Why Do Small Businesses Need Loans? Using Loans to Stimulate Small Business Growth
As a business owner, you have several options when it comes to getting financing for your company. You can use your own savings to support your business. You can find investors to give you money in exchange for an ownership share in your company. Or, you can apply for a business loan from a bank or another type of financial institution. You may be wondering if you have to pay back small business loans. When your business takes out a loan, it is responsible for paying back the amount borrowed, plus interest, on a set schedule.
Is it a good idea to take out a business loan? Depending on your company’s goals and current financial situation, the answer might be “yes.” Business owners must ask themselves how they’ll finance business growth and what other areas may require additional capital.
What Do Small Business Loans Cover?
Getting a small business loan can provide your company with the funding it needs to get started, expand or cover day-to-day expenses. Compared to other financing options, there are some benefits to a business loan. If you are not sure if a loan is right for your company at the moment, learn more about smart reasons to get a business loan, the advantages of doing so and the loan options available to small businesses.
Why Do Small Businesses Need Loans?
Why should you get a business loan? The reasons a business needs a loan range from getting the company up and running to allowing it to grow profitably. A loan can help your company achieve its goals or provide the financial cushion it needs to take the next steps. If you aren’t sure whether taking out a loan is the right move for your business, consider some of the more common reasons companies apply for financing.
1. To Help With Expansion
Expansion can take many different shapes. For some companies, expanding means opening up a new retail location in a different part of town, a different part of Pennsylvania or in a different state entirely. For other companies, expansion can mean renting more office space and hiring more employees. In some cases, expanding means introducing a new product or service.
What each example has in common is that all of them typically require cash to get going. If you want to open a new brick-and-mortar location, your business will need financing to rent the building, purchase furniture for it and stock up on inventory. If you need more office space, your company also needs to pay the rent and the salaries of the additional team members. You might need funds to conduct research or create a new product or service.
Before your business takes out a loan for expansion, it’s a good idea to run the numbers to see if this type of growth will increase your revenue. Ideally, you will be able to pay back the loan with ease after your company has opened a new location or added a new product line.
2. Establish an Emergency Fund
Emergency funds aren’t only for personal use. Having cash in a savings account to cover unexpected expenses is also a good idea for businesses. In many instances, cash reserves can be what helps a business survive from one year to the next. If your company has a lean period or if business drops off, you can tap into your emergency savings to keep things afloat until business picks up again.
Getting a business loan can be the quickest way to build a decently-sized business emergency fund. Instead of having to tap into your own personal savings or put away a small amount over several months and years, you can start with a fully-funded emergency account, paying back the loan with your company’s earnings each month.
3. Manage Your Company’s Cash Flow
Cash flow refers to the way money travels to and from your business. When customers make purchases or clients pay for services, cash should flow in. When your business pays its invoices and bills, cash flows out. Ideally, your business will have a positive cash flow, meaning more cash comes in than goes out. That doesn’t always happen, though.
If you operate a seasonal business, you might have the same bills due year-round but might not have the same revenue all year. A loan can help balance your cash flow situation. Depending on how much you borrow, the loan can provide the cash you need during leaner months to keep up with bills or make investments in your business, such as buying more equipment.
You’ll want to keep a few things in mind if you are considering using a loan to manage cash flow. One is that you want to be sure you will be able to repay the loan and the interest due without difficulty. Your company should already be profitable. If your company isn’t earning a profit, you might want to consider another type of financing, such as investor funding, instead.
4. Keep an Ownership Stake in Your Company
Speaking of investor funding, it is a way to get financing for your business that you will not need to pay back. There is a caveat though. When you bring on an investor or a team of investors, you give them a stake in your company. Depending on the number of investors you partner with, and the size of the ownership stake they receive, you might end up owning just a small share of your business. When it comes time to make important decisions, you might have less of a say in how the company operates or in the direction it takes.
If you would like to retain as large a stake in your business as possible, using a loan to fund its growth can be the better option.
5. Purchase Equipment and Inventory
Your company might need new equipment to make its products or continue to offer its services to clients. If that is the case, you typically have two options: buy or lease the equipment. Buying equipment brings with it tax benefits, such as getting to deduct the expense from your business income. A loan can help your company afford the upfront cost of the equipment.
Before you take out a loan to buy new equipment, consider the benefits of the purchase. Will you be able to manufacture more of your product or offer your services more quickly because of the purchase? Run the numbers to see if the revenue and profit you stand to earn will be more than the cost of the loan.
It might also be the case that your business needs to purchase a lot of inventory, all at once, and it might need cash to help cover the cost of the purchase. Since your company will earn revenue by selling the inventory, it can make financial sense to use a loan to cover the upfront cost of the purchase.
6. Build Business Credit
One last reason why getting a small business loan might be a good idea is that applying for and getting approved for a loan, then repaying the loan according to the terms can help your company establish a solid credit history. The better your business credit, the more likely it is to be approved for loans in the future, which can help it continue to grow and reach its goals.
What Are the Advantages of Small Business Loans?
You might be hesitant to apply for a business loan, as getting the loan does involve some risk. Your business will need to pay the loan back with interest. Depending on the type of loan and whether it has collateral or not, your company might lose property or equipment if it cannot repay the loan. For many companies, though, the advantages of a business loan outweigh the risks. It is important to consider the advantages of small business loans and determine if a small business loan is the right option for your business.
Some of the benefits of a business loan include:
- Loans let you retain ownership of your company: When it comes to comparing the advantages of business loans vs. selling equity, business loans can come out on top, as they let you retain an equity stake in your business. Retaining ownership of your company is important, especially after you’ve poured a lot of effort and energy into building it up. You don’t want to give up that ownership just as your company is starting to turn a profit or as it grows and increases its profitability.
- Loans help your business grow: Whether your plan is to hire more employees, expand into a new market, offer new products or grow an existing location, your business needs cash to do so. A business loan will cover the upfront costs of expansion, allowing you to pursue profitable growth.
- On-time payments raise your credit score: Like individuals, businesses have credit scores. And, just like individual credit, the more business credit you have, the more likely you are to be approved for a loan. When your company is just starting out, it can be more challenging to get a loan, but once you get the loan, making on-time payments will strengthen your company’s credit history and raise its credit score. The higher your company’s score, the more credit opportunities will become available to it.
- Many different types of loans are available: If you are considering a business loan, you are not locked into a single option. Several types of loans are available to small businesses. The type of loan that works best for your company depends on its needs and goals. A business line of credit can be an appropriate choice if you are not sure how much you need to borrow or if you want the flexibility to borrow as you go. If you have a specific purchase in mind, such as a new building or piece of equipment, a commercial installment loan might be right for your business.
What Types of Loans Are Best for Small Businesses?
The type of loan that is best for a small business depends on several factors. The first is the company’s credit history. The second is how the business plans to use the loan, and the third is the amount the company wants to borrow. Weigh the pros and cons of different types of loans for small businesses:
- Commercial loan: A commercial loan can help your company purchase new equipment, buy or lease a property or purchase inventory. You can also use the loan as a working capital loan. Financing options, such as interest rates and loan terms, can vary depending on your company’s credit history. Standard commercial loans are typically available to businesses that have an established credit history.
- Commercial line of credit: A line of credit is an example of a revolving loan, similar to a credit card. You receive a credit limit, and you can borrow as much or as little as you need, up to the limit. You can use the money in the line of credit for various reasons. Typically, a line of credit is valid for 12 months and offers the option of renewal at the end of the 12-month period. It can be a good option if you have flexible borrowing needs.
- Small Business Administration (SBA) loan: SBA loans are guaranteed by the U.S. SBA and are designed to provide businesses that do not have other funding options with the financing they need. Since the SBA guarantees the loans, lenders can offer them to businesses that might not have established credit histories. The loans are available for several reasons and for a wide range of amounts.
- Microloan: A business that only needs to borrow a small amount might consider a microloan, which can be for up to $50,000, but is usually for much less. The average microloan amount is $13,000. Although many microloans require collateral, they cannot be used to purchase property.
As a local community bank, Mid Penn Bank can discuss your business financing needs with you and help you choose the loan option that will work best for your company.
Best Small Business Loan Tips
If you are considering applying for a loan, follow these tips for getting small business financing:
Have a Written Business Plan
Whether you are applying for an SBA loan or a conventional commercial loan, your lender will likely want to see a written business plan. Having a written plan for your company is a good idea in general, whether you are trying to get financing or not. The plan allows you to map out the next steps for your company and can help you make decisions about what to do. Your business plan should have multiple sections, but the section that will be of most interest to a lender will be the financial part. Include details of your company’s earnings and expenses, your company’s cash flow statement and your plan for repaying the loan.
Only Borrow What You Need
Even if the lender offers you a loan that is considerably higher than you anticipated or you receive a line of credit that is worth more than you need, it is usually in the best interest of your business not to borrow more than is necessary. You want to minimize the chance of getting too deep into debt.
Have a Repayment Plan
Before taking out a loan, check your company’s budget to see how the monthly payments will work. Will your company need to cut some business expenses or make adjustments to afford to repay the loan? How much will monthly payments be and how long will it take to pay off the loan?
Have a Goal for Your Business Loan
Know why you are borrowing money for your business and what you will put the funding towards before you start a loan application. Having a purpose for the financing will make your loan application stronger, as your lender will want to know exactly how you plan on using the money and why you are applying for a loan. Knowing how you intend to use the financing will also help you narrow down your loan options. If you need it to purchase inventory, a line of credit might be a better choice compared to an installment loan. But if you are planning on buying property or equipment, an installment or SBA loan can be the better pick.
Keep Business and Personal Finances Separate
Although nearly 22% of small business owners use personal savings to fund their companies, a safer option is to keep business finances and your personal finances separate. When you borrow money for your business, there is a risk that the company will not be able to pay back the loan. If the loan is your name, your personal credit score could drop if your company defaults on the loan. You could also lose personal property if you combine business and personal money matters. It is not uncommon for business owners to put their home or other property up as collateral on a business loan, meaning a lender could repossess the house if the business falls behind on payments.
Pay Attention to Interest Rates
Interest is the cost of getting a loan. The rate your company is offered depends on its credit history and the type of loan, as well as the repayment term and the amount of loan. Often, the less you borrow, the higher the interest rate, but getting a lower rate isn’t exactly a good reason to borrow more than you need to.
Focus on Building Business Credit
The longer your company stays in business, the more opportunities it will have to grow. As it grows, it is likely to need financing from time to time. Focusing on developing your company’s credit from an early stage will help to ensure that it has the reputation required to get the funding it might need in the future. Building up your business credit will do more than help your company qualify for loans. The higher your business credit score, the lower the rates on business insurance. Building up your business credit also makes it easier to keep your personal and company finances completely separate.
Work With Mid Penn Bank When You Need Small Business Financing
A small business loan can help your company reach its goals and pave the way for profitable growth. Whether your company qualifies for an SBA loan program or you are interested in a line of credit or conventional commercial loan, Mid Penn Bank is here to help. We offer a variety of business loans and are an SBA Preferred Lender.
We work with companies across Central Pennsylvania, in many different industries. Contact us today to learn more about our business loan options and to get started on the path to successful business growth.
The material on this site was created for educational purposes. It is not intended to be and should not be treated as legal, tax, investment, accounting, or other professional advice.
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