Small businesses have more financing options today than ever before. Yet, navigating this maze of options can make it challenging to choose the right loan and the right lender for your business. The days when the bank was the one-stop-shop for small business loans are over, and business owners need to be savvier about evaluating their options. Before you get a small business loan, there are 11 questions you should ask—three you need to ask yourself and eight you need to ask your potential lender.
Before You Get a Small Business Loan, Ask Yourself:
1. What do I need the extra capital for?
In other words, why do you need a loan? This seems like a pretty straightforward question, but it’s one that is often overlooked by borrowers. According to a small business credit survey, the most common reasons for seeking small business financing are (1) to meet operating expenses (44%) and (2) to expand, pursue a new opportunity or acquire business assets (56%). Identifying the purpose of your loan is an important first step, as it will help you answer some of the other questions you’ll need to ask.
Among other things, the purpose of your loan will help you identify the term that makes the most sense for you. Business owners looking for extra capital to fill a short-term need, like the purchase of quick turnaround inventory, will decidedly benefit from a quicker term than one looking to make a more long-term investment, like opening a newlocation.
As a general rule, the shorter the term the higher the periodic payment, but the lower the total dollar cost. Longer-term loans typically have a lower periodic payment, but the total dollar cost of accrued interest, or total cost of the loan, will be higher (this is often true even if the APR for the shorter-term loan is higher than the long-term loan).
2. How much money am I looking for?
Your loan purpose should drive the answer to this question. Although there is a popular belief that you should borrow “as much as you can get”, this is not necessarily wise. It’s important to consider the costs associated with borrowing and make sure you have enough cashflow to make your payments on time. Small Business Expert, Barry Moltz, recommends applying for the amount required to meet your current business need (for example, the amount you need to purchase new equipment or launch your new product) plus 10-20%. This way, you’re covered if expenses are more than anticipated or revenue takes longer to generate than expected – but you’re not taking on more debt than you can handle.
Determining the amount of money you need can also help you determine which lender to approach. Over the last several years many traditional lenders have shifted their focus toward bigger businesses and bigger loans. Banks, for example, would rather lend $500,000 or $1 million than $50,000. It’s hard to blame them; they both carry about the same administrative and regulatory costs associated with underwriting the loan.
Fortunately, many lenders specialize in smaller loan amounts, which are specifically geared towards small businesses. According to the small business credit survey, 57% of small businesses applying for a loan seek $100,000 or less.
3. How quickly do I need the funds?
Your loan purpose may not allow the luxury of time, and waiting several weeks to gain loan approval could lead to a high opportunity cost. For example, if you need extra capital to fulfill a new customer contract, a weeks long loan process could cause you to lose a valuable sale.
There are many times when fast access to additional capital is critical to taking advantage of an opportunity to create additional ROI or meet a short-term business challenge. In fact, 63% of surveyrespondents listed speed of funding as the primary reason they chose to apply for online financing.
Now that you know why you need capital, how much you need and how quickly you need it, you’re ready to talk to a lender. You understand your needs and you’re equipped to evaluate a potential lender based upon whether they’re a good fit for your business.
Before You Get a Small Business Loan, Ask Your Potential Lender:
1. Do you lend to businesses in my industry?
Many lenders specialize in working within specific industries or have identified industries they won’t work with. Asking this question early will help you avoid wasting time with a lender that won’t be able to help you—regardless of your creditworthiness.
2. Do you offer a loan term that fits my business need?
Because you’ve identified your loan purpose (your business need), you know whether you’re looking for a short-term or a long-term loan, and you’ll be able to recognize which loan types are a good fit.
There are lenders that offer exclusively either short-term or long-term loan options. So, by asking this question, you can eliminate lenders that don’t offer the terms you’re looking for and focus on the ones that do.
3. What are the interest rates and the total cost?
When considering your small business financing options, you’ll want to determine the associated costs of every alternative. There are a number of different pricing and comparison tools that can help you assess and compare financing options.
APR (Annual Percentage Rate) is one way to compare loans. The APR calculation includes all fees, so be sure you are comparing an APR to another full-APR and not just the annualized interest rate.
It’s also important to know what the total interest cost—or total dollar cost of the loan would be. This is especially true when trying to compare loans of different duration. For example, if you were to borrow $10,000 and your total payback was $11,500, your total dollar cost would be $1,500. The dollar cost can help a business determine affordability and easily compare cost to the expected ROI.
4. What will my payment schedule be?
The advent of daily and weekly periodic payments is a departure from the more traditional monthly payment approach. Many lenders (including online lenders) have adopted a more-frequent-than-monthly payment schedule for a number of reasons. For the borrower, this tends to smooth out the cash flow burden throughout the month rather than the traditional lumpy cash flow drain associated with a single payment every month.
Some lenders allow you to choose between daily or weekly payments, so you can select the schedule that best fits your needs and cashflow.
5. When is my first payment due?
When making a monthly loan payment, it’s logical to assume your first payment will be due at the appropriate time of the month following when you take the loan. On the other hand, if you have a daily repayment schedule, your first payment will likely be due on the next business day after you’ve accepted the loan proceeds. This could be a concern to a business owner who wasn’t expecting the first payment to be due at that time, but can be accommodated if you are aware of that expectation—so be sure to ask. It’s the unexpected requirements that can cause difficulty.
6. How do I make my periodic payments?
While there are some lenders who still accept a mailed paper check, many (including online lenders) have turned to automatic debits from a business’ bank account. This is a common practice, which many business owners find very convenient.
On one hand, this is an easy way for the lender to collect your loan payment in a timely manner—an obvious benefit to them. On the other, there are a few reasons why this could be considered good for the borrower:
- Each payment is automatically made on time. (No more risk of forgetting!)
- Automatic payments save your business time and money. (ElectronicPayments.org suggests it costs the average business owner $1.22 to write a paper check.)
- This type of electronic debit makes capital available to some borrowers who might not qualify within a more traditional payment model.
Make sure you understand exactly what will be debited from your account with each periodic payment. Will it be a fixed amount, or will it fluctuate depending upon what’s in your account? If you have a daily debit, you’ll want to confirm whether your account will be debited every day or every business day, so you can be prepared and ensure you have adequate funds in the business account to cover the payments.
You’ll also want to make sure you understand the process should there be a problem and there aren’t enough funds in your account when the periodic payment is due. A good lender should be willing to work with someone who proactively comes to them with an isolated problem. They want to see the loan process be successful as much as you do.
7. How long will the loan application process take?
Depending upon the lender it could take anywhere from a day or two to several weeks—or even months. For example, a loan from the bank could take weeks to go through, while a loan from an online lender tends to be finalized within a few business days. Depending upon your loan purpose and how quickly you need the capital, there may be some lenders you weed out early because their typical approval process just takes too long.
Fortunately, there are lenders like OnDeck who are able to offer a quick decision, where if approved, you could have funds in your account in as quickly 24 hours.
8. What is your Better Business Bureau (BBB) rating?
Looking at a BBB rating is not the only way to learn about how a company does business, but it can give you insight into how they resolve issues. In addition to reading their customer success stories and testimonials, don’t be shy about visiting a review site or two, such as TrustPilot, to learn as much as you can about the lender.
Are most of the reviews positive? Do the same concerns seem to reappear? If something looks out of place, don’t hesitate to ask about it. And, if the lender can’t resolve your concerns, don’t be afraid to look someplace else.
When evaluating your small business financing options, you’ll discover that some loans and lenders are a better fit for you than others. By asking the right questions, you’ll confidently be able to make the best choice for your business.
Edited content. Originally published by OnDeck Capital and written by Ty Kiisel.*