6 Best Practices to Follow When Applying for a SMB Loan

6 Best Practices to Follow When Applying for a SMB Loan

Applying for a small business loan can be easy when done correctly, but there are many mistakes that small business owners make when they start the business loan application process.

Mistakes in a business loan application draw out the process and can even result in your loan application being declined. In this article, I discuss the best practices and common mistakes that are made in order to help business owners avoid them when applying for a loan.

Taking the appropriate steps, and avoiding these mistakes will save you time, effort, money and many headaches!

Understand your options

More than ever, business loans are readily available for small business owners. However, that doesn’t mean that every option is optimal for your business. Before starting your research and looking for a business loan, first spend time planning what your business loan proceeds will be used for. Will you use the money for equipment? Are the loan proceeds going to be used for working capital? Do you have an expansion plan that requires funding? This is a very important first step before analyzing potential business loan options.

Why is this one of the most crucial steps? This is because you want to search for loan structures that align with the use of proceeds. An example of this would be the following.

Nancy owns a retail store that needs to purchase inventory for the holiday season. The inventory that Nancy purchases involves a three-month period from the time the inventory is ordered to the time that it’s sold. Once the inventory is sold, Nancy won’t have to use an inventory loan until the next holiday season.

In this situation, Nancy wants to search for a business loan that she can repay in three months and use again for the next holiday season. Nancy should search for a business line of credit that enables her to draw what she needs during the time she needs it, pay it back, and stop paying interest until the next time it’s needed.

If Nancy started a broad search for business loans and ended up applying for a term loan to be repaid over multiple years, it would not align with her needs. Why would Nancy pay interest for multiple years for inventory that churns in three months? Instead by understanding her needs and researching her options, Nancy avoids unnecessary documentation, wasted time, credit pulls, and potentially getting stuck in the wrong loan product.

A second example of this would be if Nancy was looking to purchase equipment for the store. The equipment has a 10-year lifespan and doesn’t immediately result in revenue for the company. In this scenario, Nancy would want to use long-term financing with low monthly payments.

Keeping Nany’s payments low with a long-term equipment financing program will have little impact on cash flow, and it provides the necessary equipment for the store. Long-term needs require long-term financing, and short-term needs require short-term, flexible solutions.

To help you understand the different options that are available, here is a list of business loan programs and brief details about the products.

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Business line of credit

The type of business line of credit that you apply for will impact both the timeframe and the document package. For alternative lines of credit under $250,000, the process to apply can take just 24 to 48 hours. If you are applying for a bank line of credit, the process will require a full document package, including financials, and can take as long as 45 days.

Asset-based loans 

This loan program relies on your business assets for collateral and is typically structured as an interest-only line of credit. The main assets that are used are accounts receivables (invoices), inventory and equipment. You can expect the process to take 15 to 30 days from application to closing.

Business term loans

Terms range from 24 to 60 months and take 10 to 14 days to complete the application and funding process.

Small business bridge loans

Bridge loans are often a quick and easy process, but have higher rates and shorter terms. Terms range from six to 24 months with the approval process taking 24 to 48 hours.

Invoice factoring 

This type of loan depends on many factors with your business. The time frame from approval to funding can range from seven to 21 days, and in many respects, is similar to asset-based lending and a business lines of credit.  

Equipment financing

Equipment loans are ideal for companies with smaller equipment needs that need financing for $250,000 or less. The process from application to funding can be completed within three to five days. For larger equipment needs, the process can take 14 to 21 days.

Know your credit profile

Two important credit factors that lenders look at is both your personal credit score and your business credit score. Both credit scores are weighted heavily in the underwriting process, and each lender has different credit requirements.

There are dozens of free services (Credit Karma is one such service) where you can sign up and learn your credit score. It’s prudent to consistently check your personal credit to learn what your current score is, where you need to improve and how to boost your score for the future. Your personal credit score is far more important than most people realize. It’s used when you apply for a home mortgage, a business loan, home utilities, such as cable and electric, a car lease, etc. A good score will help you lower monthly payments across the board!

It’s more difficult to check your business credit score, but the factors that impact your business credit are the same that impact your personal credit.

Double-check that all of your vendors are paid current, your credit cards or loans don’t have any past due balances or late payments, and that your credit utilization is a low as possible. Utilization is a major driver of credit scores; the higher your utilization, the lower your score. Common ways to check your business credit score are through Dun & Bradstreet, Equifax and Experian.

Be proactive, not reactive!

A common mistake that small business owners make is waiting until they need money rather than planning ahead. Being reactive versus proactive will have a negative impact on your business loan application, and can be the difference between getting approved and having your application rejected. Two things that frequently occur when you don’t plan ahead are

  1. Poor cash flow: More often than not, a business’s cash flow looks worse when business owners reactively apply for a loan versus planning ahead. Business owners tend to use available capital up until the point there isn’t enough cash flow to support what’s needed. Rather than waiting until this point, anticipate cash flow crunches, and apply for a business line of credit or term loan beforehand.
  2. Time constraint: This is an often overlooked benefit of planning ahead. Business loan programs that have lower rates and more attractive terms tend to require more documentation and take longer to get approved. When you plan ahead, you give yourself the ability to apply for the most attractive loan programs, instead of programs that are fast but have less attractive terms.

Prepare your financials

When you apply for financing, you will be asked to provide a list of documents for the lender to underwrite your business. The documentation that’s required depends on the type of loan you are applying for.

As a rule of thumb, the larger the loan amount and the longer the term, the more information you can expect to be asked to provide.

Here is a breakdown and short summary of documents you can expect to be required.

  1. Business tax return(s): For almost any business loan application, the prior one to three years of business tax returns will be required. Showing profitability on your business tax return will help with your approval.
  2. Personal tax return(s): When it comes to longer-term financing, one to three years of personal tax returns can be required. This shows lenders what your personal income is and if there are other sources of income to enhance your credit profile.
  3. Profit and loss statement(s): Also known as a P&L, this document will be required with almost all types on business loans. A P&L will outline both your business revenue and expenses. A frequent request is for your businesses prior year-end P&L and a year-to-date P&L.
  4. Balance sheet(s): A balance sheet will be requested for the prior year-end and a current snapshot for a lender to understand what types of liabilities and assets you have in your business.
  5. A/R aging report(s): For B2B businesses that sell on net terms, an A/R aging is an important document that helps a lender understand who your customers are, if there is any customer concentration and if your customers pay within terms.
  6. A/P aging report(s): Opposite of the A/R aging report, which shows money owed to you, an accounts payable aging report shows lenders whom you owe money to, what your payment terms are and if they are being paid on time.
  7. Debt schedule: This document outlines all the outstanding debt that your company has. It shows who the creditor is, the original loan amount, current balance, interest rate and the monthly payment.
  8. Business bank statement(s): As straightforward as it sounds, business bank statements are required for lenders to understand what your cash balances are, the frequency of deposits and the historical cash flow trends of your business.

Don’t rush. Take your time!

It’s safe to say that nobody likes doing paperwork. Paperwork and administrative tasks are nonrevenue generating and, frankly, boring! However, taking your time to correctly fill out a business loan application helps you avoid a lot of headaches. Rushing through a loan application almost always results in doing double work. Forms need to be filled out correctly, paperwork needs to be supplied accurately, and information needs to remain consistent. Not only will this increase the likelihood of being approved for a business loan, but it also speeds up the process.

A quick business tip! When you supply organized, accurate and labeled paperwork, lenders tend to review your information before other business loan applicants!

Know who you are working with

Any time you are seeking business financing, it’s critical that you know whom you are working with. In the business application process, you are supplying both personal and business information that should only be shared with reputable companies. There are many steps you can take to ensure that you are working with the best company. Here are three tips when working with a prospective lender:

  1. Check the company profile on LinkedIn
  2. Check to see if the company has online reviews
  3. Ask for references! If they provide a great service, they should be happy to provide client references.

A business loan can help improve your working capital, expand your business and take your company to the next level. There are a lot of small business lenders that provide great solutions, just make sure the one you choose is right for you!

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