Small businesses have traditionally looked to banks when trying to find financing. But, over the last couple of decades, that has become harder for a number of reasons. While the advantages of loans mean that businesses often prefer them to equity funding where ownership is lost, banks have been more wary of lending to small businesses since the financial crash in 2009. Lending by banks to small businesses has increased again in the years since the crash, but it has happened slowly, and there are still certain owners who struggle to obtain funding. With the rise of ‘new’ industries and niches, for example tech-heavy companies like SaaS businesses, that don’t use the same kinds of metrics as brick and mortar stores to measure growth and success, banks are struggling to keep up. Alternative financing has grown to fill much of that gap in the past few years. If you’re looking to obtain financing for your small business in the near future, it’s worth considering the advantages and disadvantages of loans from traditional banks, and what alternative financing is available if loans aren’t an option or don’t come with good terms.
Traditional banks generally offer a number of different types of financing, from traditional term loans, to business credit cards. If you already have a relationship with a bank where you hold a business account, then you definitely want to assess what types of financing they can offer you and on what terms each type of financing is available.
These are the normal types of financing available from a traditional bank, although you should always ask your bank directly to understand if any alternatives are available:
Term loans. These are standard loans that you can generally use without limitations being placed on how you use the funding. You should be aware that a bank is likely to want to see a business plan, however, that defines what you intend to do with the money. So while legally what you use it for may not be specified, that information may be required to justify the loan being granted. Term loans are generally medium term - for 3 - 5 years - and the interest rates can be fixed or varied.
Small business administration (SBA) loans. These are loans that are partially guaranteed by the federal government. The process of obtaining the loan can be faster, as the paperwork is often reduced, and unlike most traditional banks, they offer loans to businesses that have been up and running for less than two years. Interest rates on SBA loans are also often lower than they would be with regular term loans.
Lines of credit. This is a type of financing that allows a business to access cash as and when needed. The company only needs to repay what they borrow, unlike a term loan where interest starts accruing immediately after the lump sum is paid out, and some banks will allow you to increase your credit limit over time.
Equipment financing. Traditional banks will often offer loans specifically to purchase equipment, with the amount offered being based on the amount of the purchase. Often 100% - 120% of the price of the equipment will be offered as the loan amount. This can be great for businesses with a need for a lot of expensive equipment to allow for growth, but not all businesses or industries need such equipment.
Real estate financing. This is a type of term loan or line of credit that is offered specifically in relation to the real estate a business owns, including for purchase, to refinance, or to borrow against your equity.
For businesses, a bank loan or other type of financing can be incredibly useful. It allows you to move away from bootstrapping or taking out shareholder loans, and if you have already obtained venture capital funding, it also allows the business to grow without further dilution of the capital.
If you already have a business bank account, then building up a relationship with your bank can allow them to see your business responsibly growing and paying back loans and other financing in accordance with the terms, which can often make future financing easier to obtain from that institution.
During periods of market uncertainty, it can also be useful to obtain additional capital without obtaining debt or non-dilutive financing, and some forms of bank credit (or alternative methods of financing) can provide that.
The biggest disadvantages of obtaining a bank loan or financing are several fold. For one, a bank may not be willing to offer any financing to you, even if you have a good financial plan that predicts growth, if you are in a new industry, or if you measure growth in a way that the bank is not used to assessing. If you’re a startup, for example, and the business is younger than two years old, then banks may not be willing to consider lending regardless of what other terms you meet. For many SaaS businesses that are in a predicted period of fast growth, shoring up your sales functions early by using working capital to create a solid process, can be key to consistent, fast growth, but a bank will not always lend in that scenario.
Also, bank loans often depend on a personal guarantee or good personal credit score of the founder or other stakeholders in the company. The potential profitability of the company is not always enough for a traditional bank to take a risk on a business, or if it does, the terms of the loan may not be acceptable to you.
Usually a bank will require the following items from a business before offering credit:
Personal credit score. A disadvantage of loans from banks can be the requirement to connect the loan to the founders personally. If you as founder don’t have a credit score of over approximately 680, then the profitability of the company may not be enough to persuade a bank to lend to you.
Financial and legal documents. A bank will want to see business and personal bank statements and tax returns as well as other financial information directly relating to the company like profit and loss statements and balance sheets. A bank is also likely to require your business plan and any financial projections. If you don’t already track your key metrics and understand how they predict your future growth, then you will want to do that before applying for any kind of financing, bank or otherwise.
Annual revenue. Banks sometimes have annual revenue requirements of $100,000 or income of 1.25 x normal operating expenses. Depending on your current position as a business, even if you can predict aggressive future growth, if your revenue isn’t meeting specific current standards, you may struggle to obtain bank financing.
Time in business. Unless you’re obtaining an SBA loan, many banks require you to have been in business for at least two years.
Collateral. Not all types of bank financing require collateral, but it is not uncommon to require to show personal credit scores, bank and tax statements, and sometimes to provide a personal guarantee.
Eligible industry. Banks are not always willing to lend to any industry or sector. Obvious ones that banks shy away from are in the adult industry and the cannabis sector. You should carefully check if a bank will lend to your niche if your business is non traditional.
Due to the considerable disadvantages of loans from traditional banks, a wide range of alternative financing options have become available. You should also carefully assess those and compare them to the financing options offered by your bank, to see which offer the best terms and rates. Lenders like Capchase often specialize in particular industries or niches, and will understand the metrics you use to predict growth in a more nuanced way than a traditional bank. Our Grow product, for example, is great for SaaS businesses and tech-enabled companies that are looking to scale their investments by injecting the capital they need exactly when it is needed. Capchase Extend is a great source of runway funding for recurring revenue and tech-enabled companies that are looking for expense financing without having to dilute equity or take out debt. If you would like to understand how Capchase could help you finance and grow your SaaS or tech-enabled company, then enter your key metrics into our capital calculator today.