Most small businesses borrow money at some point. What is unique to each business, however, is when they borrow money.
For example, does it make sense for you to borrow to start a business or just when it’s time to expand? Is it smart to borrow to improve cash flow or just when you purchase real estate?
Every small business is different and will have different borrowing needs. However, knowing the right time to borrow – and the kind of loan you need – can help you make smart financial choices for your company.
Types of Business Loans
Timing is critical when it comes to business borrowing, but so is the type of loan. This is why it’s important for small business owners to understand what kinds of loans are available and their common uses.
Term Loan
With a term loan, you receive the full amount of the loan at closing. These loans can have fixed or adjustable rates and can be secured or unsecured. Term loans can range from $25,000 to several million and usually have terms of less than 10 years. You can typically use a term loan for any business purpose.
Line of Credit
A line of credit gives you on-demand access to cash – typically with an account credit card or checks – up to your credit limit. The monthly payment is based on the outstanding balance, and credit is freed up again after you make payments. Most business lines of credit have variable interest rates and can be secured or unsecured. A line of credit is often used to improve cash flow or as emergency funds.
Small Business Administration (SBA) Loan and Line of Credit
An SBA loan and line of credit may have lower rates, fewer collateral requirements, longer terms, and other features that can make borrowing more affordable. The SBA application process can be complex, so it’s recommended you work with a lender with SBA experience.
Real Estate Term Loan
Business real estate loans are used to purchase property. These loans can have fixed or variable rates, longer terms, and are usually secured by the property you purchase.
Timing Matters
From starting out to taking advantage of an opportunity, there will likely be several inflection points in the lifecycle of your business when strategic borrowing can facilitate long-term growth and profitability.
At Launch
Starting out can be a smart time for you to borrow. It can help you launch your business properly in a prime location with the right equipment and talent, increasing the odds of success. Start-up borrowing can also eliminate the need for you to rely on personal credit, which can be risky.
Borrowing to start your company can also help you establish credit and facilitate larger-scale borrowing down the road. In many cases, good options for start-up borrowing are term loans, either traditional or SBA, and lines of credit. Today, commercial term loans can be structured to have lower payments for the first few years, which increase as the business becomes more profitable.
A line of credit can also be a helpful option as you launch your initiative because you can borrow just what you need, when you need it. For both options, your creditworthiness, along with a strong business plan, can help increase your odds of getting approved.
During a Cash Flow Crunch
Many businesses find cash flow management challenging, especially seasonal businesses and those with wide gaps between sales and receiving revenue. A term loan or line of credit can provide a cushion to keep your business going during periods when cash flow wanes. The key is to make sure the cost of borrowing to improve cash flow is as low as possible and fits into your short-term budget and long-term strategy.
When Experiencing Growing Pains
When you realize you need to expand your facility, purchase new equipment, increase inventory, or hire employees, you should definitely consider borrowing. All these signs point to one thing: your business is growing. However, even rapidly expanding small businesses can find themselves without the cash on hand to pay for growth, which is why borrowing at this time can be smart. Term loans, SBA or traditional, as well as lines of credit, can be excellent borrowing options during times of growth and expansion.
Considering a Brick-and-Mortar Purchase
Buying real estate is a big step for any business, but again, timing is critical. For example, a small start-up business might be better served by leasing space and spending money on equipment, talent, and inventory.
What’s more, a less established business might find the cost of borrowing to purchase real estate is higher than they wish to pay. As your business becomes more established, you'll have a better understanding of future growth, sufficient cash flow, and improved credit, which may make borrowing to purchase real estate more affordable.
When Opportunity Knocks
Business opportunities come along all the time. Maybe it’s the chance to buy extra inventory at a lower price, land top talent, or purchase a competitor. In many cases, these opportunities appear suddenly, making it next to impossible to plan for them. Be sure to carefully analyze any opportunity to make sure it’s a good fit for your company.
In the end, if you decide it is a good opportunity, borrowing money can make sense. In this type of situation, the kind of lending will likely depend on the type of opportunity. For example, a line of credit could be used to purchase inventory, but a term loan could be a better choice for purchasing a competitor’s business.
Getting Started with a Small Business Loan
Just like a personal loan, getting any type of business financing will require you to prove your creditworthiness and your ability to repay the loan. To do so, you will need to provide a variety of documentation when applying for financing. This includes general information about your business, such as the address, type, years in business, tax ID number, ownership details, number of employees, and more. The lender will also require detailed financial documents showing annual sales, net profit, assets, and any debts or obligations. In most cases, you will be required to provide personal information as well, including personal income, assets, debts, and more.
There are many options when it comes to business borrowing, from traditional banks to online lenders. And while there are certainly legitimate online lenders, working with a bank – especially when applying for an SBA loan – typically means you'll experience more personal service and guidance during the borrowing process.
