If you’re opening a new franchise, you’ve probably already gone through tons of meetings, paperwork, and expenses. How can you expect to keep financing your franchise when you’re already tapped out?
The answer is a small business loan. This article will walk you through the basics of a small business loan, including where to get one and what to look for before you sign up.
What is a Small Business Loan?
Small business loans give business owners access to capital (cash) so that they can fund business operations, make a major investment, or cover unforeseen expenses.
Small business loans can also help people start a new business. Many new franchise owners don’t have all the cash they need to start their business — besides the costs of setting up a business, franchise owners need to be prepared to cover operations costs for the first few months after opening for business.
Where Can I Get a Small Business Loan?
If you’re looking for a small business loan, there are three places you should try:
- Banks: Banks have been the traditional source of small business loans for generations. The first place to try getting a small business loan is with the bank that manages your business’s checking account. Banks can offer the best deals on a loan if you have an established relationship with them and can show that your business is doing well. However, banks are notoriously slow to process paperwork, so you’ll need to look somewhere else if you’re in a hurry.
- Small Business Association (SBA): The SBA doesn’t directly offer loans, but they do agree to back loans. In other words, if your business can’t pay off the loan, the SBA agrees to pay the lender what you owe. This makes lenders much more willing to offer you favorable loans. The SBA also partners with lenders around the country so that you can find the best loan terms.
- Online Lenders: There’s been a surge of online small business lenders that offer quick loans. Compared to bank loans, online lenders don’t offer the best terms but might be the solution if you need the cash really soon.
What Can I Use a Small Business Loan For?
A small business loan can be used for just about any business expense, from equipment upgrades to hiring a business process outsourcing company (BPO). Keep in mind that SBA loans cannot be used for personal expenses or to purchase personal property. For example, you can’t use an SBA loan to buy a company car in your name, even if you use the car for business. If you get an SBA loan, keep detailed records of how you use the money.
What’s in a Small Business Loan Agreement?
Just like with an insurance policy, there are 5 key parts of a small business loan agreement that you should read extra carefully:
- Down payment
- Collateral
- Loan terms
- Covenants
- Personal guarantee
Let’s explore each of these in more detail.
1. Down Payment
If you’ve taken out a mortgage or financed your car, then you’re already familiar with down payments — an amount of money you agree to pay the lender before they cover the rest of the loan. Different lenders require different down payments, but they’re typically 20%–30% of the loan value. Some loans offered by the SBA only require as little as a 10% down payment.
If you default on your loan, then you’ll forfeit your down payment.
2. Collateral
Many lenders also require collateral before granting you a loan. Collateral is an asset owned by your business that the lender can claim if you don’t repay the loan. The idea is that the lender can then sell your collateral to try to get the rest of the loan back.
Collateral can include tangible assets like real estate, cars, inventory, or equipment. However, lenders can also accept future income (your accounts receivables) as collateral. What’s important is that your business fully owns the collateral. So, if your business wants to offer property as collateral, you need to have paid off the mortgage and be up to date on your property taxes.
3. Loan Terms
The loan terms lay out the total loan amount, interest rate, administrative fees, and the repayment schedule.
Always repay your loan on time. Keep in mind that, unlike personal loans and credit, you may not be able to pay off your loan early without getting charged fees. On the other hand, if you pay late, you risk having to pay late fees or defaulting on your loan. Make sure that the repayment schedule works with your business’s cash flow. For example, if you know that you have to pay your HR outsourcing company at the end of the month, ask to make loan repayments in the middle of the month so that you’re more likely to have the cash.
4. Covenants
A financial covenant is a condition you need to meet while repaying your loan. For example, many lenders require your business to maintain a certain income-to-debt ratio or to notify them if you take out another loan.
Take covenants as seriously as your repayment schedule. If you breach a covenant, the lender can find you to be in default on your loan, even if you’ve never missed a payment. If that happens, your default will be reported to credit bureaus, and you’ll need to repay the rest of your loan immediately.
5. Personal Guarantee
If your business is new or has bad credit, a lender might require a personal guarantee on the loan. This means that if the business can’t repay the loan or goes bankrupt, the lender can still require you to personally pay back the loan. They can even take you to court and sue you for your house, savings accounts, and other personal assets.
Think very carefully before agreeing to provide a personal guarantee. If your business is a corporation or LLC, you’ll be forfeiting the liability protection that these business structures provide.
What is a Small Business Line of Credit?
Most small business loans are a form of installment credit — once you pay off the loan, you’re done with the lender. Another popular type of small business loan is revolving credit — also known as a line of credit.
A small business line of credit works a lot like a credit card. The lender approves you for a certain amount, which you can take out as needed. You can either pay back the full amount or pay off the balance every month with interest.
A line of credit is a great way to have quick access to cash if your business runs into unforeseen expenses. However, your business will need excellent credit to qualify for a line of credit.
A Small Business Loan Can Help Your New Franchise Thrive
When you’re running a new franchise, small business loans aren’t just helpful — they’re critical if you want your business to survive and thrive, no matter what life throws at you. At Confie, we’re committed to making sure franchise owners have the tools they need to succeed. Get in touch with us today to learn more, or give us a call at (714) 252 2500.
