What Exactly Are
 Small Business Loans

You can consider small business loans in terms of business loan products offered by lenders, or more appropriately, you can look at where small business debt based funding comes from.

The reality is that small businesses are financed by any source of capital they can get their hands on, with a significant portion coming from some type of personal debt instrument (line of credit, mortgage, term loan, promissory note, etc.)

During our discussion on the commercial finance market , I talked a lot about how personal credit and net worth are key financing criteria for many lenders offering small business loans.

 Then it shouldn’t be much of a surprise to learn that many small businesses use personal financing sources to fund their businesses, especially during the start up period.

Even when a business owner secures a business loan, he or she will most likely be required to sign a personal guarantee, based on their personal net worth, or personal covenant. Some may wonder why lenders, banks especially, even go to the trouble of calling small business loans, business loans.

A proper definition of a small business loan is any source of debt financing that is utilized in the operation of a business entity.

This is an important distinction because regardless of the source of capital, the impact to the business is the same. That is, interest costs are incurred and expensed, debt needs to be repaid, and future borrowing capacity is impacted.

So, in many cases, a small business will use a combination of personal and business loans to finance business activities.

Why is this important?
Because business owners will many times go out of their way to try and secure a “business loan”, when a personal financing option may be easier to get and potentially lower cost.

One of the reasons for this one dimensional focus is the misplaced belief by the business owner that a business loan versus a personal loan will reduce their personal liability. But, as I mentioned earlier, almost all small business loans are secured by a personal guarantee, eliminating the argument for personal risk reduction via a small business loan.

This is not to say that business loans shouldn’t be the primary focus when looking for financing for your small business operation. They definitely should, and I will explain why in a minute.

But at the same time, a business owner must consider all options for financing and make sure that his/her decision making process is sound, and based on a realistic risk/benefit/cost assessment, rather than an intuitive approach that may not consider all relevant options.

The reason you need to consider all sources is simple.
Profits are made or lost based on the ability of an individual or organization to take advantage of a situation in the market place. Whether it’s funding working capital to increase sales, or purchasing assets at the right time for the right price in order to support the end sales process, timely acquisition of financing can be critical.

Everyday profitable opportunities are lost because there was too narrow a small business loan focus.

Here’s an example.
Say you are a profitable wholesaler of widgets and your monthly sales are $30,000 with a gross margin of 60% or $18,000. Now say that out of the blue you get a purchase order for $100,000 worth of widgets from an A+ customer. This is great, right? You can make an immediate gross profit of $60,000 just by filling the order.

One problem.
You need an additional $40,000 in working capital to complete the sale. So you quickly look for a small business loan, but are turned down. For whatever reason, you can’t get approval for a small business loan for $40,000 anywhere you apply.

So now the deal is hanging in the balance. What do you do? Are you prepared to consider any financing options, business or personal, to make the deal happen? Or should you just forget about it and watch $60,000 go up in smoke?

The answer will always be a personal choice of risk and reward, but shouldn’t you first figure out how the deal can be done before you decide to move forward or not? If you can’t find any financing, the decision is made for you. If you can, then it’s a totally different decision making process.

Take it a step further, what if 6 months later you finally find a small business loan for $40,000. Is the deal still going to be there?

I mentioned earlier that you should always look for a business loan first. There are a number of reasons for this.

First, it will be easier to administrate, as it will only flow through your business accounts and there will be no bookkeeping confusion with your personal record keeping.

Second, you are building your business credit rating through acquiring and timely repayment of a small business loan.

Third, a small business loan can be secured by your business assets, leaving the borrowing leverage of your personal assets for other purposes including contingencies for your business.

Fourth, there are situations where business assets and cashflow are the only forms of security taken, which eliminates personal risk.

Fifth, for established businesses, many will need to leverage both their business assets and their personal assets to get the amount of money required, so focusing on the harder to find small business loan sources first usually makes the most sense.

Small Business Loans take many different forms, focusing on some combination of assets, cash flow, management, credit rating, and business and personal covenants.

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