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You might need to take out a business loan for many reasons. You might need to expand your location, buy more inventory, purchase necessary equipment, hire additional staff, or are building your bad credit into a better credit score for the future. 

On the other hand, you might be starting a new business and need enough money to accomplish all these goals. Whatever your reason for taking out a business loan, there are a few things that you need to understand before you consider your business financing options.

According to the latest data from the Federal Reserve, the average business loan was $663,000, ranging from $13,000 to $1.2 million. Cash flows of that size will come with many strings and responsibilities. Failing to repay a personal loan can ruin your credit for several years. But failing to repay a business loan can lead to lawsuits seeking compensation for the outstanding balance and additional interest, penalties, fees, and other costs.

Applying for a business loan is much more complicated than trying for a personal loan. There are a lot of factors that will be taken into consideration, and you’ll likely get rejected multiple times. In some cases, you might not have any idea why your application was denied. 

Being denied a loan will be incredibly frustrating. But if you want to secure the business loan you need, you’ll have to dust yourself off and try again.

Here’s how to apply for a business loan

There are several steps involved when you apply for a business loan. The process is essentially the same whether you’re just starting or have been open for multiple years. It might take some time to perform your due diligence regarding these steps. 

However, much money is at stake, and you’ll take on significant risks. You must take the necessary time now so that you can avoid running into insurmountable problems later.

1. Determine why you need the loan

Not all business loans are the same. The reason you need to take out a loan will determine which type of loan is best for you. 

For example, let’s say that you need new equipment for your business. You can use the equipment you’re purchasing as collateral for the loan. By doing so, you would be entering into a secured loan agreement. If you fail to repay the loan, the equipment could be seized, sold, and used to cover your outstanding balance. 

The lender would be taking on less risk in the event of default, so it’s more likely that your business loan application will be approved.

Taking out a business loan that’s just a flat sum of money is a little more tricky. Since the loan isn’t secured by collateral, the lender will take on much more risk if you default. Banks are a business, and loans are considered an investment. 

Unsecured loans are much riskier and come with lower limits and stricter requirements. For example, PNC only offers unsecured loans ranging from $20,000 to $100,000, but secured loans can range from $100,001 to $3 million.

2. Calculate how much you need

The amount you’re requesting will play a significant role in whether or not your loan is accepted. 

The more capital you ask for, the higher the risk the lender will assume and the less likely they will accept. A lender is more likely to counter-offer a smaller amount and revisit the issue in the future after you’ve built up a solid reputation for being trustworthy.

In the previous example, we used the idea of buying new equipment as the reason for your loan. In that scenario, you would need to borrow enough money to cover the cost of the equipment (plus any taxes, shipping costs, or other additional fees), the installation, the inventory needed to use it, and the costs of any insurance or utility that might apply. 

In other words, borrowing $50,000 for a piece of equipment that costs $50,000 will not be enough.

A loan can be easy enough to cover the next month’s day-to-day operations. You just need to figure out your daily costs, multiply them by the number of days you operate in a month, and request a loan for that amount. 

However, it can get a little more complicated when you ask for a loan to establish or expand your business. It’s virtually impossible to calculate all the costs accurately, so it might be better for you to apply for a business line of credit instead. You would use the credit as needed and repay it in a similar way that you repay personal credit cards.

3. Create a detailed business plan

The next step is probably the most critical factor in whether or not your loan is accepted. Now that you know why you need extra funding and how much, you’ll need to create a highly detailed business plan. 

A business plan is exactly what it sounds like: a formal document containing your business’s goals, the methods of achieving them, and an estimated period. You’ll be reassuring the lender that you aren’t just borrowing money for no reason. There is a well-detailed plan in place, and the loan is an essential part.

Creating a business plan can be quite a challenge. You’ll need to consider and include a lot of information on your project. You’ll need detailed projections that explain precisely how your business will make money and a rough estimate of the profits. 

You’ll also need to present current and future marketing strategies to help grow your business. Include the background experience you have as an owner and the expertise of any managers working at your company. 

Those are just a few examples of the types of information that a lender will want to know while reviewing your loan application. 

4. Shop around for the best terms

You have quite a few options for taking out a business loan. The last thing you want to do is rush into an agreement without looking for the best terms. Going with the first offer is an easy way to wind up spending more money than you should.

The first instinct you probably have is to go with a traditional bank loan. Financial institutions like banks and credit unions typically offer some of the best interest rates for loans. Even a few hundredths of a percentage point less can add significant savings in the future. 

The downside is that they tend to be extremely strict and have a long list of eligibility requirements. These requirements include providing proof of credit reports, credit history, bank statements, and business assets, including commercial real estate. The application process will also take a lot longer than most, so you won’t be seeing your money anytime soon.

One alternative to using a traditional bank for your loan is to apply for a loan from the Small Business Administration (SBA). A few different loan options are made available by the SBA, including 7(a) loans, 504 loans, and microloans. Generally, SBA loans will come with lower down payments, no collateral conditions, and educational programs to help you grow your business. The downsides of SBA loans are that they are notorious for including strict underwriting requirements, extensive paperwork, and taking a very long time to process. 

The last business loan option is to seek an online lender. You’ll have way more options for loan types with online lenders as there is much more flexibility available. The odds of your loan being approved are much higher with online lenders as the requirements are much less stringent. 

Another benefit is that online lenders are usually very fast with reviewing your application and sending you your funds. The biggest downside of online lenders is that the interest rate is typically much higher. The benefits of getting a loan from an online lender can cost you several percentage points in interest. 

5. Submit your application and hope for the best

Once you’ve completed all the other steps, you’re finally ready to submit your application. Each traditional lender will have its unique system for loan applications. 

You might need to include additional information such as information about the business, financial statements, and some of the personal data of yourself and other prominent partners. 

Be sure to answer any questions as honestly and thoroughly as possible. However, you should avoid revealing anything more than necessary. This is strictly a business loan, so you must ensure that you’re protecting your personal information.

Taking out a business loan is difficult, but not impossible

Most businesses will need to borrow money at some point or another. Funding a startup without a loan or working capital is practically unthinkable, and growing a business without a loan would be impractical. As a business owner, you’ll need to take out a loan sooner or later. 

You’ll need to consider many factors when determining the type of loan you want, how much you’ll need, and where you’ll be getting it. 

The process will likely be an enormous hassle and headache. However, it’s all been done before by millions of other business owners, and you won’t be the last to go through it. There’s no reason to suggest you can’t get the loan you need to create a highly successful business.

Information provided on Entrepreneur Guide is for educational purposes only. Your financial situation is unique and the products and services we review may not be right for your circumstances. We do not offer financial advice, advisory or brokerage services, we do not recommend or advise individuals to buy or sell particular stocks or securities. Performance information may have changed since the time of publication. Past performance is not indicative of future results

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