Small businesses have more financing options today than ever before, yet navigating the maze of loan types and lenders can make it challenging to choose the right loan and the right lender for your business. The days when the bank was the one-stop-shop for small business loans are over. Meaning, business owners need to be savvier about evaluating their loan options.
Before you get a small business loan, there are 14 questions you should ask—four you need to ask yourself and 10 you need to ask your potential lender.
1. What do I need the extra capital for? In other words, why do you need a loan? It seems like a pretty straightforward question, but it’s a question often overlooked by borrowers looking for extra capital. The reason I believe this should be the first question is because articulating loan purpose will help answer some of the other questions you’ll need to ask.
Your loan purpose will help you identify whether you’re trying to fill a short-term or a long-term need. For example, the financing needs of purchasing quick-turnaround inventory are decidedly different than those of purchasing an expensive piece of heavy equipment or a new location for a restaurant. It might not make sense, for example, to borrow with a four- or five-year term to pay for inventory that will be sold in a month or two.
A recent survey of 592 small business owners sponsored by the Electronic Transactions Association (ETA) and conducted by Edelman Intelligence revealed that most business owners who borrow online anticipate a 5X return for every dollar they borrow. The most common reasons for seeking those business loans were to purchase equipment (54 percent) or to purchase inventory (51 percent).
Identifying the purpose of your loan will help you identify the term of the loan that makes the most sense to meet your needs. As a general rule, the shorter the term the higher the periodic payment, but the lower the total dollar cost. Longer-term loans typically have a lower periodic payment, but the total dollar cost of accrued interest, or total cost of the loan, will be higher (this is often true even if the APR for the shorter-term loan is higher than the long-term loan).
You might be surprised to know that 57 percent of the small business owners in the survey chose a shorter-term (six-month) loan to minimize the total interest cost when compared to a longer-term loan.
2. How much money am I looking for? This is another pretty straightforward question. Unfortunately, popular culture has many business owners convinced that a lot of money will solve all their problems. When I have occasion to ask a borrower how much they’re looking for and the reply is, “As much as I can get,” I cringe. This answer tells a potential lender that you haven’t really thought through your loan purpose. Your loan purpose should drive the answer to this question.
I disagree with the idea that you should borrow as much as you can at any opportunity you have because you never know when you won’t be able to borrow again. There are costs associated with borrowing that should be thoughtfully considered every time you seek borrowed funds. In fairness, I look at this process from a very conservative point of view. In my opinion, if the borrowed funds will drive increased returns on investments (“ROI”) or add value to the business, a small business loan could make a lot of sense—if not, I wouldn’t suggest borrowing. In other words, borrow what is required to fulfill your business need, but no more.
96 percent of the ETA survey respondents say the loan they secured enabled them to drive business growth. In my opinion, a loan purpose that will generate a positive ROI or growth of some kind is a good reason to consider a small business loan.
Determining the amount of money you need can also help you determine which lender to approach. Over the last several years many traditional lenders have moved upstream, looking for bigger businesses and bigger loans. Banks, for example, would rather lend $500,000 or $1 million than $50,000. It’s hard to blame them; they both carry about the same administrative and regulatory costs associated with underwriting the loan.
Fortunately, many lenders specialize in smaller loan amounts, which are specifically geared towards small businesses. According to the ETA survey, the average loan amount for an online business loan was $25,000. And the average number of times those business owners had borrowed over the past five years was three.
3. What does my credit profile look like? You credit profile really makes a difference—both your personal credit score and your business credit profile can dictate where you might find success looking for a loan. What’s more, one of the biggest small business credit misconceptions is that many business owners are unaware of their business credit profile, meaning they don’t know what it says about their business’ creditworthiness. You need to focus on building both a strong personal credit score and business credit profile.
Although your personal credit score might not be the most accurate measure of how your business meets its obligations, most lenders will review your personal credit score when evaluating a business loan application. Some lenders weight your personal score differently than others. For instance, a credit score below 680 will make it difficult to qualify for a loan at the bank and a score below 650 will make it challenging to qualify for a small business loan.
There are some lenders that will accept lower scores, provided other metrics demonstrating a healthy business are in place. Nevertheless, most lenders look at your past credit behavior to make judgments and decisions about what you will likely do in the future—so maintaining a good personal credit score and building a strong business credit profile should be a business priority for those seeking a small business loan.
Although an impeccable credit profile is no guarantee of financing, it will create more opportunities than a less-than-perfect profile. Another study, conducted by Nav (a free site offering business owners access to their personal credit scores and business credit profiles), the American Dream Gap Report suggests that the businesses that regularly monitor their credit were 41 percent more likely to be approved for a loan.
Levi King, one of Nav’s co-founders and the CEO says, “I think it’s human nature to make a difference in the places where you’re really paying attention. Basically, attention drives behavior.”
Building a strong profile starts with getting familiar with it. And, an honest evaluation of your profile will help point you in the right direction when looking for a loan.
4. How quickly do I need the funds? Although this question is at the bottom of the list, it’s a very important question. Some loan purposes don’t allow the luxury of time to wait for several weeks to gain a loan approval. For example, ramping up your ability to serve a new customer contract might require additional capital within the next few days and waiting weeks for a small business loan could carry with it an opportunity cost that is too high.
63 percent of the ETA survey respondents listed speed of funding as the primary reason they chose the loan they did—which indicates the importance of this question and another reason why your first question should be, “What do I need the extra capital for?”
Now you’re ready to talk to a lender. You know what you need the capital for, you know how much you need, you know what your credit profile looks like, and you know how quickly you need the funds. With a better understanding of what you’re looking for to meet your business need and the type of lender you’re looking for, you’re better equipped to evaluate a potential lender based upon whether or not they’re a good fit for your business.
Ask Your Potential Lender:
Many small business owners leverage borrowed capital to fuel growth and fund other business initiatives. In addition to the right loan, finding the right lender can make the difference between successfully using a business loan to create value in your business; or contribute to putting your business’ viability at risk. Here are ten questions to help you determine whether or not a potential lender is a good fit for you.
1. Do you lend to businesses in my industry? Many lenders specialize in working within specific industries or have identified industries they won’t work with. Asking this question early will help you avoid wasting time with a lender that won’t be able to help you—regardless of your creditworthiness.
Last year the Federal Reserve Bank of New York reported the average small business owner spends 33 hours looking and applying for a loan. According to the ETA survey, the average small business owner in that group valued their time at $170 per hour. If that’s the case, that 33 hours can get very expensive very fast. Asking some of these questions early will help you save some of that very expensive time.
2. Do you offer a loan term that fits my business need? This is another important question. Because you’ve identified your loan purpose (your business need), you can determine whether or not you’re looking for a short-term or a long-term loan and will recognize a loan type that might not be a good fit.
In much the same way most consumers wouldn’t purchase a new car with a 30-year auto loan, you can quickly determine if the loan terms are right for your situation. There are lenders that offer exclusively either short-term or long-term loan options; so if you’re interviewing a lender who doesn’t offer the terms you’re looking for, you’ll recognize it.
3. What are the interest rates and the total cost? There are a number of different pricing and comparison tools to help you assess and compare financing options. APR (Annual Percentage Rate) is one way to compare loans, although it should be considered along with the total dollar cost of the loan – this is especially true when trying to compare loans of different duration.
The APR calculation includes all fees, so be sure you are comparing an APR to another full-APR and not just the annualized interest rate..
As noted above, along with asking about the interest rates and the fees, it’s also important to know what the total interest cost—or total dollar cost of the loan would be. For example, if you were to borrow $10,000 and your total payback was $11,500, your total dollar cost would be $1,500. The dollar cost can help a business determine affordability and easily compare cost to the expected ROI.
Your loan purpose will help inform this decision and is one reason why you want to ask yourself this question before you get in front of a loan officer at the bank or an online lender.
4. What will my payment schedule be? The advent of daily, weekly, and monthly periodic payments is a departure from a more traditional monthly payment approach. Nevertheless, many lenders (including online lenders) have adopted a more-frequent-than-monthly payment schedule for a number of reasons. Not the least of which is that it tends to smooth out the cash flow burden throughout the month rather than the traditional lumpy cash flow drain associated with a single payment every month.
If your potential lender requires a daily or weekly payment schedule, it’s important to make sure your business has consistent cash flow throughout the month. This type of payment schedule might not be a good choice for businesses that rely on a month-end influx of cash flow to maintain business operations or on infrequent inward deposits.
5. When is my first payment due? When making a monthly loan payment, it’s logical to assume your first payment will be due at the appropriate time of the month following when you take the loan. On the other hand, if you have a daily repayment schedule, your first payment will likely be due on the next business day after you’ve accepted the loan proceeds. This could be a concern to a business owner who wasn’t expecting the first payment to be due at that time, but can be accommodated if you are aware of that expectation—so be sure to ask. It’s the unexpected requirements that can cause consternation.
6. How do I make my periodic payments? While there are some lenders who still accept a paper check sent by the borrower to the lender, many lenders (including online lenders) have turned to automatic debits via an ACH withdrawal from a business’ bank account. This is a common practice, which many business owners find very convenient.
This is an easy way for the lender to collect your loan payment in a timely manner—an obvious benefit to them. There are however, a few reasons why this could be considered good for the borrower:
- Each and every payment is made in a timely manner. This benefits the business because the single biggest influence to building a strong business credit profile is making each and every payment on time.
- An ACH payment can save your business money. ElectronicPayments.org suggests it costs the average business owner $1.22 to write a paper check.
- This type of electronic debit makes capital available to some borrowers who might not qualify within a more traditional payment model.
Make sure you understand exactly what will be debited from you account with each periodic payment. Will it be a fixed amount or will it fluctuate depending upon what’s in your account. If you have a daily debit, you’ll want to confirm whether or not your account will be debited every day or every business day, so you can be prepared and ensure you have adequate funds in the business account to cover the debits.
You’ll also want to make sure you understand the process should there be a problem and there aren’t enough funds in your account when the periodic payment is due. A good lender should be willing to work with someone who proactively comes to them with an isolated problem. They want to see the loan process be successful as much as you do.
7. How long will the loan application process take? Depending upon the lender it could take anywhere from a day or two to several weeks—or even months. Depending upon your loan purpose and how quickly you would like the capital, there may be some lenders you weed out early in the process because their typical approval process just takes too long.
Fortunately, there are lenders who are able to offer a quick decision, where if you are approved, you can have funds in your account sometimes as quickly as within 24 hours.
8. What is your Better Business Bureau (BBB) rating? This is not the only way to learn about how a company does business, but it can give you insight into how they resolve issues. Don’t be shy about visiting a review site or two, such as TrustPilot, in addition to the BBB to learn as much as you can about the lender.
9. May I speak to a few of your current and past customers? You will likely be talking to a selection of successful customers, but it might be a good idea to speak with a customer or two, review any customer success stories they may offer, look for customer testimonials, and even search online for reviews. Are most of the reviews positive? Do the same concerns seem to reappear? If something looks out of place, don’t hesitate to ask about it. And, if the lender can’t resolve your concerns, don’t be afraid to look someplace else.
10. Do you report my credit history to the business credit bureaus? If they don’t report, your good credit behavior with them doesn’t do anything to help you build an even stronger business credit profile. There are some lenders, like merchant cash advance providers, that don’t. So don’t assume the lender you’re interviewing with does. This should be an important consideration when you’re looking for a small business loan.
You will discover there is likely more than one option available to you when you’re looking for a small business loan and some will likely be a better fit than others. As a result, you can look for a loan that will be a good option for your particular business situation.
If you’ve come across any questions I’ve missed, please share them in the comments.