Small business loans are available from numerous traditional and fintech lenders. Small business loans can help your business grow, through enhancing the research and development wing. They can also help you go beyond national territories, contribute to marketing and advertising, streamline inventory management, hiring key personnel, and set up a robust manufacturing unit or develop internal compliance and regulatory systems.
Here are the 5 key steps before considering a business loan.
Step 1: Type of Business Loan
Before we begin, let us take a look at the two types of business loans that you can take from marketplace lenders and banks.
- Secured Loans: These loans are given against collaterals which can be inventory, land, building, shares and securities. This is because, if the organization is unable to pay back the loan, a lender can recover the loan amount (or the approximate loan amount) through liquidation of collaterals.
- Unsecured Loans: These are loans without collaterals. Here, the risk is entirely faced by the lender. The business loan interest rate is much higher than that of a secured loan due to the high risk. These loans are mostly disbursed to small businesses that do not want to risk their assets and are willing to pay a higher interest.
Step 2: How should you assess the amount of loan?
Check your capital allocation between equity and debt. If you apply for an amount greater than you actually need, it might lead to poor allocation and higher EMIs. On the flip side, if you take an amount lower than your requirement, it might be detrimental to your growth. One should also assess the EMI on the loans through Business Loan EMI calculators, which are available online.
Step 3: Research Lenders
- Direct online lenders
- Private or public sector banks
- Co-operative banks
- Peer lending
With the above-mentioned lenders, the business loan interest rates vary. So, after getting quotes from such lenders, always check the monthly EMIs through the Business Loan EMI calculator.
Step 4: Lender Assessment
Even though lenders are looking at opportunities to disburse loans, ultimately they take a call based on the factors mentioned below, whether the risk to reward ratio is feasible in making such a transaction or not. They might perform an end-to-end financial and legal due diligence before approving any loan. Here are a few points they consider:
- Credit risk: Lenders will review your past credit history, loans taken earlier, check the timely payments under credits.
- Outstanding loans and cash flow: Lenders will review if the business’s debt service coverage ratio will be more than 1, i.e. if the P&L projections will cover the debt service.
- Collateral: Assets in the business can be attached as collateral in case of default.
- Investors in the company: If reputed angels and venture capital companies have invested in the company, it improves the credibility.
- Financial statements: End-to-end financial and cash flow analysis
Step 5: Approval and Disbursement
Finally, the loan will be approved or rejected, but one needs to make sure that the proposed business loan is on agreed terms and conditions. The borrower should thoroughly go through the contract before signing it to check the business loan interest rate and repayment schedule, prepayment penalties and other miscellaneous items.
A loan can be a boon or bust for a company. If utilized in the right manner, the return on capital grows in leaps and bounds. But, if things go awry, then it can lead to a severe financial crisis and ultimately bankruptcy. A borrower should be a good capital allocator and raise the right amount of debt in order to efficiently run the business.