Although traditional business lending has rebounded since the start of the great recession, the recovery has not been as robust for the smallest small businesses—the small merchants, restaurants, drycleaners, and mechanics most of us think of when we think of small businesses. Fortunately, in addition to a term loan at the bank, small business loans can be found outside the bank.
Borrowing from the Bank
The local bank has traditionally been the source of capital for small business owners in Canada. In fact, when most small business owners realize they need financing, their local bank is the first place they think of. This makes sense when you consider they often use other bank services; like a business checking account, maybe a business credit card, a merchant services account, or even a business savings account.
Business borrowing from the bank can be a good option for many small business owners, provided they can meet the potentially rigid qualification criteria. Nevertheless, even if you do have the right credit score, have sufficient collateral, and meet the other requirements, a loan at the bank might not be the best loan to address your situation, so it makes sense to understand more about a loan at the bank and investigate all the options to make sure you pick the right loan to meet your small business needs.
How Will the Bank Review My Loan Application?
Although any particular bank may evaluate you and your business differently, here are some pretty basic criteria most banks are looking at when you’re applying for a small business loan:
- Personal Credit Score: Most banks like to see a personal credit score of 700 or better, although some will go as low as 680 if the borrower can demonstrate an otherwise healthy business and other criteria are met.
- Collateral: Obtaining approval for most small business loans will typically require some form of collateral to secure the loan. This helps the bank mitigate their losses should a borrower default. As a general rule, something like equipment, real estate, or other high-value assets that can be sold by the bank is generally accepted as collateral.
- Time in Business: Although they don’t all require the same amount of time in business, all lenders look at your track record in the past to make decisions about whether or not a small business owner will be able to successful service the debt of a small business loan in the future. As a general rule, the bank likes to see several years (even four or five) in business before they will approve a loan.
How Does a Term Loan Work?
The way a loan at the bank works is also very familiar to anyone who has ever had a mortgage or an auto loan. In the phrase “term loan,” the word “term” applies to the length of the loan. For example, a 30-year mortgage would be considered a 30-year term loan. In the same way, a four-year auto loan would be considered a four-year term loan. A small business loan at the bank will typically carry a term of four to 10 years—sometimes longer. So if your loan purpose would be served by a longer-term loan, a loan at the bank could be a good option.
Although many traditional term loans at the bank require a monthly periodic payment, some banks are requiring a more frequent periodic payment schedule. This is something you’ll want to confirm with your bank as they discuss loan terms, payment schedules, and interest rates.
The interest rates you’ll pay at the bank will vary depending upon the following:
- The current index rate (usually the Prime Rate, LIBOR, or the Treasury Rate—depending upon the type of loan)
- The perceived credit risk represented by your loan (your personal and business creditworthiness)
- The length of the loan term
Interest rates may be either fixed or variable. A fixed rate will not change throughout the loan term, regardless of what happens to the Prime Rate, LIBOR, or Treasury Rates. Therefore, a good time to get a fixed-rate loan is when the interest rates are low.
Variable rates are based upon the above index rates and will fluctuate with the rate as it moves up or down. When you agree to a variable rate, you are agreeing to a rate based upon the index, plus a defined spread. In other words, as the lenders cost of funds changes, so does the interest rate you pay—going either up or down.
When Could a Loan From the Bank Be a Good Choice?
There are a number of loan purposes that make sense for a term loan from the bank, including:
- Equipment, machinery, and other tools for manufacturing, service, and repair businesses
- Technology and other office equipment, such as computer equipment, phone systems, copiers, furniture, and other similar technology
- Real estate, office space expansion, renovations, and new construction
Applying for a loan at the bank will require submitting an application with information about you and your business. The specific information required can be different from bank to bank, but you should be prepared to dive into the details of your business’s financial health as well as your personal creditworthiness. Some of what the bank may want to see includes:
- A detailed business plan that outlines why you are looking for a loan, what, if any, assets will be purchased with the proceeds from the loan, and how you expect the business to benefit from using the borrowed funds in this way.
- Business financial statements for up to the past three years, including balance sheets and profit and loss statements (P&L).
- Tax returns for both the business and the owners for the past three years.
- A debt schedule.
- Personal financial statements of all the business owners.
- The lease for the business premises, if applicable.
- Financial projections for three years showing what you expect revenue and expenses to be. You should also plan on demonstrating how those operations will make it possible to repay the proposed loan.
- Resumes for all business owners and key employees.
- Information about the assets to be purchased, including a copy of the sales contract or purchase agreement, if applicable.
As a small business owner, it’s likely that your personal creditworthiness will always be a factor in loan approval decisions—particularly at the bank. Many bankers look at your personal credit score as the first go-no-go metric when making decisions about your loan application. Your business credit profile will also factor into the decision-making process, so it’s important to understand what is reported within your personal and business credit profiles.
The turnaround time for a bank loan can take up to several weeks, so it makes sense to be prepared to help streamline the process as much as possible. You can start by having the above-mentioned information at your fingertips. You should also be prepared to respond quickly with any additional information they might ask about.
Small Business Loans From the BDC
The Business Development Bank of Canada (BDC) is a federal development bank structured as a Crown corporation wholly owned by the Government of Canada. Its mandate is to help create and develop Canadian businesses through financing, growth and transition capital, venture capital and advisory services, with a focus on small and medium-sized enterprises.
The bank was founded in 1944, and its corporate headquarters is located in Montreal. BDC has more than 118 business centers across Canada and more than 49,000 clients. BDC’s debt obligations, secured by the Government of Canada, are issued to public and private sector institutions.
BDC offers loans and advisory services with a focus on small and medium-sized companies. BDC Capital, a subsidiary of the BDC offers specialized financing, including venture capital, equity as well as growth and business transition capital.
BDC’s Venture Capital arm makes strategic investments in Canadian companies through its Energy/Cleantech Fund, Healthcare Fund, and IT Fund. BDC is a complementary lender, offering commercial loans and investments that fill out or complete services available from private-sector financial institutions. It also provides advice to businesses through its advisory services division
A BDC Small Business Loan
The BDC offers a small business loan for business owners who need quick and easy access to finance. Loan amounts up to $100,000 and in little as 48hrs. The loan offers small business quickly access the funds they need, at an interest rate that they can afford. Best of all, they can postpone the capital payment for the first 6 months and repay the loan at their pace over 5 years.
Loans can be used for:
- Buying equipment
- Attending tradeshows
- To purchase new software or hardware
- Apply for a patent or trademark
- Intellectual property protection
- or other business expenses
To be eligible, a business has to meet the following criteria:
- Canadian-based business
- Generating revenues for at least 24 months
- Good credit history
- You’ve reached the age of majority in the province or territory where you live
Equipment Financing Loan
This loan can be used to cover the purchase cost of new or used equipment and related expenses so that businesses can expand and modernize operations, and replace out-of-date machinery. An equipment financing loan can be used to cover purchase cost as well as related expenses, such as shipping, installation, and training.
An equipment loan can be used for :
- Purchasing production line machinery and equipment
- Accessing specialized technology, such as lab equipment
- Buying commercial vehicles and much more
The loan repayment schedule can be matched to the cash flow cycle and can be paid off at any time without a penalty.
Small Business Loans From an Online Small Business Lender
In addition to traditional bank loans and the BDC, a new breed of online lenders are offering small business loans. In many ways, online loans are similar to their traditional counterparts. The difference is in the way they leverage technology, their approach to the small business loan process, and the paradigm they use to evaluate a business borrower’s creditworthiness.
As traditional lenders shied away from the smallest small businesses, loans to those businesses have been in decline and slow to recover, online lenders are making more capital available to small businesses by adding a financing option that didn’t exist previously.
In the same way companies like Amazon, AirBNB, and Uber have changed the way we shop, stay in a hotel, or hail a cab, these lenders are using technology to match loan purpose with the right loan product to help them fuel business growth and meet other capital needs. According to a survey of 592 Main Street small business owners conducted by the Electronic Transactions Association (ETA) in early 2016, the average business owners in the survey anticipate a 5x return for every dollar they borrow. What’s more, 94 percent of those same business owners perceive that having more options helps them do that.
Although many online lenders share some of the same characteristics, they are not all the same. Some lenders tend to focus on either long-term loans or short-term loans. Nevertheless, there are lenders that do both. As a result, depending upon your loan purpose (what you’re borrowing the money for), you’ll likely need to know before your search begins what terms might make the most sense for your loan purpose. For example, the loan term when purchasing short-turnaround inventory and a large piece of manufacturing equipment could be very different.
Applying for an Online Business Loan
The application process for an online loan is very different from a traditional loan at the bank or an SBA loan. Applications are usually a simple online form that only takes a few minutes to complete and the business will often receive an answer to their application within and hour—sometimes as quickly as within a few minutes.
The documents required for an online business loan will vary from what is required by the bank and may include:
- The borrower’s Social Insurance Number
- The business’ Tax ID Number
- Several months of business bank statements
- Financial statements
Although the requirements might vary from lender to lender, most online lenders don’t require specific types of collateral to secure a loan. Rather, they apply a general lien to business assets during the loan term and require a personal guarantee (a common practice also used by many banks).
Interest Rates and Fees for Online Business Loans
Interest rates and fees will vary from lender to lender. And, because it can be confusing to compare loans with different loan terms, it’s important to ask any potential lender for some of the following information:
- The total cost of capital (or total cost of the loan)
- The fees associated with the loan
- APR (which includes an annualized interest rate plus any fees)
- Prepayment policies
This information will make it easier to compare loans from different lenders who might express the costs associated with their loans in different ways. For example, 57 percent of those who participated in the ETA survey chose a shorter-term loan option with a higher APR for a hypothetical short-term business opportunity because it offered a lower overall dollar cost when compared to a longer-term loan with a lower APR.
Although loans for consumers are commonly expressed in terms of APR, there is only one way an online lender might express the costs associated with a business loan since dollar cost is important to consider in relation to an investment opportunity. And, use of APR may be most helpful when comparing loans of similar term, but it’s always a good idea to also ask about the fees, the total dollar cost of the loan, and prepayment policies. In many situations, the total dollar cost might be a more important metric than the APR to a small business borrower.
Repayment Terms and Other Considerations
The advent of daily and weekly periodic payments is a departure from a more traditional monthly payment schedule; nevertheless, many lenders (including online lenders) have adopted a more-frequent-than-monthly payment schedule. Not the least of these reasons is that it tends to smooth out the cash burden throughout the month and helps the lender control the risk associated with the loan.
If your lender requires a more frequent periodic payment, it’s important to make sure your business has the appropriate cash flow to accommodate the payment schedule. This type of payment schedule might not be a good choice for a business that relies on a month-end influx of cash flow to maintain business operations or infrequent inward deposits.
There are several situations where an online small business loan could make sense:
- Your business doesn’t meet the rigid credit criteria at the bank: Because many online lenders consider dozens of other metrics that demonstrate a healthy business, beyond just your personal credit score, they will often accept a lower personal credit score (provided other metrics demonstrate a healthy business).
- You need to fill a short-term business need: As described above, there are situations where a long-term loan will include a total dollar cost that is too high for the loan purpose. An online loan with a six- to 12-month term could be a better fit.
- You need an answer regarding your application quickly: Online lenders are typically able to respond with an approval or a decline of your credit application within the same day—sometimes within a few minutes.
- You need the capital quickly: There are times when opportunity costs are high enough that paying a premium for 24- or 48-hour access to capital is worth the extra expense. For example, the opportunity to purchase quick-turnaround inventory at a steep discount could justify paying a premium for the funds.
The qualifying criteria for an online business loan will vary depending upon your lender, but are typically less strict than a traditional loan.
- Required Time in Business: Usually between 1-2 years
- Minimum Annual Revenue: $75,000-$250,000
- Minimum Personal Credit Score: 500-650
- Industry: Industry requirements vary by lender, but restricted industries sometimes include financial services, homebuilders, real estate investors, etc.
The Devil is in the Details
Regardless of whether you opt for a loan at the bank, and SBA loan, or an online business loan, it’s important to understand any and all fees and charges that could be applied to your loan down the road. In addition to late fees, are there other fees or policies you need to be aware of?
The fine print isn’t always fun to read, but it’s important to make sure you understand what’s included in there. For example, you should understand how frequently you might expect rate changes with a variable rate loan.
If there are financial terms you don’t understand, make sure they are explained to you by the lender or have a trusted advisor like your accountant or lawyer review the document and explain the terms to you before you sign it.
There are more options available for small business owners than ever before, but it’s important that small business owners become savvy about their choices to determine the financing option that will make the most sense for their business.