Misconceptions About Getting a Loan for Your New Business

So you have an idea for a business, and all you need is several thousand dollars to make your dream a reality. After speaking depleting your own bank account and begging from friends and family, you still find yourself short and want to get a loan from the bank or SBA. But you've been told certain things about loans and the banking industry that may or may not be true, leaving you open for a surprise when you start your quest for financing:

Myth #1: If your cash flow, character, credit history and collateral aren't in order, no loan for you.
While it's true that, in the past, banks considered a loan applicant's character, credit history and collateral, today most financial institutions focus only on your credit history when considering whether or not to give you a loan. There are many reasons why this is true, but an increase of automation at banks is probably the biggest and most significant. A person's credit history is usually a good indication of repayment probability, and these days it just costs too much time and money for banks to delve into the other sections. This shift is particularly true for loans under $250,000. For loans over that amount, some banks are more willing to invest the time to meet with applicant and discuss his or her business. For smaller loans, the decision to extend a loan is far more automated and works similar to the application for a credit card. Most banks today are even organized so that business loans under $250,000 fall under the "consumer lending" banner instead of "commercial lending".

Many entrepreneurs and business owners don't see how a business loan can fall into the consumer category, and assume the bank will look at their business instead of their personal credit. But the truth is, since loans under $250,000 are considered "consumer lending" at most banks, your personal credit history is the primary and most important criteria in determining your likelihood for getting a business loan. After all, it isn't your business that's doing the borrowing, it's you yourself. That means if you're borrowing under $250,000 and your business doesn't have a history of profitability (or a history at all, for that matter) your bank is going to require you to guarantee the loan personally.

Myth #2: You can always get a loan from the SBA.
Actually, no, you can't, even though there are countless people out there who claim to be able to get you one. In truth, the SBA doesn't directly make loans. The SBA's website discusses what it does offer, which is financing options and loans they can help you obtain through other institutions, but it clearly states that the organization does not offer loans directly. Instead, they provide guarantees to banks who do offer loans to business owners. This guarantee allows banks to offer loans that are riskier than those they would otherwise offer.

You do, however, need to be aware that changes may be coming to the SBA shortly, including the Bush Administration's 2006 elimination of the Microloan program for loans under $35,000. If you're in this category, you should read up on this and other changes before approaching your bank to request a loan. Also keep in mind that SBA guarantee usually can't be used by startup businesses that have less than three years sales history.

There is good news on the horizon for small business owners seeking financing: data companies are currently setting up business credit ratings that are separate from personal credit ratings, and many banks who realize the potential of relationships with small businesses are specializing in small business lending. Many companies are also helping startups establish and/or improve their business credit rating. Understanding the truth behind these major myths and realizing that the process of getting a small business loan is similar to that of getting a credit card will help firmly plant your dreams in reality, and possibly speed your application along.