Loans and lines of credit as a way to finance new businesses and existing small businesses
Starting and growing a small business can be very difficult. However, with proper planning and preparation, it can be done successfully. As a current or future business owner, one of the keys to success is to use all the resources available to you. This includes loans and investments from family, friends, and angel investors. It also includes loans and lines of credit from a bank, which are resources that many entrepreneurs do not consider to be a viable option to start or help grow their business.
If you listen to any media outlet with a business segment or financial focus, you will definitely get the message that the amount of capital available to entrepreneurs starting small businesses has shrunk. It’s true that as a result of the most recent recession, lending institutions have tightened the requirements for lending money to business owners. However, funds are still available to help entrepreneurs reach their financial goals. “In the US alone, there are approximately 27.5 million small businesses. And nearly 80 percent of them get their money through bank loans, credit cards and lines of credit.” (Julian Hills) The key is that as a business owner, you can’t be afraid to seek the financing required for your business.
There are several options available to business owners to finance their business. However, we will focus on SBA loans, lines of credit, and guarantees. A term loan is often used as a way to pay off a major business investment or acquisition. Term loans typically have fixed interest rates, with monthly or quarterly payment schedules, a fixed maturity date, and typically require collateral to secure the loan. A term loan is best used to finance the acquisition of a business, equipment, or real estate purchase.
“A line of credit is a simple financing product that allows you to withdraw funds up to a predetermined amount.” (Marco Terry) With a line of credit, you only have to pay interest on the outstanding balance, usually monthly. However, capital reductions must be made regularly, if not monthly. Lines of credit are very flexible and, unlike term debt, can be used for more than one purpose, such as paying suppliers and covering operating expenses. Lines of credit can also be used to cover gaps in cash flow from operations, which can be very beneficial for business owners, especially those in the start-up or growth stage of their business.
The challenge is that credit lines are very risky for banks. If the line is not used properly, it may need to be canceled and repaid through principal and interest payments over a fixed period of time. Therefore, most lines of credit, especially those for early-stage businesses, require collateral. This consists of liquid collateral, such as certificates of deposit and brokerage accounts, equipment, or a lien on real property. Banks prefer lines of credit to be fully secured by collateral. However, in the event that there is a shortfall in collateral, there are ways in which the bank can still provide financing to startups while protecting their investment. One of those ways includes getting a guarantee from the SBA.
The SBA (Small Business Administration) is a government agency that provides a variety of services to small business owners. One of the services they are best known for is offering guarantees on small business loans. This is done in partnership with financial institutions that provide financing to small businesses. Although the SBA does not lend money directly, it does set guidelines for loans made by financial institutions. It is important to note that business owners must be able to qualify for commercial bank loans contingent upon obtaining an SBA guarantee in order to qualify for an SBA loan. The main benefits of getting an SBA loan are structured loans with longer terms, lower down payments, lower interest rates, and less collateral than conventional loans. Some of the challenges with SBA guaranteed loans is that they require more paperwork and time than conventional loans.
References:
Terry, Mark. (unknown). The facts about startup lines of credit. Retrieved from http://factor-this.com/startup-business-line-of-credit/
Hills, Julian. 2013, October 21. How to finance a startup today. Retrieved from https://www.entrepreneur.com/article/229459