When most people are in the market for a small business loan, they think of a 3-5 year term with monthly payments. The problem with the business lending industry is that many business lenders are offering bad credit business loans. Small business term loans are very different from what the majority of the industry offers.
My company, Ventury Capital, helps businesses access capital for growth. We specialize in term loans for small business owners and want to help entrepreneurs understand how to navigate them.
If you’ve ever had an auto payment or mortgage, you’ve had at least one type of term loan. That would fall into this monthly-payment-with-interest type of situation. A business would normally use a term loan when it needs to finance the purchase of assets – for instance, equipment, inventory, expansion, or a vehicle.
How Term Loan Payments Work
Term loan lenders look at debt service coverage, business financials, time in business, and FICO scores to determine to whom they will lend. This is the first step. The minimum guideline for a simple interest loan with monthly payments is two years in business.
The next thing they will look at is debt service coverage. Debt service coverage is a ratio that shows your profit compared to your expenses. A debt service of a 1.00 means that for every $1 dollar your business earns, you also spend $1 dollar. A debt service of a 1.10 means that for every $2 dollars your company earns you spend $1 dollar, and a debt service of a 1.20 means that for every $3 dollars your company earns, you spend $1 dollar. A business needs to have a minimum debt coverage of 1.00.
Then the lender will look at your business financials. Typically, you’ll need three years of tax returns (or interim profit and loss statement if you’ve been in business two years), the most recent six months of business bank statements, and one year of personal tax returns.
Lenders look at your personal FICO score next. Typically, you need to have a 650 or higher to access a small business term loan. There are some extenuating circumstances where you can fall to a 620 with positive compensating factors like time and business margins.
Term Loan Interest Rates and Fees
With a term loan, you’ll be charged interest on the amount you borrow. The interest rates vary based on the current rate, use of funds, and the perceived risk as evaluated by the lender.
The interest rate you’ll be offered depends on a variety of factors. Typically. rates are 5.5 percent to 15 percent APR, but many things can affect these rates. Lenders take into consideration some particulars of the business, such as the time in business and the industry, when calculating rates.
In addition, lenders typically look at the debt service ratio, the increase in sales, and your cash flow management of the business when setting interest rates as well.
Term Loan Approval Rates
The SBA offers several term loans, as do some alternative lenders. According to Entrepreneur, SBA approval rates are significantly less due to the due diligence the SBA requires for its business owners. This is highlighted by the fact that the SBA is only responsible for 21 percent of term loans, as opposed to 61 percent in the alternative lending space.
If your business meets the minimum requirements for a term loan, including FICO score, debt service coverage, financials, and time in business, approval rates can be as high as 85 percent.
As with most loans, there are closing fees involved. On small business term loans, you typically see three points on a loan that are taken out of the net proceeds. For example, if you borrow $100,000, you will usually net $97,000, but pay interest on the full $100,000.
Both traditional banks and alternative banks offer term loans. To give yourself the best shot at approval, contact a professional loan officer who offers multiple programs. They can tell you based on your debt services and financials which lender gives you the best shot at approval.
Unless you’re in the industry, finding out all the caveats of the small business term loans can be a daunting task. Definitely confer with experts before making any decisions!
A version of this article originally appeared on BusinessCollective.
Nick Bentley is a best-selling author, radio host, and the cofounder of Ventury Capital. He helps companies of all phases and revenues access capital financing. With specialties in private capital lending, venture capital, and commercial real estate, he has the ability to work with business owners in multiple industries. Nick partnered with Kevin Harrington, one of the original “Sharks” on Shark Tank, and a team of digital marketers out of Austin, TX, to form Ventury Capital.