If you own a small business or you are thinking of buying one, you may first think of your local commercial bank as an option for a small business loan. Commercial banks, large and small, are only two of your options.
According to the Biz2Credit Small Business Lending Index, small business loans through commercial banks had a banner year in 2019 and they are in a position to have another great year in 2020. Since small businesses drive the economy and are responsible for much of the job creation, this is good news not only for small business owners but for the economy as a whole.
The Biz2Credit Small Business Lending Index showed that small business loans were approved at a post-Great Recession high of 28.3%. This was the post-recession high for loan approval by large banks, defined as those having more than $10 million in assets. Small business loan approval by small commercial banks dropped slightly, but that’s normal at the beginning of a calendar year. Usually, small banks make more Small Business Administration loans and they often wait until the previous year’s tax returns are filed before they grant small business loans.
Small businesses who make application for loans through commercial banks don’t always fare quite this well. When the economy is stagnant, growing slowly, or in decline, commercial banks are more reluctant to take a chance on risky small businesses. When the economy is booming, commercial banks are a source of debt financing to small businesses.
Here are some important points you, as a small business person, need to know about the relationship between small businesses, small business loans, and commercial banks:
- If you have an idea for a new small business or if you want to buy an existing business, you will probably think of talking to your commercial bank about a small business loan first. The approval rates for small business loans are low from commercial banks. In 2004, before the Great Recession, loan approval rates for small business loans from commercial banks were twice what they were in 2017.
- Don't just stick with your commercial bank. Compare financial institutions and you may find a lender to work with you. Compare large, regional banks and small, hometown banks. Compare interest rates, loan terms, and what services they offer you.
- It is often difficult for startup small businesses to qualify for a small business loan through a commercial bank. Even in booming economic times, you see that the approval rate is only in the high twenty percentile. It is less if the economy is not growing. Startup businesses may have to tap other sources including home equity and alternative sources of financing.
- Understand banking terminology that may be in a loan application before you apply. You will need to know terms like annual percentage rate, collateral, loan term, maximums and minimums, loan covenants, and other specialized banking terms.
- Firms are evaluated based on the 5C's of credit by the bank loan officer for a decision to be made on how the bank will allocate its limited resources. Evaluate those 5C's on your own and make sure your credit history is in good shape and that there are no errors on your credit report. Decide how much money you can put into your company on your own. The more, the better as far as a small business loan through a commercial bank is concerned.
- Other important factors involved in qualifying for a small business loan are your business plan and the documentation you provide your loan officer with your loan application. If your business is established, you will usually have to present five years of financial statements. This point is relevant to existing businesses and not startups.
- Existing and mature businesses need money to operate. They can finance their operations through loans even though using debt financing will raise their risk. Small businesses need small business loans for working capital or short term assets that fund their day-to-day operations. They also need long-term loans to finance their equipment and other long term needs.
Small business loans are necessary for most small businesses to operate. Commercial banks, both large and small, are only one source of loan money. Other financial institutions, along with crowdfunding, can also help.