What to consider before applying for a small business loan


By Sam Tulp, former staff member; Para la versión en español de esta historia, por favor oprima aqui.

Do you have a great idea for a business? Or already own a business and are looking for ways to take it to the next level? A loan could provide the extra boost your small business needs.

However, before applying for a loan, ask yourself these questions. 

  1. Why do you need the money? What is that money going to help you accomplish? What is the purpose of this loan?
    Itemize how you’re going to spend every dollar that you’re going to be requesting. It’s really important that you’ve put some thought in beforehand as to how you want to use those funds.
  2. How will this loan help you grow your business? The purpose shouldn’t hopefully be just to keep doing what you are doing. You want to be looking to expand, to grow, to bring in new revenue streams.
  3. Can I afford this loan right now? Yes, you may want the money, but it’s important to make sure that taking out this credit isn’t going to stop you from what you’re currently doing. It’s going to supplement what you’re currently doing.

If you’ve already thought about those questions, it’s going to make the loan process a little bit easier. It’s going to make you look like you are on top of your business, that you are someone we want to give money to because you are professional, you are responsible, you are prepared.

Organizing ideas into a business plan

A good way to work through those questions is developing a business plan. Before reaching out and getting in touch with a bank or another loan entity, you should have some sort of business plan in place that helps organize and explain to other people all of the great ideas that you have about your business.

Putting those thoughts into a cohesive story is going to make selling your business easier to potential investors, lenders, even your friends and family. And, oftentimes your business plan will include a request for financing which gives you an opportunity to fully explain what you want the money for, answering those questions in a streamlined easy-to-digest way.

The Center for Rural Affairs and a number of other small resources will offer help in writing a business plan.

Gathering documents before applying for a loan

All lenders are going to have different criteria they look at when they assess a loan requisition. Document requirements vary by institution and by the size of the loan request. Generally, any lender is going to want to see some financial documents and business verification documents.

A good place to start is once again your business plan. From there, you can build out a profit and loss statement or a balance sheet, which are financial documents that give us a snapshot of the financial health of your business at that moment in time.

In addition, most lenders are going to want to see previous tax returns and bank statements—both on personal and business. Not only is the business asking for money, but you are going to be personally responsible. Oftentimes, there will be questions about your personal finances and being prepared will make those conversations easier.

You’ll also want to have available your assumed business name or articles of organization, depending on how you registered your business and what type of legal entity you are. You’ll want to make sure you have the proper licenses for your industry. For example, if you are a salon, you’ll want to make sure you are up to date with cosmetology; if you are working in a restaurant industry, you will want to make sure you are up to date with your food handlers and liquor licenses; and if you’re working in a day care, you’ll want to make sure you have the appropriate licenses there.

One thing I tell borrowers is document everything. Make sure you are keeping record of all of your business transactions, all of your business expenses. When we can see those things on paper, it’s easier to lend out to you in the future. And, it’s easier for you to track your growth over time. The purpose of getting a loan should be to grow your business. If you don’t know how your business is doing now, how will you know if that loan is improving your business down the line?

The larger the loan request, the more intensive the documentation may be. Sometimes, we’ve asked for as many as 3 years worth of tax returns just to show the business is consistent over time. There’s been increased documentation recently so we can see what the business looked like before the pandemic, and what it looks like now.

Ensuring you are loan ready, with best practices

Beyond asking yourself questions about affording the loan, what you need it for, and putting together your business plan, there are 5 things that you should do.

1. Prepare a business plan.
Make sure you are requesting the right amount of money, and that you have a plan for how you want to spend that money. There are a lot of resources available to help you build out your business plan.

2. Put together those financial documents.
There are a lot of resources available to small business owners, for example, I provide templates of what I ask for. And, you can find examples online.

3. Get to know your credit history before applying for a loan.
You should have an idea of any red flags. You should know what balances you are carrying, and there’s an easy way to do so. Visit annualcreditreport.com, a free government-backed website that allows you to pull your credit report once per year, free of charge, without dinging your credit in any sort of way. This is different than pulling your FICO score from your mobile banking app because it’s going to give you deeper information about each of your accounts. Once per year, you can also request a credit report from each of the credit bureaus directly, including TransUnion, Equifax, and Experian. If you get a full credit report from each of those agencies, you get one potentially every three months. That lets you keep up with how your credit is improving, changing, or hopefully staying the same.

4. Research before deciding where to apply.
There are a number of financial institutions and banks that are large, small, local, or national. Banks where you may already have an account or relationship. There are also community development financial institutions, like the Center for Rural Affairs. There are credit unions and grant opportunities. So, I think it’s important to make sure you are aware of all of those options. Take a look at interest rates and terms available to you. Reach out to those agencies beforehand. You can often get prequalified for a loan.

5. Consider the 5 Cs of credit.

  1. Do you have any collateral, including personal or business assets you can use to strengthen your case as a borrower? In case things go bad with the loan, you’re putting a little skin in the game. 
  2. What are current market conditions? During the pandemic, business was down, so maybe you’re not going to spend as much on inventory. Maybe you want to be thinking about other ways to strengthen your business, but you want to know what the market looks like at that time.
  3. What is your capacity? How much extra revenue do you have at the end of each month that you could be using to pay down a loan? And, if your business is not profitable, maybe it’s not a good time to take out a loan because you’re not going to be able to pay that obligation back.
  4. What kind of capital do you have? This is investing all of your assets. Take inventory of what you have available to you.
  5. Think about your character as a borrower. This is where your credit report comes into play. When I am working with borrowers, I want to see a good history of on-time payments for mortgage, rent, and bills. I want to make sure you are going to pay me back. Making sure you take care of any unpaid debts or any collections goes a long way to showing you are going to be a good borrower moving forward. 

Whether you are a starter business or a current business owner, these are some considerations you need to take before applying to a loan. And, there are many resources out there that will help you access and compare. We at the Center for Rural Affairs will help you get ready whenever you need it.

Feature photo: Veronica Reyes, Center loan specialist, assists a loan client with documents.  |  Photo by Kylie Kai