Finance

Looking for small business financing? Here are the challenges you’ll face.

Small Business Loan

As a small business owner, you may find that it is difficult to sustain a company without seeking outside financial assistance. At some point, you will probably need extra working capital to support the growth and expansion of your business.

If you are a small business owner who is looking for assistance in the form of borrowed capital, there are many options available to you. However, before pursuing a loan or any other type of funding, you should become familiar with some of the challenges that small business owners commonly encounter when seeking financing.

You do not have to be a financial expert to run a small business, but learning some aspects of money management will empower you to support your company’s financing needs. Anticipating certain obstacles, and knowing what it takes to overcome them, will put you at an advantage when it comes time to seek out funding. The following are the most common three hurdles that you may face when pursuing a loan or a line of credit for your business. 

Your Business Has No Credit History

The main reason that small business owners struggle to borrow capital is because the business is too new and has no credit history. This means that, whether or not your business is creditworthy, there is no past performance available for a lender to assess. Even if your business is well-established with years of success, it will be difficult to borrow money without a credit profile. 

Banks and other lenders must have a track record that they can use to validate creditworthiness, and they strongly favor businesses with a long history of credibility and success. Most banks prefer to evaluate at least several years of borrowing and repayment. However, there are some online lenders that will provide loans to qualifying businesses that have been operational for a minimum of just six months. Online lenders also have a faster application process and require fewer documents, which means you will have faster access to money. Some of these lenders even offer rates that are comparable to what you would get with a traditional bank loan.

Overcoming a lack of credit history is not a simple matter, but there are a few strategies that you can use to create a credit profile and demonstrate that your business is not a credit risk. One idea is to take advantage of trade credit, which is an agreement that allows you to receive merchandise or equipment from your distributors today and pay at a later time. You can set up a 30-day payment system with vendors, who will then report your performance to business credit bureaus. Trade credit is a great strategy that can help your business establish a positive credit report quickly.

Another way to help build your company’s credit profile is to apply for a business credit card. While business loans have strict requirements regarding credit history, business credit cards are usually much easier to obtain. For example, you will not need a lengthy record of business profitability to quality for a business credit card. Furthermore, your access to funding will be granted in a matter of days. The interest rates associated with credit cards tend to be higher compared to loans, but you can avoid these extra costs by paying your bill in full each month. 

You Are Struggling To Prove Your Ability To Cover The Debt

As a potential borrower, lenders will look into your business’s debt service coverage ratio, which is a measurement of how much revenue is available to pay the company’s current debt obligations. Online lenders usually have minimum monthly revenue requirements of around $10,000, while more traditional lenders such as banks may have revenue requirements that are much higher. 

If you are struggling to demonstrate that your business is generating enough cash to make monthly payments, it is not very likely that you will be successful in receiving a loan. However, this does not mean that you are out of options. For example, the Small Business Administration (SBA) has a microloan program that may provide you with a loan of up to $50,000 for business development or expansion, with an average loan of $13,000. In addition, there are nonprofit organizations who serve as microlenders with a mission of helping small businesses build credit.

Another option for financing your business is to raise capital by starting a campaign on a crowdfunding website. This is a particularly good choice if you have a unique product or service that could draw attention to a large number of investors. Successful crowdfunding campaigners use the same approach that you would use to attract angel investors or equity investors. They build a strong presentation to promote their business goals. Crowdfunding is advantageous because it can help you spread the word about your new business as you raise the money to finance it. Fundable is one example of a crowdfunding site that was designed specifically for small businesses. 

Furthermore, you may want to look into a source of financial assistance known as factoring. This option is contingent on how you bill your customers or clients. Monthly invoices, which are also known as accounts receivables, can be sold to a third party at a discount. Factoring may cost more than a financial solution that is offered by a bank, but it will provide you with immediate cash flow regardless of your credit profile. The factor usually takes over billing, so your customers’ credit standing becomes more important than the credit status of your company.

You Are Not Entirely Aware Of Your Company’s Financial Position

When you are trying to show a lender that you are qualified to repay your debts, it is extremely important that you are familiar with your company’s financial statements and what they mean. For example, cash flow is one of the most common metrics used for measuring cash that is coming and going from the company. 

According to a 2019 report from Guidant Financial, 33 percent of small business owners struggle with a lack of cash flow and consider it to be their biggest challenge. If you are not aware of how to measure and manage your company’s cash flow, this can be very detrimental to the future of your business. Poor cash flow management is also damaging to how you appear to a lender. Ultimately, uncertainty about your company’s financial health will make you an unattractive candidate for a loan. 

The best way to take control of cash flow management is to create a cash flow model by mapping the net amount of cash and cash-equivalents coming and going from the business. The model will allow you to analyze your business’s cash flow in the past and present, and can be used to forecast future cash flows. If your business has a limited history of performance, financial projections may give a lender more confidence in your ability to service debt. A cash flow analysis will give both you and your potential lender a better understanding of how much money you can comfortably pay back. A cash flow model will also be a major help when you prepare the company’s taxes.

If you are still not entirely sure about your business’s financial standing, it may be a good idea to invest in the help of an accountant or bookkeeper. A financial expert can analyze your reports to recognize trends and recommend profitable changes. It can be greatly beneficial to the financial health of your company to develop a long-term partnership with an accountant or other financial advisor. In addition, you can use accounting software to monitor and manage your cash flow. Some accounting software, such as GnuCash, has specific features for small businesses and offers free online access.

Common Lending Challenges Small Businesses Face

Other common lending challenges small businesses face include the following:

  • Fragmented market. There are a lot of specialty lenders offering capital financing options for specific small businesses niches. For small business owners, securing affordable financing, or getting financing at all, often requires finding the right niche lenders.
  • Different credit policies. Lenders have different credit policies making it hard for business owners to find to the right loan.
  • Credit worthiness is highly subjective. There are various factors lenders consider when determining the credit worthiness of a small business. The way lenders determine credit worthiness can be subjective, whereby creating confusion for how to qualify for financing.
  • Lack of financial awareness. Many business owners are not entirely aware of their financial position. They don’t know the strengths they offer or weakness they need to overcome to qualify for affordable financing.
  • Lack of organization. The loan application process and required paperwork can be cumbersome and time confusing for business owners that don’t have their finances properly organized.
  • Rejection. When a lender won’t qualify you for a loan they make it seem as if its your fault. Often, its the lenders stringent credit criteria or lending constraints that keep them from making a loan.
  • Over marketing. Lenders market loans to a large number of applicants in order to collect just a few loans. This creates confusion in the marketplace.
  • Lack of product awareness. Borrowers often are not aware of all of their financing options. Consequently, borrowers may accept a loan from any lender that will extend them credit.
  • Stopping at the first “No”. Borrowers often stop looking for financing after a lender denies them for credit. They erroneously believe if they’re denied by one lender they will be denied by all lenders. This isn’t true.
  • Emergency borrowing. Business owners seeking financing often make their loan seem like an emergency. This not only causes a lot of stress for the business owner, it can also worry the lender. Plan ahead and don’t try to force rush loans.

What You Need to Prepare a Loan Application

If you want to maximize your chances of qualifying for financing, you’ll need to include the following items in your loan application.

  • Loan Request Form
  • Management Resume
  • Personal Financial Statement
  • Last three years personal tax returns
  • Last three years business tax returns
  • Year to Date P&L and Balance Sheet
  • Description and History of Business
  • Schedule of Debt
  • Summary of Project Costs
James Hoffman
James is the current Senior Vice President of Commercial Lending at LENDBASE—a one stop shop for commercial credit with offices from New York to Seattle serving clients nationwide. He is also the more...
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