Understanding How Business Loans Work

Business loans are crucial, whether they’re to get a business up and running, help it grow, or smooth out a rough patch. But getting a loan isn’t always easy.

To learn more, check out the infographic below, created by Maryville University’s online Bachelor of Science in Business Administration program.

Nobody should sign for a business loan without being absolutely clear what the terms are. Even before signing on the dotted line, ask yourself a few key questions: Is a loan even the right choice for me? There might be alternative ways to boost your cash flow. You could ask family or friends, see if you’re eligible for alternative funding streams, or just do the best you can with the money you already have. Other questions to ask yourself include:

To make sure you give yourself the best chance for approval, you should have the following basic information ready: personal credit score, business credit score, credit reports, and detailed financial information. Sometimes, you’ll also need collateral information. If the financial requirements seem overwhelming, consider calling in someone with expertise in business administration. Across the U.S., hundreds of thousands of loan officers and specialty loan brokers are available to evaluate your business to make sure you get what you need — for a fair price.

There are a number of business loan options available to entrepreneurs.

Entrepreneurs can pursue business loans from banks, online lenders, and microlenders. Banks are best for people who have been in business for at least two years, people with good credit, and people who don’t need fast cash. Meanwhile, online lenders are best for people with no collateral, people running a brand-new business, and people who need fast cash. Finally, microlenders are best for people who run companies too small for traditional loans.

Even within the same lender, the types of loans available vary. Business credit cards or personal loans are good for startup capital, while day-to-day expense needs are best served by a business line of credit. If you’re looking to grow your business, consider a traditional term loan or a loan from the U.S. Small Business Administration (SBA).

The SBA doesn’t directly lend money, but it does make it easier for individuals to get a loan and help reduce the risk for lenders. It brokers microloans, which can help with inventory, supplies, furniture, machinery, and other items valued at $50,000 or less. The SBA also helps broker 7(a) loans, which are good for refinancing debt, buying supplies, or securing short- and long-term working capital, as well as 504 loans, which are good for companies with a tangible net worth of less than $15 million.

Repayment terms will depend on the loan. Terms loans give you a specific amount of money upfront and require payment over a period of time set by the lender. Business lines of credit will give you revolving credit that you can borrow, repay, and use as you need while paying only the interest. After a set period, you’ll repay in monthly amounts totaling your balance based on the terms of your agreement.

Meanwhile, with business credit cards, you get revolving credit similar to a line of credit, and you repay as you would a personal credit card. With trade credit, you get credit from a vendor or supplier, and you repay via future income you put up as collateral. Invoice financing is similar in that you get a loan with your future income as collateral.

Nonprofit business loans can be pretty tricky, but if traditional loans aren’t working, grants are a great alternative. There are plenty of options, from crowdfunding and corporate-giving programs to nonprofit loans and grants. The SBA can help with nonprofit loans and grants. There are also plenty of grant-giving organizations, such as the Nonprofit Finance Fund, Propel Nonprofits, 3M Foundation, and The Carnegie Foundation. There are even business credit cards that can be helpful for nonprofits, such as Chase Ink Business Cash, Capital One Spark Cash Select for Business, and American Express Blue Business Cash.

Sometimes disaster strikes, and loans are available for those circumstances, too. Check the SBA for a variety of loans geared toward offsetting disasters. You can find loans for physical damage, mitigation assistance, economic injury, and military reservists.

Banks reject 80% of small-business loan applications, meaning the odds of being turned down are high. They say no for all sorts of reasons, including too new of a business, sole proprietorship business, risky industry, bad credit history, or insufficient cash flow. If your loan application is rejected, you’re not out of options, but you do need to be careful.

Predatory lending is when the loan is good for the lender but the terms make it difficult for the business to pay it back. Predatory lenders typically target people who recently lost their jobs, who have less of an understanding of how loans work, who have a more immediate need for money, or who are older.

Some common warning signs include risk-based pricing, hidden or false terms and fluctuating payment schedules, hidden or inflated fees, and seemingly overly complicated terms. You should also watch out for terms that disguise the total amount you’ll owe and contracts that bar you from taking legal action if things go wrong.

The SBA also recommends you watch out for unfair, abusive terms; lenders who rely on deception or coercion; anyone who tells you to leave signature boxes blank; anyone who asks you to lie; fees that are higher than 5% of the loan’s value; and lack of disclosure of information, such as the annual percentage rate or the full payment schedule.

Sometimes even when the loan isn’t predatory, obstacles can occur. If you’re unable to make your scheduled payments, you may receive a letter or phone call telling you you’re in default, asking for payment. If your loan was secured, the lender can take what you put up as collateral. If your loan wasn’t secured, the lender can sue you.

Loans can help you start or grow a business, or survive a rough patch, but navigating the lending process can be complicated. You want to make sure that you’re finding the right loan option from the right source and avoiding predatory lenders. Sometimes that means educating yourself on business finance processes and knowing when to call in a business administration expert.

Sources

Accion Opportunity Fund, Resources

Business News Daily, “8 Factors That Keep You from Getting a Small Business Loan”

Debt.org, “What Is Predatory Lending?”

Forbes, “9 Thing to Ask Yourself Before You Get a Business Loan”

Fundera, “Nonprofit Business Loans: Top Funding Options for Charities”

Fundera, “10 Best Credit Cards for Nonprofits in 2021”

Funding Circle, “6 Reasons Your Small Business Loan Application Was Rejected”

Lexington Law, “What Happens If You Default on a Business Loan?”

The Muse, “7 Ways to Get Funding for Your Business Idea”

Nav, “How Do Business Loans Work?”

Nerdwallet, “How to Get a Business Loan in 5 Steps”

OpenEdition Journals, “The Role of the State Towards the Grey Zone of Employment: Eyes on Canada and the United States”

U.S. Bureau of Labor Statistics, Loan Officers

U.S. Small Business Administration, Disaster Assistance

U.S. Small Business Administration, Loans