Business capital refers to money used by a business to pay for assets and day-to-day expenses. This money is also used to pay for expansion in the future.
Sometimes, a business doesn’t have sufficient capital of its own and needs to get funds elsewhere—this is where financing comes in. The business could approach a financial institution for a loan or look into other options such as venture capital.
You’ve probably come across the concept before and have a good idea of how credit works. It’s possible that you already have personal or business credit and understand its benefits and drawbacks.
In the perfect world, no one would ever need to borrow money to cover their business costs. Unfortunately, it’s unlikely that any company can grow without additional funding; this is why capital is so important.
You don’t want to use your day-to-day funds to cover the costs of expensive machinery or large projects since you need that money to pay for daily expenses. Capital allows you to obtain tangible assets and invest in bigger projects without worrying about paying the normal bills at the end of the month.
An opportunity could come your way where your income will be boosted greatly, but to take on the project, you need to do additional research and development; purchase large quantities of raw materials; or hire extra employees. These circumstances necessitate an increase in working capital until you get paid for the work—finance can help in this case, too.
At some time, your business might go through a slow period, like when shops closed during the pandemic. It’s reasonable to look for credit during such times to ensure your business can remain open despite its financial constraints.
Once you determine that you need some financial help, you will need to apply for credit. Before you do that, you should understand the basic idea behind credit.
A financial institution will lend you a sum of money known as the principal amount. In turn, you need to repay the principal amount plus interest or an annual percentage rate (APR) on it over a specific period of time.
In some cases, the financial institution may ask you for collateral to secure the loan. Collateral is some kind of guarantee that you will be able to repay the loan. For example, you might have a vehicle, building, or expensive equipment in your business. If you do not pay the loan, then the institution can seize the collateral mentioned and sell it off to cover the loan.
When you need credit for your business, there are several options available to you. It helps to understand the different types of capital available so that you can choose the one most suitable to your needs. It doesn’t help to go with the first option available to you. You have to consider alternatives, which is something Trak can help you with.
An MCA provides you with an up-front cash lump sum (up to $250,000 or even more) when you cannot get credit from the bank. Repayments are not made in installments; instead, payments are made through your sales. As such, you have to use your monthly revenue to demonstrate that you can afford repayments.
You can choose to have a percentage of your daily debit or credit card sales go toward repaying the MCA. The financial institution will withhold this percentage automatically. Alternatively, you can opt for a fixed daily or weekly withdrawal amount directly from your bank account.
● Cash is accessible quickly
● Accessible with lower credit scores
● Collateral is not required
● Extremely high APR
● Cash flow problems can arise from frequent payments
● Does not affect credit score
An MCA is best suited for businesses that experience a high volume of card sales in order to make constant repayments without affecting their day-to-day cash flow. It also works well for companies that have a short time span in which to get capital and don’t have a decent credit profile to qualify at another bank.
A business line of credit is a predetermined credit limit that you can borrow against time and again. Interest is payable only on the amount you have drawn which provides greater credit flexibility.
After applying and getting approval, you can withdraw money whenever you need it. The revenue and credit profile of the business are crucial for lines of credit which makes qualifying for them challenging. If you do get approved, your business may qualify for up to$100,000.
● Flexible borrowing
● Instant access to money
● Usually don’t require collateral
● Need a strong credit record
● Can have high fees
● Must have a good amount of annual revenue
Businesses that have sudden, unanticipated cash flow problems or need money for a short-term solution may benefit from a line of credit. Seasonal businesses with strong revenue can also use this option during their off-peak seasons.
A term loan provides a lump sum amount to be repaid over an agreed-upon period. Interest is applicable to the entire loan amount, and most financial institutions require collateral, especially for larger loans. Some lenders offer loans up to $1 million.
The term for these loans depends on whether the focus is short, medium, or long term and ranges from a couple of months up to 20 years. Banks usually take some time to approve term loans, so many business people prefer to make use of online lending services.
● Can borrow higher amounts
● Upfront cash available for investments
● Reasonable interest rates
● Long waiting periods if using a bank
● Online lenders may charge higher fees
● Typically requires collateral or a personal guarantee
Term loans are ideal for businesses that have a history of good performance and want to expand their operations. If you are planning to open another outlet, branch out into another country, or are busy prototyping a new product, then it is worth looking into a term loan that can be paid off over several years.
A business credit card allows you to access a revolving line of credit whenever you need it. Credit card limits vary between $1,000 and $25,000. Financial institutions require a minimum monthly repayment for the business to maintain the facility.
● Don’t need to put up collateral
● Could be part of a rewards program
● Easier to get than a line of credit or term loan
● High fees
● Interest may vary depending on spending and repayment
● Potentially longer waiting time for approval
Business credit cards are the perfect solution if you need some extra cash for ongoing expenses during the month. It also works well to give them to reliable employees who need to make purchases on your behalf, to pay for travel costs, and for accommodation expenses.
Venture capital is a type of financing provided by wealthy investors who believe a business has long-term growth potential. These are not traditional loans; instead, it is considered an investment by venture capitalists into a business in return for a share of the business. The share is usually stated as a percentage of the equity in the business.
Venture capitalists frequently invest their money in rounds over several years or until a specific goal has been reached. They also have an exit strategy in place from the beginning and plan on withdrawing their funds by selling off their equity share. Most venture capitalists sell their stake about four to six years after the first investment was made.
● Can get much larger investments
● Corporate growth occurs faster
● Many venture capitalists also provide business advice
● Raising venture capital is an intricate and lengthy process
● Giving away equity to investors
● Company might not be ready for rapid growth
Venture capitalists usually invest in start-ups with a bright future. They are taking a chance on young businesses, so if you recently started a company and believe you are going to grow rapidly, then this could be a good option for you.
A microloan is a loan for a smaller amount, possibly up to $50,000. This capital option is made available mostly by nonprofit organizations that desire to help out smaller businesses. Microlenders tend to lend money more easily to underserved communities and start-ups.
● Available to those with a limited credit history
● Microlenders potentially offer free business training
● Interest rates comparable to credit cards
● Approval process takes up to three months
● Some microlenders only trade in certain states
● Shorter repayment periods affect cash flow
Microloans are a good option if you recently started a business or own a relatively young business and need some cash to cover basic expenses or some kind of expansion. Some microlenders are willing to provide loans to businesses with little to no credit history, so it might be your only option if other financing options aren’t viable.
The U.S. Small Business Administration supports small enterprises that are in need of financial help by administering SBA loans. These loans are available from participating lenders, such as banks, which can be seen on the SBA website. The SBA guarantees these loans, so they are promising that they will pay back the loan should the borrower default on payments.
● Lower interest rates
● Longer repayment terms
● Can borrow large amounts
● Application process takes months
● Can only use credit for specific things
● Difficult to qualify
Although the SBA loan application process is rigorous, it is well worth the time for many companies. It is a good optionfor businesses that need working capital, have to buy equipment, or need to refinance debt.
Realizing that you need external financial help for your business is a good thing because it means you are considering all your options. In any case, it’s necessary to understand how business credit works before you even get to the stage where you need it so that you can prepare yourself for the process and know what to expect.
Before you apply for a loan, you have to determine what you need the money for and set some kind of goals relevant to it. You can’t just go into the process blindly and ask for a bunch of money if you are uncertain about how you will be using it—that’s a sure way to get yourself into financial trouble.
If you are in the early phases of planning a start-up and require funds to open your business, then calculate how much capital you require, what it will be used for, and get an idea of when it will be paid back. You should always do a budget and projections to help you.
Money for ongoing business expenses is known as working capital. If you opt to get a loan for this, then you need a clear understanding of how it will be used and when you will make repayments.
Your business might be ready to expand but doesn’t have the cash flow to accommodate the related expenses. For example, you might need to purchase new equipment or open a facility at another location. In this case, a long-term loan could assist the business.
It’s quite possible that your business already has debts but cannot afford to pay them back currently. Some lenderswill refinance your present debt and give you more favorable lending terms that allow the business to repay its loans in an affordable way.
Have a look at which credit options may work for your business. Keep in mind your current expenses, future income, and think about the repayment period.
It could be useful to do some research about the alternatives available at different financial institutions, or go speak to your local bank manager. Trak can also help you to find curated capital options specifically for your business.
Once you have chosen the capital option that works best for you, you will submit an application for credit. Usually, this requires filling out forms and providing the lender with a bunch of information.
The lender will require you to submit full business details, such as the company name, start date, contact details, and location.
The owner(s) of the business must supply proof of identification. You also need to provide an Employer Identification Number (EIN), Tax Identification Number (TIN), or Social Security number (SSN).
Most credit providers require businesses to submit financial statements or bank statements to prove their current revenue. They could also consider how much debt the business currently has and whether they can afford to repay any credit granted to them.
Depending on the type of financing you require, the lender may do a credit check. The lender could check your personal credit score, although most also look at how you are handling business credit.
The company providing you with capital will let you know whether the application has been accepted or rejected. It can be quite an anxious wait, so ask the lender for an approximate waiting time. Most online lenders provide fast responses, while banks take several months.
It’s quite likely that you will need to fill in additional forms, supply extra documents, or put up collateral at this point. Check the offer details carefully to ascertain whether you need to do any of these things.
Every bit of capital comes with an agreement to repay the money in a specific manner. Read all paperwork before you sign it, and judge it on its own merits when deciding which financing option to go for.
There could be certain stipulations that you don’t agree with or obscure clauses which you don’t understand properly. You need to know the agreement inside and out to avoid being caught off guard later on.
If you are happy with the capital offer made to you and you have reviewed all the documents thoroughly, then go ahead and accept it. In most cases, the lender will deposit the money into your account or open your line of credit or credit card within a couple of hours, although this can take several days to happen.
Now that you have more capital at your disposal, you need to update your business budget. Add the new funds to your accounts and allocate them to the right places—the last thing you want is for loaned money to go to the wrong expenses such as business lunches.
Create a schedule of when and how you will use the money. Make a note about the amount for each expense, and add this information to your cash flow statement. It could be a good idea to keep this capital in a separate part of your bank account so that you can monitor it closely.
Remember to add the repayments to your budget and cash flow statement. Keep the relevant amount ready to make timely payments as agreed with the lender.
Qualifying for capital doesn’t have to be a challenge. Your business will find something that works for it among the many credit options available. It can be daunting at first, but the process pays off once you start reaping the benefits from the additional capital available to you.
There are always lots of things to think about when you consider financing. Think carefully about why you need it and how it will be used because you don’t want to spend much-needed funds on unnecessary expenditure. Credit isn’t something to rush into, so take your time with the research ahead of time and then act swiftly once you need to make a move.
If you have a good understanding of what a specific lender needs from you or what factors you need to meet to be approved by them, then it becomes much easier to qualify.
One of the first things you should consider is whether you need credit for the short or long term—this comes back to your business and financial goals. When you know what you intend on doing with the funds, then you can make better choices.
A short-term credit solution is suitable if you only need money to get you through a slower season, to tide you over until a customer pays a large account, or to make a purchase of raw materials for preordered items that will be delivered quickly. You will be able to repay the credit quickly, so something like a line of credit or business credit card will suffice.
Long-term credit is necessary when you know the business needs a large influx of cash that will take time to pay off—for example, to purchase new machinery. SBA loans or term loans could be suitable.
Sometimes, the amount of credit you require and your repayment period are somewhere between the short term and the long term. Many different types of credit work well for the medium term, but do consider APR when choosing the best one for your business.
The pandemic forced many businesses to close their doors temporarily or affected them in some other way—such as not being able to procure sufficient stock or being unable to operate at maximum capacity. Due to COVID-19, many business owners couldn’t repay their debts, as they weren’t making a proper income.
The SBA knows this is the case and that small businesses are struggling as a result of the pandemic. They have made it easier for these business owners to obtain credit through several COVID-19 relief options.
Make use of these loan alternatives to pay employees, have debt payments made for you, or to revitalize your business. There are also some options that cover specialized industries or expenses.
Your personal and business credit record affects the decision made by lenders. A well-established business could rely on only its own credit score if it has a good track record. However, most lenders will consider your personal credit record, too, as you are ultimately the person responsible for running the business.
An excellent credit score opens the door to many different credit options. It allows you to borrow larger amounts and enables you to negotiate interest rates. The better the score, the more likely you are to get a better interest rate.
A poor credit score results in very limited capital options. In most cases, traditional financial institutions will not lend money to you, so you have no choice but to look for alternative lending options. This frequently results in exorbitant interest rates or a high APR.
The best thing to do is to build your credit record from the beginning. Start with your personal credit record because you will need it if you want to get business financing.
Ensure you make timely payments, and only use what you need. Stick to your plan, and use the credit for its intended purposes so that lenders can see you are using the money responsibly.
Pay all personal and business credit as agreed upon with the credit provider. This will improve your credit score even more and allow you to access additional funds in the future.
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Which loan is best for you? This question is of utmost importance and an excellent one to ask.
You don’t want to use a credit card to pay for equipment that you need years to pay off—just like a 10-year term loan isn’t ideal for working capital required for two months of the year. It’s precisely why you have to determine a suitable capital option before you start filling out credit applications.
As you do your financial planning for the year, reevaluate your capital situation and start thinking about whether you may need additional cash throughout the year. Determine what type of capital you will need and consider several factors so that you can research the options available to you.
Determine what qualifications your business has to apply for capital. Consider aspects such as the years it's been in operation, its credit record, and revenue. Examine the financial statements and review future projections to ensure that capital really is necessary.
At this time, it’s also a good idea to check the information for yourself and any other party who holds equity within the business. Get a credit report (you get one free annually) for each owner to ensure everyone is in good standing with the credit bureaus.
How quickly you require the capital is a huge consideration when it comes to credit. It can limit the options available to you or open them wide if you are willing to be patient.
If you know you only need money in a couple of months, then it could be worth the effort of getting an SBA loan that offers lower interest rates. However, if you need funds immediately, then you will have to settle for credit that is accessible faster albeit at higher interest rates.
Any capital you receive from outside sources has to be paid back in some way. Be realistic about how much you can afford to repay at set intervals so that you don’t overcommit.
As you consider the repayment schedule, have a look at the effect APR has on your payments. You might find that a specific financing option is more affordable than another.
Once you are certain of your options, ask the lender how flexible they are when it comes to repayments. You have to consider the worst-case scenario in which you might not be able to pay due to unforeseen circumstances. An understanding lender will help you to alter the repayment plan, within reason, to accommodate your situation.
Depending on the type and size of credit you require, you may need to provide collateral to the lender. Determine if you have any collateral to offer and its value—the lender isn’t going to accept a $1,000 vehicle in exchange for a $20,000 loan.
It’s essential to realize defaulting on your credit payments will result in the lender seizing the collateral which they can then sell to recoup some of the lost money. Losing your collateral is a further blow to your finances and the last resort.
The table below provides a comparison of different business loans available to you. Use it to help you quickly determine whether a specific option is suitable for your situation.
The minimum credit score and approximate APR reflect industry averages, but it can differ between institutions. Use these values as a guide only—confirm the actual values with the lenders you apply to
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