Joe Johnson, Ph.D.
Entrepreneur. Investor. Startup Expert.

One of the issues that keeps entrepreneurs awake at night is the need to secure funding. Angel investors aren’t as common as the Unicorn stories might lead one to believe and bootstrapping isn’t for everyone. Depending on your business structure and industry, however, there are other options, including bank loans, factoring, and purchase order financing. While many people don’t like the idea of incurring debt to start a business, unless you’re able to bootstrap, it may be necessary. To help ensure that you’re selecting the best funding option and investing your own time wisely, it’s important to understand each process. In this article, I’ll be discussing a range of topics worthy of your consideration if you’re even thinking of applying for a loan.

Securing a Loan for Your Business

Many entrepreneurs consider bank loans to be their primary option for startup capital. However, bank loans aren’t the best choice for everyone. Before beginning what can ofttimes be an arduous process, be sure to investigate which type of loan might work best for your company, whether the terms are appropriate for your business or lifestyle, what information you’ll need to assemble for your application, and your overall likelihood of success.

The Great Recession claimed many victims. One industry which is only slowly rebounding is small business lending. While the gross domestic product is currently higher than it was before the recession, small business lending has not bounced back at the same rate or to the same degree. Big banks remain reluctant to loan capital to small businesses. Recent Fed rate increases may encourage lenders to back a greater number of small businesses, but only time will tell. There is also talk of bank deregulation, which may spur more lending. Meanwhile, it’s important to understand the current climate and to select a funding option that works for your company.

Types of Loans

To determine the type of loan for which to apply, consider how much money you’ll need and the specific use to which it’ll be put.

The SBA recommends asking yourself the following questions when determining your financial needs:

  • How quickly do you require the capital?
  • For what purpose do you need the money?
  • Are you trying to expand or are you having trouble meeting your obligations?
  • Is your business just starting out or is it well-developed?
  • Would a bank consider your business to be high- or low-risk?
  • Is your business subject to seasonal cycles by nature?
  • Do you need a line of credit or an influx of cash to purchase equipment or property?

Your answers can help you decide whether to look at SBA-backed loans or to approach a bank that offers business loans. Knowing how you plan to use the cash can help guide you in applying for the loan that’ll best suit your needs. For example, if you need working capital, a line of credit may suffice, while the purchase of land or equipment will likely require a lump sum.

There are different organizations that originate small business loans. Before checking with the big banks, be sure to research the different programs listed on the SBA website. These programs emphasize small business lending and may offer more favorable terms than would a commercial loan.

The SBA is not a lender. Rather, it is a guarantor. While they don’t provide you with cash, they do help to guarantee your loan with the bank, thereby reducing their risk and increasing the likelihood that you’ll be able to receive funding.

SBA-backed offerings include:

General Small Business Loans (7a)
What it is: This loan is backed by the SBA and is the most common type of small business loan.
How it can be used: This loan can be put toward starting a new business, acquiring a business or franchise, operating a business, or expanding a business.
More info: For information about eligibility, terms, and how to apply, visit the 7a SBA page.

SBA Microloan
What it is: The SBA’s microloans are loans up to $50,000 that are provided by a select group of nonprofits and community-based organizations.
How it can be used: Microloans can only be used to launch or grow a business.
More info: To learn about eligibility, terms, and the application process, check out the Microloan program here.

Real Estate and Equipment Loans (CDC/504)
What it is: The CDC/504 program is intended for the purchase of fixed assets.
How it can be used: CDC/504 loans can be used to purchase land, pay for remodeling, pay for construction, or to purchase equipment and machinery.
More info: Eligibility requirements, loan terms, and more information about the application process is available here.

Disaster Loans
What it is: Disaster loans aim to help those who have been the victims of a natural disaster such as flooding or a hurricane.
How it can be used: A disaster loan can be used to repair or replace damaged property.
More info: To see if you are eligible for a disaster loan and to learn more about the process, visit this SBA page.

If these loans don’t meet your needs, check the websites of your local banks and credit unions to see what kind of business loans they originate.

Common bank offerings include:

Small Business Line of Credit
What it is: This on-demand cash flow functions like a credit card in that the amount you owe is tied directly to the amount of credit outstanding at any given time.
How it can be used: Essentially, you write a check or initiate a transfer to cover your payroll or material purchases. It’s generally utilized for rent, payroll, and daily operations.

Small Business Loan
What it is: A small business loan is a lump-sum infusion of capital.
How it can be used: A small business loan can be used to purchase equipment or to fund an expansion.

Small Business Mortgage
What it is: Just like a home mortgage, a small business mortgage allows you to purchase real estate.
How it can be used: A small business mortgage can facilitate either the initial purchase of a commercial property or your business’ expansion into a new location.

The Terms

As with any lending, beware of the fine print. Before signing anything, read it thoroughly and be certain that you fully understand all of the contract’s clauses and their long-term implications for your finances, both business and personal. There are many lenders out there – more than ever before – and some are quite predatory in nature, charging near-usurious interest rates or requiring extravagant collateral. If you have the ability to review a given loan’s terms in detail prior to submitting your application, by all means do so. Knowing whether you’ll need to risk collateral or repay the entire loan within five years (or some other especially short period) before applying can be of inestimable help in determining whether or not to apply at all.

In some cases, you may need to wait until you’re approved before you can peruse the detailed terms. If so, take your time and read every document provided before entering into a legal contract. Being approved for a loan does not obligate you to accept it. If the loan terms are not to your liking, you should move on to the next one.

When reading through a contract, look for these four terms and make sure that you fully understand their ramifications:

  • Collateral: Do you need to back the loan with your personal property?
  • Repayment: How long do you have to pay back your loan? How much do you need to pay back monthly?
  • Interest: Exactly how much will you be paying back? Will your interest rate ever change? The interest rate is a key component in determining the cost of borrowing money and whether doing so is financially beneficial to your company.
  • Liability: If your business can no longer meet its loan obligation, who will be held responsible?

About the Author

Dr. Joe Johnson is an entrepreneur, investor, and startup expert. He is the founder and principal of GoodField Investments and the GoodField Foundation (www.GoodField.com).

Joe has a Ph.D. in Entrepreneurial Leadership and an MBA. He is the author of the upcoming book on The Science of Why Most Entrepreneurs Fail and Some Succeed.

Most importantly, he is the incredibly blessed husband of one amazing wife and father of six wonderful children. He resides in Bradenton, Florida. For more information on Dr. Johnson and his work, go to www.JoeJohnson.com.