Seven factors for small business owners to consider.

1. The Loan Amount

The loan amount should include the funds needed for both hard costs and soft costs.

The hard costs would include real estate, equipment, inventory, and the soft costs may include payroll, marketing expenses, insurance, licensing costs and other miscellaneous expenses.  Sometimes it is beneficial to consolidate the soft costs and identify them as working capital.

Make certain the loan amount is adequate to cover all the closing costs and all operating deficits.  You may have to prepare cash flow projections to determine the funding requirement if an operating deficit is expected during the first few months of the loan term.

2. The Interest Rate

How do you know that the rate that is offered is a favorable market rate?

There is no simple answer to that question since a quoted rate is usually determined by risk.  If the borrower has a qualifying FICO score of 680 or higher, the interest rate may be lower than the rate quoted to a potential borrower with a low FICO score.

Some lenders will deny funding based on a credit score that is unacceptable. A borrower seeking funding should address the credit score requirements prior to submitting a loan request and see what can be done to bring the FICO score up to the required score for a favorable loan interest rate.

In addition, the rate charged will be determined by the borrower’s experience in the industry.

Some types of businesses are considered low risk – i.e. medical professionals, and other businesses are consider high risk – i.e. restaurants.

3. A Fixed Rate vs Variable Rate Loan

Some lenders will offer funding with a fixed interest rate for the loan term or for a portion of the loan term.

Other lenders will only offer variable rates that adjust with changes in the index that they use to adjust the loan rate. The lender’s rate structure is usually determined by the lender’s policies and the type of financing requested.

Loans with SBA guarantees can offer longer term loans, usually with fixed rates for at least 5 years.  A portion of SBA loans can be fixed for the entire loan term.

4. Loan Fees

Many loans have closing costs and loan fees.  And, there may be additional fees required for loan extensions and prepayment privileges?

Fees can be amortized over the term of the loan. Therefore, the shorter the loan term, the more impact fees will have on the financing costs.

5. The Loan Term

Many businesses would prefer a line of credit to a term loan, but lines of credit are not available for start up businesses or businesses with less than two years of operating history. Young businesses will be offered term loans that do not extend beyond the term of the lease for the business operations.

A prospective borrower should ascertain that the term of the loam matches the term of the intended purpose of the loan.

WARNING!  avoid using a credit card to pay for a long-term investment such as machinery, real estate, or vehicles.

6. The Loan Guarantee

In almost all cases the shareholder who own 20% or more of the borrowing entity will be required to guarantee the loan.  Lenders that provide funds for the purchase of equipment will also require UUC filings. 

7. The Unknowns

• Loan underwriting requirements

The loan documents required by each lender vary. Lenders that simplify the underwriting process and do not request historical information on the company and the guarantor(s) usually charge higher rates. These loans often require automatic weekly payments of debt service from a corporate bank account.

• The time required for loan processing and closing

Payday lenders and factoring companies are known to close loans within a few days.  Traditional lenders that provide lower interest rates and various loan structures take longer to underwrite and close loans. If borrowers keep their financial information current and allocate the time that is needed for approval, they will be able to secure the most favorable loan terms.

WARNING! Always read the small print in an agreement.  You may need a magnifying glass to enlarge the print to make it readable, but it is worth the effort. The small print usually contains the unfavorable terms of the agreement.

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