Fundraising: Loan Financing
Bond Street’s Samantha Novick on the When, Why, What, and How of the SBL
Funding isn’t a stroke of charity in a moment of desperation. Nor is it an automatic reward for being an entrepreneur, baking a cookie and slapping on a sticker. It’s a relationship of profound trust, mutually earned between you and the financial entity that’s collaborating with you, based on your needs, your track record, your potential, and what the entity has to offer in return. This relationship is made especially vivid in the breakdown of the Small Business Loan, below, as presented by our mentor Samantha Novick of Bond Street.
It’s easy to go into the SBL process defensively — focusing on proving yourself and explaining your needs. After all, you’re the one with the ask. You have to know what you need and know, more importantly, why getting it will be profitable. Novick’s steps show precisely where in the process you have to be at your most clear on both points.
But the ask is half the battle. The other half is the get. You need to know what it is you’re putting on the table, what it is worth, and how to get the fairest deal under your particular circumstances. Novick emphasizes in her advice that, ultimately, “you’re in charge of your business finances.” Your ass is on the line. And it’s in everyone’s best interest that you cover it. The fairer the transaction is for you, the safer it will be, ultimately, for your lender too.
WHEN
Maybe never. Samantha Novick works for the innovative lender Bond Street. Her first words of advice are a cold shower of a warning to anyone getting ahead of themselves.
“It’s important to start by saying that acquiring a small business loan may not be the right next step for your company’s current needs. It’s possible, and sometimes advantageous, to grow your business slowly and with less risk by bootstrapping. Paying back lenders and dealing with investors are serious responsibilities that can cripple your small business if done carelessly.”
She quickly comes back to the logic that ultimately drives her work: “When done right, raising external financing is the key to growth for many businesses.”
WHY
It boils down to the bottom line. A very specific, well-defined bottom line.
“The difference between good and bad reasons to look for external capital comes down to return on investment (ROI),” says Novick. “Evaluating ROI is critical. You should be using funds towards an expense that will generate growth or revenue — hiring a new employee, expanding to an additional location, or buying inventory. Repainting your walls, on the other hand, typically isn’t the right use case for a small business loan.”
Read more: An Introduction to Small Business Financing
WHAT
- YOUR OPTIONS
“Before you submerge yourself in the small business loan application process, make sure you understand your options,” says Novick. “Small business financing is available in many forms, from business credit cards and small business loans, to invoice financing or factoring. Understand the pros and cons of each so you know what to expect and where to find the most appropriate financing for your business.”
Depending on your small business type, growth stage, and needs, the following types of financing are available:
Lines of credit for short-term flexibility
You draw down from a line of credit to make cash available in your business bank account. Lines of credit are limited by a certain maximum and must be paid back quickly or you will incur interest costs. They are usually secured by collateral and therefore have lower rates than business credit cards. To qualify, a business must usually have at least two years of operating history, one year of profitability, and a positive net worth. Lines of credit provide a lot of flexibility and are great for expenses you can repay within at most 12 months.
Small business credit card for small fluctuations in expenses
Small business credit cards are much like personal credit cards. They offer a revolving line of credit useful to a huge range of businesses for small and emergency purchases. They help simplify accounting, separate your business and personal finances, and come with rewards. While very convenient, you are personally liable for business credit cards, which often have interest rates topping 15%.
Merchant cash advance for short-term working capital
A merchant cash advance is upfront cash that you repay, along with a fee, through a % of daily sales. The loan has no fixed time period; it continues for as long as it is not repaid. MCAs are appropriate for short-term working capital needs, yet they tend to be the most expensive type of debt with advances generally cost between 20–40% more than the face value of the loan.
Invoice financing for smoother cash flow
Invoice financing is when you exchange your invoices for upfront cash equivalent to a percentage of the invoices’ value. If your business struggles with gaps between invoices and payment, this is a good option to smooth cash flow. Invoice factoring and invoice discounting are two types of invoice financing; technically, only invoice discounting is debt financing. But the two methods are very similar.
Term loans for growth investments
With a term loan, the lender provides you with a lump sum of cash that you repay over a set period of time. At Bond Street, we seek to fill the gap between banks and alternative lenders by providing term loans of $50K-500K over 1–3 year terms. However, repayment can last as little as three months or extend over several years, depending on who you choose to borrow from. A term loan is perfect for making an investment in an opportunity that will create a steady stream of cash in the near future. Common term loan use cases-include:
- Moving into a new office to accommodate an increasing number of employees and clients.
- Opening a new store, renovating an existing space or purchasing inventory.
- Refinancing high-interest debt.
- Revamping a business website.
- Hiring new employees.
- Investing in the new technology, space, and employees to take on new markets.
- Getting working capital to cover seasonal fluctuations.
2. YOUR CREDIT and 3. YOUR USE CASE
“Once you’ve decided you’re ready to dive into the world of small business loans, you’ll need to get a firm grasp of two essentials: your credit — personal and business — and your use case.”
Analyze your credit — boosting your score if need be — and determine the specific financing need for your loan request.
“If you hope to get a small business loan one day, the very first thing to do is analyze your credit now. Lenders consider both your personal credit scoreand business credit score in assessing the risk of extending credit to your company. A good score can mean a lower interest rate and APR, or better terms on your offer. The best way to keep your score in good shape, or to improve a low score, is to make timely payments. You can boost your score by disputing errors on your credit report (they’re more common than you might think!), keeping your outstanding balance low, and keeping your utilization rate (the percentage of available credit you’re using) under 10%.”
Read more:
- Your Personal Credit Score
- How to Raise Your Credit Score
- Your Business Credit Score
- Maintaining a Healthy Business Credit Score
- Your Credit Report
4. YOUR SUPPORTING EVIDENCE
You’ll want to gather these additional documents, says Novick.
- Business financials, i.e. income statement, cash flow statement and balance sheet
- Tax returns
- Business deposit history
5. THEIR OFFERS
When comparing multiple loan offers, Novick explains, weighing each loan’s most important features can make that decision easier. She breaks it down into three stages:
(i) “Consider how much money each lender is offering versus the loan’s APR — a calculation of interest, taking into consideration all other fees associated with the small business loan. Locking in a smaller loan than you need, at a lower rate, isn’t necessarily beneficial, if you have to supplement what you’re borrowing with another loan that carries a higher rate.”
(ii) “Look at the loan repayment term. A short-term loan may need to be repaid in one to three years; a 504 loan through the SBA can be amortized over a period of up to 30 years. You must know what repayment time frame works best for your business, and for the specific investment you’re making.”
(iii) “Finally, consider whether any collateral is required. While you will not need to pledge any personal assets for an unsecured loan, the interest rate is typically higher. A term loan, on the other hand, may require you to offer collateral, depending on the loan’s purpose.”
HOW (AND HOW NOT TO)
Novick gives some deeper insight into how lenders think, how the process works from their end, and how you can anticipate that process with some help from a pro.
“Small business loans are meant to meet very specific needs. A good lender will not give you a loan for a financing need better met by credit cards or angel investors. Nor do they want to see your business squashed under the weight of an oversize loan. That’s why they study your financial statements and calculate your debt service coverage ratio, or DSCR. If you do this same process with the help of an accountant before applying, you can make a very compelling case for why you need the amount you’re requesting and why you can be trusted to pay it back. All the lender will have to do is double-check your math and send you the offer.
In addition, understanding the difference between interest rates and APRwill make you a true master of small business loans. With that knowledge in hand, you can compare offers and understand exactly how much a loan is going to cost you by the time you’ve paid it off. Don’t accept a loan just because it’s been offered. You’re in charge of your business finances.”
Finally, Novick leaves us with a warning about two specific areas that are often traps for rookie entrepreneurs: the Merchant Cash Advance, and accurately evaluating your loan offer.
“Many small business owners look to a merchant cash advance as a shortcut to funding. At first glance, the benefits of using a merchant cash advance in lieu of something like a term loan are numerous, but there’s one specific drawback that can outweigh them all. Unlike a loan, a merchant cash advance isn’t assigned an annual percentage rate. Instead, business owners pay what’s known as a factor rate. The factor rate is expressed as a decimal point and it represents the amount that you agree to repay to the advance provider. This fee varies but it’s normally between 1.1 and 1.5. The factor rate is one of the most misunderstood aspects of merchant cash advances because it makes the interest rate appear lower than it actually is. When you take time to run the numbers, however, it becomes apparent that merchant advances can be one of the most expensive borrowing options.”
Important information to keep in mind when evaluating your loan offer(s):
- All lenders are required by law to tell you the APR on your loan. Be sure to check that it is within the range you expected.
- Consider all loan options given your business’s creditworthiness, financial position and the APRs on offer. A little legwork can save you and your business a lot of money.
- Read the terms of your loan carefully, and make sure to confirm whether the rate is fixed or variable, what variable rates are dependent on, and when they take effect.
Read more: Evaluating a Loan Offer
Read about other funding options in our Series on Fundraising:
