How do business loans work?
From application and approval to fees and rates, this is everything you need to know about business loans.
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Most businesses need loans, but that doesn't mean business financing is simple. There are a number of finance options available and it's important to understand what these choices are so you can pick the one that will work best for your business. This guide will take you through what you need to know.
What types of business loans are there?
There are a number of different types of business loans, but each of these can be split into two main types of finance: equity finance and debt finance. Equity finance is money that is sourced from within the business or from an investor and doesn't need to be repaid. Debt finance is money that is borrowed and needs to be repaid. Here are some examples of equity and debt finance:
- Angel investors
- Venture capitals
- Initial public offering
- Investments from family and friends
- Private investors
- Government grants
- Loans from banks
- Loans from standalone business lenders
- Invoice factoring
- Loans from family and friends
How do interest rates and fees work on business loans?
There is no standard cost structure for business loans. It depends on the type of business loan you have, such as whether it's a line of credit or term loan, and on the lender. Here are the costs to look out for:
- Interest rate. This is usually charged as an annual rate but may also be charged daily. Check to see whether the interest rate will be charged on your principal amount or on the loan balance. Business lenders may charge an interest rate or a factor rate.
- Fees. These may include daily, monthly or annual fees for the administration of the loan. They may be expressed as a dollar amount or as a percentage of what you borrow. You may also be charged application fees.
How do you know if your business is eligible for a loan?
Lenders have different criteria to determine whether you are eligible for a loan. These can include the following:
- Time in operation. How long you have been operating is one of the main deciding factors in whether you will be approved for a loan. Many lenders will not approve startups for business loans, so you will need to find lenders that specialise in startup finance or turn to equity funding such as venture capital or government grants. Other lenders have minimum operating times that start around the 6-month to 12-month mark.
- Turnover. Your business's profitability has a huge effect on the amount you can borrow. Some newer lenders will allow you to borrow a certain percentage of your business's average turnover, for example, and most online lenders require you to connect your business accounting software when you apply.
- Business plans and the purpose of the loan. You may have to talk to a business loan manager to discuss your business plans and how you want to spend the money. Cash flow projections, past business performance and profitability may be a part of the lender's decision.
- ABN/ACN. You will need a current Australian Business Number (ABN) or Australian Company Number (ACN) to be eligible for the loan.
- The credit profile of the directors. The CEO/s, founder and directors will generally need clean credit histories to be eligible for a business loan. However, you can find bad credit business loans.
- Existing debt. What debt are you currently repaying and what type of debt is it? For example, if it is a credit card debt, it will be looked at differently than if it is a loan debt. The same goes for a line of credit.
What to expect when you apply for a business loan
The applications for a business loan are generally online, but you can also choose to apply in-branch if the lender offers those facilities. Here is what to expect.
- Gather your financials. Once you've double-checked the business loan and are sure you're eligible and the loan is right for you, you'll need to start gathering your documentation. The lender should have a list of what you'll need, and we also list required documents on finder review pages. Generally, you'll need your accounting information (if the lender is online, it may just need to be able to plug into your software), your cash flow (past, current and projected), details of your individual income and your ID.
- Submit all your details. Go through the application process and ensure all the details are entered correctly. If you have trouble at any stage, get in contact with the lender directly.
- Wait for follow-up. Even if the lender is online, a business loan manager may complete the application process over the phone. Make sure you have your phone on you over the next few days.
What happens if you're not approved?
Not all lenders can provide specific feedback as to why your application was rejected, but you can always ask for more information. If they cannot provide additional feedback, you may want to review your application to see if there are any red flags such as applying for excessive finance, missing information or not providing sufficient documentation. Common rejection reasons include bad credit listings, so make sure you check your personal and business credit reports, cash flow issues or insufficient security.
If you're not approved, there are other options available. Make sure you compare your other options thoroughly before applying again.
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