Written by: Guest | Best Company Editorial Team
Last Updated: February 24th, 2020
Guest Post by Jared Hecht
Some people think that a business loan is for companies that are in financial trouble and need a lifeline to stay afloat. On the contrary, the best time to apply for and use business financing is when your company is doing well,and needs extra capital to take the next step.
Sure, there are small business lenders who will extend financing to struggling businesses. But smart business owners only take on loans when they know the return on investment will benefit the bottom line in the long run — and good lenders don’t give money to businesses that can’t repay them.
If you believe that now is the time to assume some debt in return for extra working capital, congratulations. However, to make sure that you and your business are truly ready to explore small business funding options, you should ask yourself the following questions about financing:
How do I plan on using my new funds?
The first question is perhaps the most important, for a number of reasons. If you don’t know why you need financing, you don’t need it.
There are many common business funding needs. Some obvious reasons include expanding your business by opening a new location, renovating your current space, covering the cost of new equipment or inventory, or simply evening out your highly variable cash flow.
If you can’t cover any of the above expenditures with your regular cash flow, you should consider how a business loan or other financing might work for you. You may also be required to submit a business plan to your lender to show how you will use your funds — so a step-by-step plan for your financing may be required either way.
How much funding do I actually need?
Again, financing is a question of need, not want. What’s the minimum amount of money your project or idea needs? Ideally, that’s how much you should finance. Applying for a loan amount that goes beyond what you need and can afford will put you on the fast track to debt you can’t afford.
What debt obligation can my business support?
Keep in mind that once you take on your business financing, you’ll likely need to make monthly, if not weekly, payments to your lender. Factoring in the expected bump in revenue that your business should get from your infusion of capital, what can you afford to pay out to your lender each month?
Use the Debt-Service Coverage Ratio (your cash flow divided by expected loan payment) to see what you can comfortably afford. If the result of your DSCR is less than 1, you’ll have a hard time convincing lenders that you will comfortably repay them.
What’s my business credit score?
It’s important to note that your business credit score is different from your personal credit score.
You may know what your personal score is, but do know what your business credit score is? Your business credit score is one of the defining factors that lenders take into account when deciding not only whether to extend you financing, but at what terms.
You might still receive financing if your credit score is less-than-stellar, but with a less affordable APR and a shorter repayment period. If your financing need isn’t pressing and your score needs improvement, consider taking the time to work on your credit until you’re eligible for better terms.
How long have I been in business?
Business financing is potentially available to all kinds of businesses in all stages, from startup venture to long-established chain business. The best financing, however, will only be available to companies that have been in business for several years, at least. If your business is new, you’ll need to explore startup loans that generally come with higher APRs.
What’s my average monthly revenue?
Most lenders have minimum monthly revenue numbers that they want borrowers to hit in order to be considered for a loan. Generally speaking, lenders look for consistent revenue, rather than enormous spikes of revenue every few months.
Because most repayment terms for financing are on a monthly basis, take a look at your monthly revenue to see whether your numbers are consistent and that a lender would feel confident in asking for a set amount from you each month.
Qualifying for affordable financing as a seasonal business is far from impossible, but it requires careful planning. It’s best to apply for financing during or just after your busy season, rather than in the throes of low season, to appear most attractive to lenders.
Can I qualify for an SBA loan?
Loans guaranteed by the Small Business Administration are considered some of the best small business loans available, thanks to their low rates and generous repayment terms. If your business qualifies for an SBA loan, it means your business and personal credit score is high, your business is healthy, you have access to all your important business documents such as profit and loss statements and bank statements, and you have a vision for your financing.
If you can qualify for an SBA loan, you should probably apply for one. But if you don’t apply, just knowing that you would be considered bodes well for your other financing options.
Taking on financing for your business is never an easy decision. That being said, doing so can catapult your business to success and help you grow to even greater heights and profitability. Do your due diligence by asking yourself the above questions — then explore what options are available to you.
Jared Hecht is the co-founder and CEO of Fundera, an online marketplace for small business financial solutions. Prior to Fundera, Hecht co-founded group messaging app, GroupMe.