be aware that you may not qualify for this competitive interest rate unless you have an excellent credit rating. You should also be wary of personal loans with variable interest rates because if the rate goes up, so do your payments. This may mean that the payment will become unmanageable in which case you'll struggle to keep up. While some entrepreneurs and business advisors argue that starting a business by acquiring debt may not be the best approach however if you’ve analysed the validity of your idea and have no other financial means to start the business – the risk is well worth it.
Loans for existing businesses
Most business loans taken out are usually used to finance growth or help resolve cash flow problems when times are tough. Determining whether a business loan is absolutely necessary is the first thing you need to do. The most common reason for taking out a business loan include working capital, asset acquisition, commercial premises and as mentioned, expansion of an existing business.
Since different lenders will require different documentation it’s wise to contact them beforehand to find out what is required. Large lenders are hesitant when it comes to smaller loans because they are less profitable however, if you're a loyal customer of a particular firm, they do tend to view you more favourably – since they want to keep you as a customer. Personal and business credit history is almost always required – so if you can’t provide these or have very a very poor credit history, you may not be able to secure a loan. In addition, as part of the application process providers may perform credit searches on partners, directors and shareholders of the business.
You need to declare any other debts you or the business may have, and if you have too many existing debts this will probably disqualify you. You will need to provide existing financial statements for up to 24 months, a profit and loss statement, financial projections, tax returns and other documents such as personal guarantees from all business shareholders. Projections should always include the loan repayments to show commitment to repaying the loan. You will also be required to provide information on why you need the loan and how the money will be used. A business with a bad credit score will almost always be denied credit from a traditional lender – so alternative lenders will be the only option in such a case. Some lenders have a minimum monthly turnover and will require the business to have been operational for at least 24 months, which if not met will also disqualify you.
If your business already has “open” short-term loans it will defiantly be a challenge to get approved for any long term-loan. In most cases collateral is required, whether personal or business assets in order to allow for the loan to be secured but in certain cases weak collateral can be overlooked if all other criteria is met. If you're business isn’t making a profit then you'll have to prove how this will turnaround by putting forward a very strong and well thought-out strategy.
If you're looking to acquire new assets you may want to review your request and apply for a smaller loan then initially planned because the larger the loan request the more difficult it will be to get approved. Lenders want to borrow money to people that not only need the money but will use it to move forward, repay the loan and possibly take out another, larger loan in the future – showing them how this loan will propel your business forward is important.
Finally, it is absolutely crucial that you use the checklists provided by the bank or other loan provider to prepare all the documentation as required ahead of time – this will help avoid delays and a possible denial. If your loan application has been denied you must find out why so that you can make the appropriate adjustments to your application and request. If you’ve asked for too much then ask for less, if your projections are far-fetched then have them reviewed and reapply. You should be aware that there are many scams out there, particularly when it comes to alternative online lenders – so always do your research and where possible, get referrals from people you know and trust. Loans are not easy to secure and fly by night lenders tend to prey on those with bad credit. Theses scammers ask for an upfront payment and even a processing fee – which is in some cases legit but, you should always ask for a guarantee that this money will be returned should your request be denied. The fact is that if you don't meet the minimum requirements – any lender that seems overeager to loan you money is probably running some sort of scam. If you’re not looking at large providers you have to do some serious research before communicating with any firm.