Every business finds itself in need of a loan or line of credit at some point, and for small businesses the need often arises at critical junctures for their very survival. Whether just starting out or looking to grow your business, being able to access a line of credit — expected or unexpected — provides a necessary cushion to survive, and ultimately thrive.
For sole proprietors or small business owners within construction, the question of whether to borrow money isn’t always an easy one to answer. For example, say you need to purchase a piece of equipment that costs $40,000, and you have $42,000 cash on hand. You may want to avoid paying interest on a loan and purchase the equipment outright. However, that leaves you with no safety net and can pose cash flow challenges.
Loans and lines of credit can be leveraged as tools to support productive growth and ensure ample cash flow. The options can seem limitless, but asking yourself the following key questions before signing on the dotted line can make the process easier.
1. Why do I want to borrow the money?
The most important factor in determining whether to borrow money is what you intend to use it for. Is it to purchase equipment? Do you need to bring on temporary workers for a big job? To obtain a small business loan, you must have a stated purpose, and the expectation is that the money you receive will be used for that reason alone. The purpose will help to inform what type of financing best fits your needs.
2. What type of loan do I need?
You should always consult with your certified public accountant (CPA) or bookkeeper on this question, but once you have decided on a banking partner, they can provide sound counsel on what type of financing makes sense for your purpose. While a credit card for everyday expenses may fit the needs of one business owner, a long-term, fixed-rate loan may be a better option for a business experiencing tremendous growth.
3. Am I ready to apply for a loan?
One of the biggest reasons businesses are denied loans is simply because they are not prepared to apply. First, you should shop around and look for a bank with the best rates and no hidden fees. When you decide what financing option to pursue, ensure that you have all the required essential documents and paperwork, including your business license, articles of incorporation, doing-business-as (DBA) paperwork, trade name association, tax returns, etc.
4. Am I going to qualify?
Before you apply for a loan, it’s important to analyze whether you are in strong enough financial standing to qualify. Even if the loan is put in the name of the business, the owner will need to sign a personal guarantee in case the debt is not repaid. As a result, your credit score plays a big role in determining whether you’ll be able to receive the loan you are looking for. Luckily, there are many places where you can check your credit score for free. In general, banks look to see credit score numbers at least in the high 600s to approve someone for a business loan. Other factors that will play into your qualification are your loan-to-value (LTV) and debt-to-income ratios (DTI).
5. What am I looking for in a banking partner?
No matter which type of financing you are looking for, there are bound to be many potential partners available to you. Always look for a banking institution that fits your kind of business. If you don’t have time to go into a branch, don’t work with a bank that only allows you to originate a loan in person at a branch. You should also shop rates and understand the fees that go along with the options you are exploring by going to the banks’ websites. Never work with a bank that doesn’t post their rates or disclose their fees.
Applying for a loan to help your business can be a daunting idea, but it is often necessary one for the long-term health of your business. By asking yourself these five questions ahead of time, you can go into the process set up for success.