Securing Financing for Your Small Business
Applying for a loan can be a stressful experience on any given day, but is especially so now, as more and more business are facing financial hardships as a result of the COVID-19 pandemic. Though the Paycheck Protection Program has provided the largest stimulus ever for small businesses, with 30 million businesses eligible for loans under the program, applying for these loans has proved challenging, especially as the authorized funds are quickly exhausted.
To improve your business’ chance of obtaining the financing it needs during this difficult time, consider these PPP loan alternatives.
What Are Your Small Business Financing Options?
Small business owners have a variety of creative financing options to keep their businesses well-funded and operating smoothly. Traditional lenders have expanded their application processes to approve business funding that would have been rejected in the past, and other nontraditional lenders are taking advantage of emerging technology to offer financing in ways that weren't prevalent even 15 to 20 years ago.
Business owners should research solutions that apply to their unique business and industry, but most small business financing options can be grouped into the following categories:
- Term loans
- SBA loans
- Main Street Lending Program options
- Business lines of credit
- Personal loans
- Merchant cash advances
- Equipment loans
1. Term Loans
The traditional loan process involves securing a term loan from a bank. Funds from term loans are borrowed under very specific terms at the outset. The bank outlines in the loan contract the interest rate at which the funds are borrowed and the repayment schedule that the borrower must adhere to. Any deviation from the terms typically results in penalties and additional interest. A borrower who can no longer adhere to the terms may also have to refinance the loan under new terms or face serious damage to their business credit. Depending on the amount financed, loans can be either short-term or long-term.
Long-term loans are a type of traditional term loan that is expected to be repaid over a year or longer; most long-term loans are generally issued for periods between three and 10 years. Long-term loans typically have lower interest rates than short-term loans, which is due to more stringent credit and approval requirements associated with long-term loans. These loans are more difficult to obtain, and the longer repayment schedule allows lenders to recoup a significant amount in interest, even at a lower interest rate. Borrowers can also secure more capital through a long-term loan, so they are ideal for well-established companies that need large amounts of capital for major projects or purchases.
Short-term loans are another type of traditional term loans, but these are generally expected to be repaid within a year or less. Short-term loans have less stringent credit and income requirements, but these can come at a cost. Short-term loans have higher interest rates and less flexible repayment options. These loans are ideal for businesses that need a modest amount of capital quickly.
2. SBA Economic Injury Disaster Loans (EIDL)
The Economic Injury Disaster Loan (EIDL) and EIDL Advance Program provides low-interest federal disaster loans and advances for eligible businesses that have been negatively impacted by COVID-19.
At this time, the SBA is only accepting new EIDL and EIDL Advance applications from U.S. agricultural businesses due to limitations in funding availability. Thus, non-agricultural businesses are temporarily ineligible for EIDLs and associated grants. Agricultural businesses are defined as “businesses engaged in the production of food and fiber, ranching, and raising of livestock, aquaculture, and all other farming and agricultural related industries” (section 18(b) of the Small Business Act (15 U.S.C. 647(b)).
All businesses who have already submitted their applications will continue to have their application processed on a first-come, first-served basis.
If additional funding becomes available, businesses must be located in a federally declared disaster area and be able to prove economic injury that’s resulted in a shortfall in revenue, (backdated to January 31), in order to be eligible for the loan. This will allow businesses to show their injury beginning in February or March. However, certain types of entities, such as businesses in the cannabis industry, are exempt from the program entirely.
How much can businesses borrow as part of the program?
The SBA is offering up to $2 million in assistance to eligible businesses as part of its EIDL program. Loans may be used to pay fixed debts, payroll, accounts payable, and other bills that can’t be paid because of the coronavirus’ impact. The SBA is offering loans with long-term repayments to keep payments affordable, up to a maximum of 30 years. Terms are determined on a case-by-case basis, based upon each borrower’s ability to repay. Currently, the SBA is offering the option to defer payments in the first year, although businesses that choose to do this should note that interest would accrue during this time.
How do you apply for the EIDL program?
The SBA has a 3-step application process, which businesses can take advantage of in the event additional funding becomes available:
- Applicants should check to see if they are in an eligible disaster area at: https://disasterloan.sba.gov/ela/Declarations/Index.
- Businesses can then register and apply online at: https://disasterloan.sba.gov/ela/Account/Login
- The status of your loan can be checked on the same site where you registered. The turnaround time is generally less than four weeks, but this could vary given current circumstances and expected high volume.
As part of the application, businesses are also required to submit IRS Form 4506, which will allow the SBA to access their tax returns. The SBA will also check the business’s credit, but it’s important to note that they aren’t looking for a spotless record. Instead, they’re looking for assurance that the business can afford to pay off the loan.
It’s highly recommended that businesses apply online, rather than using the paper form. Online processing will be faster, and allows the business to receive automated status updates.
If you experience any service issues, you can reach the SBA disaster assistance customer service center at: 1-800-659-2955 or via email: firstname.lastname@example.org.
3. Main Street Lending Program
The Federal Reserve established a Main Street Lending Program to support lending to small and medium-sized businesses that were in sound financial condition before the onset of the COVID-19 pandemic. The program will operate through three facilities: the Main Street New Loan Facility (MSNLF), the Main Street Priority Loan Facility (MSPLF), and the Main Street Expanded Loan Facility (MSELF).
U.S. businesses may be eligible for loans if they meet either of the following conditions: (1) the business has 15,000 employees or fewer; or (2) the business had 2019 revenues of $5 billion or less. The program also has special exceptions for non-profits organizations.
Loans issued under the program would have a four-year maturity, and principal and interest payments on the loans will be deferred for one year. Eligible lenders may originate new loans (under MSNLF and MSPLF) or increase the size of (or “upsize”) existing loans (under MSELF) made to eligible businesses.
As of May 6, 2020, the program is not yet operational. Once the program is operational, small and medium-sized businesses interested in the applying for loans through the program should do so from an eligible lender. A description of eligible lenders can be found in the program term sheets. For more information about the Main Street Lending Program, click here.
4. Business lines of credit
While traditionally structured loans may work for many businesses, some companies may be looking to secure funds that may not be needed immediately. If your business needs more flexible funding options, a business line of credit may be ideal. Business lines of credit are opened for a certain amount — $100,000, for example — but the business may draw upon those funds as needed. Once the line of credit is opened, the monthly payments and interest are determined based on how much of the open line of credit is used. This small business financing option is ideal for companies wishing to improve cash flow management or be better positioned to handle surprise expenses.
5. Personal loans
Personal loans are structured much like business loans and have similar interest rates and application processes. But using a personal loan to finance your business is a fairly non-traditional approach to securing the capital you need. Nevertheless, there are some circumstances where a personal loan can be helpful, namely if your business is relatively new and can't provide income history, or if your business credit is not well-established. In these cases, you may want to consider using your personal credit history to get your business off the ground. However, use this option with caution, as the loan will be tied to your personal credit history, which allows lenders to come after your personal assets if the business can't repay it.
6. Merchant cash advances
If your company has consistent, documented income and a large portion of your income comes from credit card transactions, you may want to consider a merchant cash advance. Under this arrangement, a financing company provides you the cash needed and takes a portion of your daily credit card sales in return. Merchant cash advances typically offer a quick, easy approval process and less stringent credit and documentation requirements. Repayment is also painless, since it's typically automated through your credit card processor. Unfortunately, these advances are usually limited to $250,000 or less, making them undesirable for businesses looking to fund large projects. Companies should also expect to trade the easier application requirements and quick approval process for higher loan fees and less flexibility for refinancing.
7. Equipment loans
Companies in a variety of industries will need to purchase, upgrade, or replace equipment at some point during the lifetime of their business. Heavy machinery in the construction or farming industries, large medical devices, restaurant ovens, or commercial vehicles can all cost well over $100,000, making these purchases a severe burden on company cash flow. Equipment loans can help companies secure the equipment needed to continue business operations without allocating all the funds necessary for the new equipment up front. Equipment loans typically require a 20 percent down payment, and the repayment terms vary depending on the amount financed.
Different Lender Options Available for Financing Your Small Business
1. Financing through a big bank
According to a recent article in Forbes, big banks' approval rates for small business loans reached record highs of 27.3 percent in March 2019. But the types of loans granted by large banks may not be a good fit for every small company. Big banks provide solid financial backing and often become a trusted partner for growing companies.
2. Financing through institutional lenders
When shopping around for business financing, institutional lenders may not be the first funding source that comes to mind, but organizations such as insurance companies, hedge funds, and other non-bank lenders are increasing their small business loan volumes. Many lenders in this category offer attractive terms and longer payback periods than traditional banks.
3. Financing through small banks
For a more personalized approach to lending, try a local community bank. Often, the lending officers will take the time to get to know their clients personally. Small banks and credit unions also offer other helpful services to small business owners, such as checking accounts, business credit cards, and merchant services.
4. Financing through SBA loans
The core SBA loan program is the 7(a) loan program. Through this program, the SBA will guarantee loans up to $5 million, with no minimum amount. SBA 7(a) loans can be used for all business purposes, including working capital, real estate, equipment, and inventory. There are also specialized programs available under 7(a), such as the CAPLines program, which is frequently used by construction companies, seasonal service businesses, and manufacturers. CAPLines provides financing for the seasonal buildup of inventory or materials needed by companies in these industries.
5. Financing through an internet marketplace
The internet has increasingly become a source of business funding. Peer-to-peer lenders pair private investors with small businesses in need of financing. Newer lending companies are assessing small business risk by creating their own models, which differ from the typical credit scoring models used by banks. Online lenders also tend to offer smaller loan amounts and more flexible repayment terms along with quicker decision times, faster loan closings, and better customer service throughout the loan process.
As with any lender, it's critical to read the fine print carefully to understand the process, fees, interest rates, any prepayment penalties, and liens on your business assets. To compare options, use a resource center for small business loans that allows you to see online lenders for various types of loans, special circumstances (veteran status, for example), or types of businesses.
Looking for additional support on how to navigate disruptions caused by the COVID-19 pandemic? Visit our Coronavirus (COVID-19) Help Center for more information and updates on financial assistance, workplace health, business continuity, payroll processes, health insurance, financial assistance, new legislation, and more.