Jody Grunden is CEO & Co-Founder of Summit CPA Group. He has helped pioneer innovative changes within the accounting industry.
There’s almost no getting around one of the biggest truths in business: You need money to make money. Sure, you’ll hear plenty of inspirational stories about tech companies starting in garages. But once you dig through the details, there’s almost always capital coming from somewhere. Most small businesses struggle to grow without an infusion of capital. Until you start generating high revenue that you can use to scale, your capital will likely need to come from small-business loans.
Dan Kalis, director of marketing and sales at QCSS and a partner of our company, discussed different lending options for small businesses and how businesses can create a lending relationship to help grow on our team’s The Modern CPA Success Show. Kalis explained when applying for a small-business loan, potential lenders will examine your application against three measurable factors: cash flow, credit and collateral. Let’s examine those factors based on that conversation:
Starting with cash flow: Positive cash flow indicates your ability to make regular payments against the loan. Potential lenders will look at your company’s earnings before interest tax depreciation and amortization to determine whether you have enough cash flow to meet new loan payments alongside other debt.
Next, properly utilizing existing lines of credit and keeping them in good standing will help boost trust in your ability to handle more debt. Also, the lender will look at how timely you made current debt payments. Lenders will also take into account your personal credit score. This can complicate matters for small-business owners. If you know cash will be tight, you will want to go to the bank before you get behind on any payments. If you are in the beginning stages of growing your business, create separate business and credit card accounts to begin establishing a credit score that’s separate from your personal one.
Lastly, collateral is an asset that the lender can consider taking possession of and selling if you default on your debt. For example, when you purchase a home with a loan, your home becomes collateral. For brick-and-mortar businesses, property such as vehicles, equipment, real estate, accounts receivable (AR) and inventory are considered collateral.
Lender Options For Small Businesses
Unless you have a friend or family member with exceptionally deep pockets, you’ll probably find yourself looking up a list of potential lenders. In the small-business world, lending options primarily occur through local, regional or national banks.
Your business will likely need to meet far more requirements to secure a small-business loan from a traditional bank lender. You may be asked to provide documentation related to your business tax returns, income statements, balance sheets, debt schedule and main operating bank account statements. Stricter documentation requirements make moving forward in securing a loan slower than other lending options.
If traditional banking is getting you nowhere because you have a poor credit score or no collateral, you may want to explore alternative lenders. For instance, a business seeking funding through a Small Business Administration 7(a) loan with no collateral must have at least two years of operating history, meet the SBA’s definition of an eligible small business, and meet their minimum credit score and revenue limits. With online or alternative lenders, a lower credit score might not be a barrier to getting a merchant cash advance. While these lenders put up fewer hurdles between you and the capital you need, the drawbacks include significantly higher interest rates, risk and lower loan amounts.
How To Choose A Lender For Small-Business Loans
Numerous components will impact the type of lender you can choose for your small-business loan. Your likely best option is to start with the bank you currently use for most business banking. Even if you don’t have a personal relationship with a banker there, your existing bank may have a wider perspective of your debt, spending and cash flow situation. Although you could just be a number in the system, you’re in the system. That provides a stronger argument for getting the loan approved. If your current lender isn’t budging, you may need to try a new bank, particularly a community bank. Establishing relationships with community banks is far easier, in my experience. Community banks are more likely to consider you holistically alongside your cash flow, credit and collateral factors.
Traditional banking may be a dead end for your business if you run an e-commerce operation or remote firm with no assets to speak of. Alternative banking options may be a good fit for you in this situation. Strong, positive cash flow generally matters far more to alternative lenders, so you may be able to secure funding through this avenue with much less friction in the process.
Almost any small business can secure a loan. If you’re not sure what your business looks like under the microscope of cash flow, credit and collateral, talk to your CPA to help draw up a profile similar to what your potential lenders will use to either approve or deny your loan request.