Loans are one of the most common sources of capital for small business startups. For your venture, you might consider one of three kinds of loans that commercial and community banks offer: a small business term loan, an asset-backed loan, and an SBA 7(a) loan.
In this article, we’ll introduce you to term loans and help you evaluate whether this source of financing can help you achieve your early-stage goals.
What are small business term loans?
A traditional term loan is an arrangement you make with a lender to borrow a specified amount of money for a specific purpose for a set period of time. Your lender will set terms, and you will agree to repay the loan with fixed, equal payments and a preset rate of interest.
Term loans generally have favorable terms and long repayment schedules (up to 10 years), making them a great option for owners looking to cover part of their startup costs, but they are notoriously difficult to qualify for.
|If you’re unable to meet the qualifications of a traditional term loan, consider online term loans, which often have less stringent credit score and credit history requirements.
Keep in mind that online term loans usually have less favorable terms than loans offered by conventional lenders. These lenders often quote higher interest rates and offer significantly shorter repayment terms than traditional term loan lenders.
What qualifications will I need to meet?
To qualify for a term loan, you’ll need:
- A strong personal credit score (generally 700 or higher)
- A source of funding to cover a down payment, which may be up to 30% of your capital requirements
- Verifiable management and industry experience
If your business is already formed and is in the early stages of its operation, you’ll need to demonstrate a few more qualifications. These include:
- A favorable business credit score
- Good credit history
- Positive cash flow that signifies your business’s ability to support the debt it’ll take on
How do I apply for small business term loans?
Determine which commercial banks, community banks, and credit unions in your area offer term loans for small businesses. Then, inquire about their rates and qualification criteria. If you qualify and are comfortable with the terms and interest rate a lender offers, you can begin the application process.
Start by gathering the documents they request. Often, these will include:
- Three years of personal bank statements, tax returns, and financial statements
- Your credit report and the credit reports of any others who will own 20 percent or more of the franchise unit
- Verification of the amounts and sources of other capital you plan to use to start or grow your business
- Your business plan, which should describe how you’ll run the business and ensure its profitability
- A statement that explains your management and industry experience
- A statement that explains how you plan to use the proceeds of the loan
Additionally, you’ll be asked to provide financial information and projections, which may include:
- Cash flow projections
- Projected profits or losses
- Balance sheet information
- Profit and loss statements
- Business tax returns for the last three years (if applicable)
- A schedule of the business’s term debt
- A third-party valuation of the collateral you plan to put up or an audited copy of your balance sheet
- Verification of your ability to make a down payment
If your loan request includes construction or leaseholder improvements, you’ll need to provide additional documentation, which may include a construction contract, a tax appraisal, and a third-party appraisal of the land or current property.
You’ll need an accountant and a valuation specialist to fulfill some of these requirements. You can check out some of our favorite accounting firms here:
You also connect with our network of valuation specialists here:
Next, you’ll complete your lender’s application. You can speed through the remainder of the loan process and boost your chances of approval by completing the application in its entirety and by being responsive to your lender’s questions and requests for clarification.
|You may choose to apply for term loans at multiple institutions to improve your odds of securing the capital you need.|
Review the offers you receive carefully. Make sure you understand the terms, conditions, and risks of the loan (which may include losing any pledged collateral upon default) before signing any additional paperwork.
A quick note: Your lender may ask you to purchase creditor insurance. This form of insurance provides assurance that the loan will be repaid in the event of your death or disability. However, lenders are prohibited from making it a requirement. You can learn more about creditor insurance in our Small Business Financing 101 article, What Is Creditor Insurance?.
What should I do if my application is rejected?
Listen to your lending officer’s explanation, and ask for feedback on what you can do to position your request more favorably in the future.
Your lender may recommend simple tweaks to your business plan or a boost to your credit score to increase your odds of approval. Or, they may point to larger issues that you’ll need to resolve before reapplying for funding. You can make the necessary adjustments and submit a new application, or you can choose to apply with other traditional lenders or online term loan lenders who may be more lenient in their requirements.
Are small business term loans right for me?
Like other forms of financing, a small business term loan has advantages and disadvantages that you should consider carefully:
(+) A term loan may help you attain all the capital you need in a single transaction
(+) Term loans allow you to spread the cost of your acquisition over a longer period of time than you can through many other financing options.
(+) Term loans can help you build credit for your business, which is essential for attaining better financing options for future capital needs.
(-) The loans can be difficult to attain.
(-) The loan process can be lengthy.
(-) Lenders may require collateral to secure your loan, which makes the downside of default even greater.
Interested in other financing options? Learn about SBA loans, term loans, asset-backed financing, 401(k) options, portfolio loans, and other options, including angel investors and venture capital, in our article, Your Go-to Guide to Raising Capital for Your Small Business.
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