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Understanding How Business Loans Work

Home » Business advice » Understanding How Business Loans Work
Understanding How Business Loans Work
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If you’re considering starting your own business, you probably wonder how you can get the money to fund your venture. 

Some entrepreneurs choose to start businesses with very little overhead costs, such as being a freelancer or accountant. Others bootstrap their companies, using their own savings or money from family and friends to fund their startup.

However, many businesses will eventually need more capital than they can come up with on their own. That means applying for a business loan. Before you take this step, it’s essential to understand how business loans work so you can get the right funding at the right price.

What Types of Business Loans are Available?

What Types of Business Loans are Available?

You might assume that a business loan is a set amount of money, paid back over time. That’s certainly one type of loan, but it’s far from the only option. Here are the types of financing available to business owners.

Business Line of Credit

A business line of credit functions a bit like a credit card, where you have a limit you can borrow. As you pay it back, you can borrow it again for other business needs. As long as you stay within your credit limit, you can make purchases and pay them back, with interest, as long as the credit line lasts.

Small Business Term Loans

These are traditional loans where you receive a lump sum of money upfront and then pay it back over time. These are intended for a specific investment, such as purchasing expensive equipment. A small business term loan is a lot like an individual getting a loan to buy a car, and the repayment works similarly.

Accounts Receivable Financing

Some businesses have invoices that aren’t paid for a period of time, such as 30 or 90 days. Instead of waiting for your customers to pay, you can sell the pending payment to a lender, who pays you upfront. You’ll pay a fee and you probably won’t get the full amount of the invoices due, since the lender has to take the risk that some of your customers won’t pay. However, you’ll get paid right away.

Working Capital Loans

If you need money for day-to-day operations, a working capital loan can help you make ends meet. Generally, a working capital loan is smaller and needs to be repaid sooner than other types of business loans. However, these loans have higher interest rates and are also tied to your personal credit, so these are best as a last resort.

Qualifying For a Business Loan

Qualifying For a Business Loan

How do you convince a lender that you’re a good risk for a loan? It’s all about making sure your business and your personal credit are in top shape. Here are some of the requirements you might encounter.

Personal Credit Rating

If your business is fairly new and hasn’t developed its own credit history, a lender will look at your credit score instead. You’ll probably need a score of 650 or better to qualify for a business loan. Lenders want to see that your business — and you — are responsible with debt and pay bills on time.

Business Age & Revenue

To qualify for a business loan, you’ll need to have been in business for at least six months, preferably two years or more. Lenders will also look for revenue of $80,000 a year or more. If you don’t meet these criteria, you might look for a startup-specific loan or funding through the Canada Small Business Financing Program (CSBFP).

Business Plan & Collateral

Finally, a lender will want to know what you plan to do with the money and whether you have any collateral to guarantee the loan. Presenting your business plan will help your cause, and if you’re using the money to make a major purchase the new investment might be the collateral for the loan. 

Repaying Your Business Loan

Repaying Your Business Loan

Once you’ve learned how business loans work and secured the funding you need, you’ll need to think about making arrangements for repayment. Most loans will have a set term and monthly payment plan. However, some types of financing are a revolving limit, so you’ll make payments toward your balance to free up credit for other purchases. 

It’s important to always make at least the minimum payment required on time each month. Otherwise, you can hurt your business’s credit rating and possibly your own as well. A poor credit history will make it hard to get funding for future investments.

You may want to make larger than minimum payments in order to pay off your loan more quickly so that you can save money on interest payments. However, ensure that your business budget won’t suffer from larger payments. You don’t want to run short on operating funds because you were too aggressive with your loan payments.

Getting a Business Loan Can Help You Grow

Getting a Business Loan Can Help You Grow

Many businesses reach a point where they can’t grow without a loan or major investment from outside the company. Getting a business loan can be a great way to move your organization forward while creating a business credit history that can serve you well in the future.

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