Things to know before applying for a small business loan in 2024

Small business loans are the lifeblood of many entrepreneurial endeavours, serving as a critical catalyst for growth, expansion, and the fulfilment of various business initiatives. In the contemporary financial landscape, entrepreneurs are presented with a plethora of business loans for startups, each tailored to specific needs and circumstances. 

This diversity arises from factors such as the nature of the small business funding need, the credit profile of the business, the duration of its operation, the availability of collateral, and other pertinent considerations. While traditional sources like local banks remain stalwart providers of small business loans, a nuanced understanding of the evolving financial terrain reveals a spectrum of alternative lending avenues that could potentially offer a more tailored fit for diverse business requirements.

1. Traditional term loan at the bank

A quintessential small business loan that often springs to mind is the traditional term loan offered by local banks. This type of loan is akin to the conventional mortgage or car loan, with a specified repayment period typically spanning four, five, 10 years, or even longer. What sets business loans for startups apart is its versatility—it can be employed for a myriad of business needs, ranging from acquiring real estate to purchasing equipment. The repayment structure follows a familiar pattern, involving periodic payments encompassing both interest and a portion of the principal balance.

This traditional approach holds particular resonance in the context of small business loans. Many entrepreneurs naturally gravitate towards their local bank for working capital loans, driven by established relationships, pre-existing business accounts, and perhaps even personal connections with the bankers. This familiarity often positions the local bank as the initial port of call for businesses embarking on the quest for a small business loan.

2. Collateral for loans

One crucial aspect of small business loans, especially those procured from traditional banks, is the requirement for collateral. Collateral serves as a security measure for lenders, mitigating their risk in the event of a borrower default. The collateral itself could be the asset the loan intends to finance—such as a piece of equipment or real estate. Drawing a parallel from the consumer lending sphere, this practice mirrors the collateralisation of an auto loan, where the purchased car serves as collateral until the balance is fully settled.

Moreover, lenders may stipulate the necessity of insurance for the asset purchased using the loan proceeds. This additional layer of protection ensures that the value of the asset remains safeguarded, with any associated costs for insurance potentially added to the overall small business funding balance.

3. Bank term loan rates and fees

Understanding the intricacies of interest rates and associated fees is paramount for businesses navigating the working capital loans landscape. The interest rate charged by a bank is contingent on various factors, including the current index rate (such as the Prime Rate, LIBOR, or the Treasury Rate), the perceived credit risk posed by the loan, and the chosen length of the loan term. Small business loan interest rates can either be fixed or variable.

A fixed rate remains constant throughout the term of the loan, offering stability regardless of market fluctuations. This stability becomes advantageous during periods of low interest rates. On the other hand, variable interest rates are tethered to an interest rate index, subject to changes in the bank's cost of capital. Opting for a variable rate entails an agreement based on the index coupled with a defined interest margin. This flexibility means that the interest rate can fluctuate throughout the loan term, mirroring shifts in the lender's cost of capital.

Comprehending these nuances, including the Annual Percentage Rate (APR), aids businesses in comparing small business loan options effectively. APR comprehensively reflects the interest cost and fees expressed as an annual percentage rate. While APR facilitates comparison shopping, it is essential to consider it alongside the total cost of working capital loans. This holistic evaluation becomes particularly pertinent when comparing loans with disparate terms, ensuring a nuanced understanding of the overall financial implications.

Why would a term loan make sense?

Amidst the myriad small business loan options available, the traditional term loan from a bank retains its appeal for businesses meeting the requisite criteria. One compelling reason is the potential for lower interest rates, making it an attractive proposition for borrowers. This type of small business funding is well-suited for specific high-cost purchases that promise enduring value to the business over an extended period.

How to apply for a term loan

The quest to secure a term loan from a bank entails a meticulous application process. Businesses must furnish specific information about the business and its owners. While the precise requirements may vary between banks, businesses should be prepared to provide additional information as the review process unfolds.

Key documentation that banks commonly request for business loans for startups include:

• A comprehensive business plan outlining the purpose of the loan, the intended use of proceeds, and the anticipated benefits to the business.

• Business financial statements for the preceding three years encompassing balance sheets and profit and loss statements (P&L).

• Tax returns for both the business and its owners over the past three years.

• A debt schedule detailing existing financial obligations.

• Personal financial statements for all business owners.

• Lease agreements for business premises, if applicable.

• Financial projections spanning three years, elucidating expected revenue, expenses, and the operational mechanisms facilitating loan repayment.

• Owners of businesses and key employees should all have resumes.

• Information pertinent to the assets earmarked for purchase, including sales contracts or purchase agreements where applicable.

Moreover, the bank offering working capital loans inspects both business and personal credit profiles through relevant credit bureaus. Consequently, businesses should proactively familiarise themselves with the information reported in their personal and business credit profiles.

The typical turnaround time for a bank term loan can extend over several weeks. However, businesses can expedite this process by ensuring all requisite information is readily available and by responding promptly to any additional information requests from the bank offering business loans for startups.

Final words

In essence, navigating multiple types of small business loans demands a comprehensive understanding of the available options in working capital loans, repayment structures, collateral requisites, and application procedures. While the local bank remains a steadfast ally in this financial journey, exploring prominent loan types by Margadarsi chit fund ensures that businesses can choose the option that best aligns with their specific needs and financial aspirations.