Is a Small Business Expansion Loan Right for You - man smiling behind a counter

Is a small business expansion loan right for you

Saturday, December 06, 2014

Today, many workers are deciding to leave the corporate world and start a new business as an entrepreneur. Many small business startups use small business loans to get the financial leg-up necessary to get going. 

If you already run a small business, you may be considering using a business expansion loan to grow your business and take it to the next level. Before you make any decisions, it is important to evaluate if a small business expansion loan is right for you; and if so, which one.

To start, you should understand what a small business loan is, what varieties there are to choose from, and how to go about finding the right one to suit your business. There are a lot of financing options to choose from, so here we’ll lay out each type of business expansion loan to help you decide.

What is a small business loan?

A small business loan is a means of financing small businesses. It can be obtained through various lenders, and there are many different types of loans that serve different purposes. We will cover the following small business financing options:

  • Business lines of credit
  • SBA loans (specifically 7a, 504, and microloans)
  • Term loans
  • Short-term loans
  • Equipment loans
  • AR financing loans

How do small business loans work?

There are many types of loans and financing available for small businesses, and they work in different ways. Small business loans are offered by lenders like banks, online lenders, or non profit microlenders. Small business loans work similarly to a personal loan, meaning you should prepare to: 

  • Share a business plan with your lender
  • Present personal and business credit scores 
  • Have cash ready to pay the upfront costs 
  • Prepare to pay interest until your repayment term is over

We will cover these steps in more detail shortly. First, keep in mind that interest rates vary depending on the loan type. A low interest rate loan will probably require good credit scores. Higher interest rates could mean a simpler application process, quicker approval, lower credit scores, and so on. 

Next, let’s look at some of the most common options for small business financing.

Business lines of credit

These are business lines of credit, also referred to as “business credit cards”. As the name suggests, this option differs slightly from a loan in its capacity to be taken out as regularly as needed, as long as the credit limit isn’t surpassed.

This makes a business line of credit an incredibly doable alternative to a loan, and also allows you to easily separate personal from business finances. This way, as long as the funds borrowed are regularly repaid, you can continue to borrow money as needed rather than taking out a large sum and dividing it up for each cost. 

As with many personal credit cards, there are often rewards systems in place, meaning the more you use it and pay it off, the more you gain from it. Interest rates on these small business loans vary, but it is possible to open a business line of credit with little to zero interest for the first year and beyond.  

If this method appeals to you, it’s important to keep in mind that a good personal and business credit score is often necessary to apply for a business line of credit.

SBA loans

A U.S. Small Business Administration (SBA) loan is a low-risk, often long-term form of financing offered through participating lenders. Most often, these lenders are banks. 

These loans are incredibly appealing for their low interest rates and partial guarantee, meaning that if a borrower is unable to pay back a portion of financing (a previously agreed-upon limit) the SBA will pay that amount back to the borrower. 

This, however, also means they are highly competitive, and the application process can be difficult to pass.

Being granted an SBA loan is not always a simple process, especially for new small business owners. Usually to qualify, a borrower must have: 

  • 2+ years in business
  • Expenses that pass SBA restrictions (they are strict with what their funding may be spent on)
  • A high personal credit score and business credit score
  • A strong annual revenue

The SBA offers loan options. Here are the three core programs:

SBA 7(a)

An SBA 7(a) loan is the most common loan available through the SBA. They offer anywhere from $30,000 to $5 million for the purchase of equipment, land, supplies, or inventory, debt refinancing, business expansion/acquisition, and more. 

Most banks require around 25% down payment, but the loan itself can extend for 25 years in repayment terms, making it a very flexible and generous option for borrowers.

Although there are no designated credit score minimums set to qualify for a 7(a) loan, lenders often look for a personal credit score of at least 690 and a minimum of 2 years of solid business revenue.

SBA 504

An SBA 504 loan is most commonly used to fund the purchase of real estate or equipment, otherwise known as fixed assets. These loans can offer up to $5.5 million and are often guaranteed for up to 20% of the loan.

Unlike 7(a) loans, these cannot be used to consolidate debt or purchase inventory but are ideal for equipment financing.

The borrower must have:

  • A net worth under $15 million
  • Net revenue under $5 million after taxes, for at least two years prior to applying for the loan

Note that non profit businesses are not eligible for the 504 loan.

Microloans

An SBA microloan is a smaller version of the 7(a) and 504 loans. The SBA microloan was designed with underrepresented (women, racial minority, veterans) and low-income entrepreneurs in mind. It grants up to $50,000 and repayment terms cannot exceed 10 years. 

Microloans, unlike 504s, can be used for non profit businesses. And, they don’t all require 2+ years of business for a borrower to qualify.

These loans are usually granted to non profit organizations that use donations, grants, and other means via crowdsourcing or government guarantees. So, while there are still general requirements in the application process, each intermediary will have their own set of requirements which means the application process may vary slightly between lenders. 

Term loans

Term loans offer lump sums of financing with fixed repayment terms and interest rates. The application process is similarly challenging to that of SBA loans; plus, because a default would be shouldered entirely by the bank or other private lenders, they require: 

  • Higher credit scores
  • Evidence of a positive track record
In exchange, term loans offer competitive interest rates. Lower interest rates mean a lower upfront cost when applying for the loan, and the fixed rate means predictable monthly payments.

Short term loans

Short-term business loans make it easier for new entrepreneurs with poor personal or business credit to be financed. The repayment terms are, as suggested, short-term, usually between a few months to a couple of years. The interest rates are also higher than that of a term-loan or SBA loan. 

The application process is much less stringent than other options for financing, but can be risky if payments are missed.

Equipment loans

This type of financing can be attained through a bank or other lenders, similar to term financing. They are good for general equipment, whereas an SBA 504 is better for large equipment and real estate.

This is another good option for borrowers with a limited (or non-existent) business track record, or those with lower personal or business credit scores.

In the event that the loan cannot be paid, or the business defaults, equipment paid for by the lender can be taken as collateral.  

Accounts receivable financing loans

An Accounts Receivable (AR) loan is financing provided for small businesses struggling with cash-flow gaps. This is a way for small businesses’ regular expenses to be covered while waiting on outstanding invoices from customers.  This is a great option for businesses that:
  • Are expanding quickly and need coverage for regular expenses 
  • Have poor credit (the application process is not as strict as SBA or traditional bank loans)
  • Need cash reserves while waiting on invoices to be paid

Where to get a small business loan

By now, you probably have some idea of what kinds of loan programs would best suit your business needs. So, how do you go about finding one? Here we will compare the main three sources of small business loans, and then we will outline the details of loan qualifications so that you can feel as prepared as possible to get out there and make it happen.

As mentioned before, there are three main places to look when applying for a small business loan: 

  • Banks
  • Online lenders
  • Non profit microlenders

Banks

If your business has been running successfully for at least two years, meaning you are making a good revenue, have good credit, and are looking for a decent chunk of cash to expand, you might consider going through a bank for your loan. 

Banks offer most types of loans, including SBA loans, for businesses like these. While interest rates and repayment terms are dependent on the borrower’s credit history, personal and business financial statements, tax returns, business plans, and so on, once approved, you will have the tools you need to expand your business with a repayment plan that works for your needs.

Online lenders

If you are a new business, don’t have the financial breadth to qualify for a bank loan, or maybe can’t wait to be approved for funding because of an urgent situation, online lenders can usually offer the same amount and type of funding in a fraction of the time it takes to go through a bank. 

The downside to online lending is the higher interest rates; but as with banks, this will depend on the same factors that you need to qualify for a loan. 

Non profit microlenders

If microloans sound like the right option for you, they can often be sought out through non profit microlenders. SBA microloans are distributed through non profit organizations, so the best way to find the right organization for your needs would be to reach out to your SBA district office to see who is in your area.

Qualifying for a loan

To get the best loan for your needs, you need solid credit, a strong business plan, and a thorough understanding of your loan requirements. As discussed in this article, each loan type and program have different eligibility requirements, and loan amounts, interest rates, and repayment terms all depend greatly on what you bring to the table in your application. 

Excellent personal and business credit scores

Even if you opt for a smaller loan, or one with less-stringent requirements, you can set yourself up for the best opportunity by preparing yourself with your best possible credit scores (both personal and business, if possible). 

A credit score determines how trustworthy a borrower is, and directly impacts the terms of the loan agreement. Simply put, the better your score, the better your loan interest rate.

If you do not have a score for your business yet (and there is more than one type of score you can get here), don’t worry, unless you are applying for an SBA or term loan. Otherwise, a solid personal score between 640 and 700 should be good enough for most lenders; and, if you have a 700 or above, that can get you just about anything.

Build a business plan

Creating a business plan and making it as thorough as possible is one of the most crucial elements to a successful loan application. Here are some questions you should consider as you prepare your plan:

  • What is the purpose of your business?
  • What is the product or service?
  • In-depth market analysis: Is there a demand for this? How do you know?
  • What is your marketing plan?
  • How will this funding be allocated?

It is important to be as specific as possible. Think of the business plan as your argument. At the end of the day, you are trying to persuade someone to give you a loan; so make it clear, succinct, and thought out.

Know the loan type requirements

There are few things more irritating than showing up to a bank with all your paperwork, questions, and plan prepared, only to find you are missing one or more requirements for the loan you are applying for. 

When you choose a loan, do your research, make a list of each requirement, and make sure you are prepared to show each one at the time of submitting your application. You don’t want to waste your time or your lender’s by showing up unprepared.

Small business loan repayment

So, you’ve figured out which loan best meets your needs and what you need to apply for it. But how does repayment work?

Repayment terms vary per loan types, so here are some specifics regarding repayment term lengths and frequently of payments:

  • SBA loans are known to be relatively easy to repay and last between 5 and 25 years.
  • Business lines of credit can be paid off quicker, from 6 months to 5 years.
  • Term loans are a good option for businesses in favor of monthly payments, thanks to their longer borrowing time.
  • Short-term loans usually need to be paid weekly or daily.
  • Equipment loans are a bit different in that the repayment terms are usually set to match the predicted lifespan of the equipment being purchased.
  • SBA microloans have a maximum term limit of 6 years.
  • AR Financing loans vary widely for term lengths, but there are options to pay back the lender directly, or the client can pay the lender.

It’s important to remember that each loan varies depending on the borrower’s eligibility. So, it’s good practice to always understand the full scope of the loan you are qualified for before you accept it.

Here are some questions you may want to ask your lender to make sure that the loan and the lender are right for your business needs:

  1. Do you lend to businesses in my industry?
  2. How long does the application process take?
  3. When is my first payment due?
  4. How often are payments due?
  5. Do you offer a loan term that fits my needs?
  6. What is the total cost?

Deciding if a small business expansion loan is right for you

Here we’ve laid out for you the basics so that you can get an idea of what small business loans are, what kinds exist, and what you should prepare for if you are searching for one. Now, it’s up to you to decide whether this is the right move for your business, and yourself, or not. 

Here are some questions to ask yourself before you move forward that can hopefully guide your ultimate decision:

  1. What do I need this money for?
  2. How much money do I need?
  3. When do I need to have this money?
  4. Are the loan terms I am considering manageable and realistic for me?
  5. Is my credit where I want it to be?
  6. Are there any better ways of funding this project? 

Today, there are many options available for small business expansion financing. This means there is bound to be one (if not several) out there that suits your needs. Hopefully, after getting a better understanding of what is available to you and how these loans differ, the right move for you is easier to navigate, and you feel ready to take the leap.


Ready to take the next step with a small business expansion loan?

Heartland helps nearly 1,000,000 entrepreneurs make and move money, manage employees and engage customers with human-centered technology solutions that allow them to rise above the daily grind and lead their businesses into a brighter future. Learn more at heartland.us