How do you begin your search for a business loan? Many banks and alternative lenders are out there vying for your attention. Once you decide on a lender, what’s next?

Here are the steps to obtaining your business loan:

Step 1. Determine why you need the money. This will drive your choice of lender and loan type. Different kinds of loans can be used to:

  • Cover the costs of launching a business.
  • Help you buy an existing business.
  • Purchase specialized equipment.
  • Provide working capital for payroll, marketing, and hiring.
  • Resolve cash-flow problems — often needed for a seasonal business.
  • Help you expand your business.
  • Refinance an existing loan at more favorable terms.

Step 2. Calculate how much financing you can afford. Determine your debt service coverage ratio by looking into your finances. Take the following steps:

  • Use a business loan calculator to find the monthly payment on your loan before you commit.
  • Check out your company’s profit and loss statement. Will incoming revenue be enough to cover the monthly payment?
  • Determine your debt service coverage ratio or DSCR. Take your average monthly net income and divide it by your monthly loan payment. It should be above 1.25 and should be calculated annually and on a rolling 12-month basis. If it’s below, maybe a smaller loan with a better interest rate will work.
  • Be prepared to comply with other financial covenants that a lender might require the company to maintain, therefore, you may want to calculate other ratios such as a quick ratio and balance sheet leverage, which is much more common.

Step 3. Consider different loan products. Consider the following options:

  • Bank loans — The cheapest financing option. Interest rates can be as low as 5%. There are some hurdles: Your business should be profitable and you will need personal or business assets to use as collateral. For small business loans where you would apply at a branch, your personal credit score needs to be high. For larger business loans, personal financial statements showing personal assets and liabilities with liquidity are looked at more often.
  • SBA loans — Slightly more expensive than bank loans and easier to qualify for. Rates range from 5% to 10% and at times there are upfront fees.
  • Medium-term alternative loans — A faster online counterpart to SBA loans or bank loans. Interest rates may be as high as 20%, but you can get approval in less than two weeks.
  • Short-term alternative loans — Just 3 to 18 months to be repaid with daily or weekly repayments. Interest rates can be very high, but you are paying for convenience and quick approval. These may be the best (or only) alternative you have if you have been in business for less than a year or you have a weak credit score.

Step 4. Get your loan documents in order — All your financial statements and tax documents, typically covering the most recent three years that have past, and interim internally prepared financial statements. (Depending on your situation, you may need an audit, review or compilation.) You may need additional paperwork such as an AR or Inventory aging report, however, no matter which options you chose, you will need paperwork to move forward.

  • Be aware the more difficult it is to qualify for the loan, the more paperwork is required.
  • Expect to be asked for your credit score, your average bank balance, how long you have been in business, your annual revenue, a profit, and loss statement and a balance sheet, as well as personal and business tax returns, for both current and historical financial information.
  • Take into account costs, which may include application fees, origination fees, guarantee fees for SBA loans, credit check fees, prepayment fees for paying back the loan early, unused portion of loan fees, and late payment fees.

Lastly, there are items to consider in regards to the current COVID-19 pandemic.  Banks may inquire regarding the following.

  • Details on how it has impacted the company’s operations, any closures, or employees affected, etc.
  • The liquidity position of the company and if the company is burning through cash?
  • Any supply chain issues or risks?
  • Companies may want to consider doing a “stress test” internally in case there is a second wave to determine how prepared they are.

This is just an introduction to a complex process. Getting a business loan is a big step, so whatever you do, be sure to get the advice of a financial professional before moving forward.

Please feel free to give us a call if you have any questions, we help our clients with all kinds of loans and can guide you and introduce you to bankers that would be a good fit for you and your company.

Jean Paul Constantino, Accounting & Auditing