6 Things to Consider When Applying for a Business Loan

by 20th of September, 2021

Applying for a Business Loan

When applying for a business loan, it's essential to prepare a detailed business plan and fully inform the lender about your proposed venture. This information helps the lender to provide you with the right type of finance and advice.

Decisions to make

Deciding that your business needs a loan is only the first step. There are a number of things to consider before you approach a lender; how much do you need to borrow; what type of loan will you need; how long will you need it for; can the business afford to repay the loan, interest and any one-off or ongoing fees that come with the loan; what security can you offer the lender and how this affects the interest rate offered. Take the following into account:

1. Access to funds you borrow

If you need to access the funds on a semi-regular basis (i.e. to help with cash flow to keep the business operating while waiting for your customers to pay for goods etc.), 'at call' loans such as an overdraft or line of credit are designed for this purpose. However, if you need the funds to buy a new business or equipment etc. to expand your existing business you will need the funds 'upfront'. This is also known as a ‘fully drawn advance’ and provides you with the entire loan amount all at once.

2. Loan terms

Loans provided upfront will need a portion of the loan plus interest paid back at regular intervals. The repayment amount will depend on the term or length of the loan. To determine the loan term suitable for your business you will need to calculate how much you can afford to service the loan. Be aware that the longer the loan term the more total interest you will pay. Loans that are at call have no fixed terms.

3. Ongoing funding

This is the average amount of an overdraft or line of credit that is used at any one time. E.g. You may wish to have an overdraft limit of $20,000 to provide money for the occasional big expense, but usually, you won't use more than $5000 of that credit limit on average. So in this case $5,000 is the level of ongoing funding you need.

When applying for an overdraft limit, things to watch out for are:

The higher the overdraft amount higher the fees
Clauses where the lender can demand repayment of the whole loan at any time.

4. Fixed or variable interest rate

The choice of the rate will affect the stability of repayments, the overall cost of the loan and the loan features available. With a fixed-rate loan, the lender bears the risk of interest rate moves, while with a variable rate you will bear this risk. Ultimately, the choice of variable or fixed rates will depend upon how much free cash flow your business generates after you have paid all your expenses, including loan repayments. If your business has a low-profit level, a variable rate loan repayment may rise beyond your ability to pay.

5. Loan security

Loans can be secured or unsecured by various types of assets, including residential, commercial, rural property or business assets. Alternatively, some loans are unsecured by any asset. Generally, the less you provide for security the higher the interest rate will be. Be aware the lender has the legal right to seize any property or asset you offer as security if you can't repay a loan on time.

6. Fees

There can be fees that can make a loan less attractive than it first seems. These include one-off fees such as establishment/application fees, exit/discharge fees and early termination fees or regular fees such as service fees or line/credit advance fees. Be sure to investigate the cost of set-up and ongoing fees in the average monthly repayment to give you a better idea of the true cost of the loan.

Seek advice

The information provided here will provide you with a range of possible finance options. It is important to seek advice from your accountant or business advisers before approaching a lender for a loan.

Plan the business, plan the finance

Lenders will ask for a lot of in-depth information about the financial history of the business. It's also important for you to create a convincing and detailed business plan which should include a profit and loss budget and cash flow forecast. The information you use to build your business plan may also be needed by the lender to assess your project. This includes both the past and future plans for your business, the people working in it and the market itself.

Applying for business loan
A projection of the cash requirements of the business is most important to a lender, as it is the actual cash left after expenses

Risk assessment

Understanding what lenders look for and what they consider risky will help you present your business in a favourable manner.

As a general rule, lenders look for:

the level and nature of your security (what you're offering to give them if you can't repay the loan)
your ability to make regular loan repayments (cash flow risk)
your ability to ultimately repay the debt (business risk), including any other debts you might already have.

You need to be able to assess the level of cash flow or business risk in your specific circumstances. A projection of the cash requirements of the business is most important to a lender, as it is the actual cash left after expenses that will repay the loan, not income. It also shows you are an effective manager.

A lender's perception of risk

The following factors can influence your lender's perception of risk. If a number of these areas apply to you and your business you may need to consider another source of finance.

Risk factors:

start-up businesses incorporate financial, business and management risk
lack of security
lack of business history
industry sector, factors will include levels of competition, barriers to entry, profitability profile and current economic conditions
highly seasonal businesses eg. swimsuits, agriculture. You'll need to demonstrate how you'll deal with cash flow pressures in the off season
lack of planning, market knowledge and finance skills
poor credit history.