Is a Business Loan Right for You? 5 Questions to Ask Before Applying

Taking out a business loan is a significant financial decision that can impact your company's future.

Whether you need funding to expand, manage cash flow, or invest in new equipment, borrowing money comes with responsibilities and risks.

Before applying, answer these five critical questions to determine if a loan is the right move for your business.

1. What Is the Purpose of the Loan?

Before applying for a loan, clearly define why you need the money and how it will benefit your business. Borrowing without a clear objective can lead to financial strain rather than growth.

Good reasons to take out a loan:

• Buying equipment or inventory that will generate additional revenue

• Expanding operations, such as opening a new location or hiring employees

• Managing seasonal cash flow fluctuations, such as a retail store stocking up for the holiday season

Risky reasons to take out a loan:

• Covering ongoing losses or trying to stay afloat without a clear plan for recovery

• Paying off existing debt without addressing underlying financial problems

• Funding a risky new idea without validating market demand

A loan should be an investment in business growth, not a temporary fix for deeper financial issues. If you're unsure whether a loan will directly increase revenue or efficiency, consider alternative funding options before borrowing.

2. Can Your Business Afford the Repayments?

Even if a loan sounds like the perfect solution, you need to be confident that your business can handle the monthly payments—even during slow months.

Here’s what to consider:

• Calculate the full loan cost, including interest, fees, and potential penalties for early repayment

• Assess your cash flow to determine whether your business can cover loan payments without sacrificing essential expenses

• Check your debt-to-income ratio to ensure you are not taking on too much financial risk

Many lenders require a debt-service coverage ratio (DSCR) of at least 1.25, meaning your business should be making $1.25 for every $1 in business debt. If your business has inconsistent revenue, taking on debt may not be the right choice.

3. Do You Meet the Loan Requirements?

Lenders have specific eligibility criteria that determine whether you qualify for a loan. Before applying, make sure your business meets these common requirements:

• Time in Business – Many traditional lenders require at least two years in operation, while alternative lenders may approve businesses as young as six months.

• Annual Revenue – Lenders often require a minimum annual revenue threshold (e.g., $50,000–$100,000) to ensure your business generates enough income to repay the loan.

• Credit Score – A personal credit score of 600 or higher is typically needed for traditional loans, while SBA loans and bank loans may require a score of 700 or more. Some alternative lenders accept lower credit scores but may charge higher interest rates.

If you don’t meet these requirements, consider taking time to build up your personal credit, reduce business costs, or explore alternative funding options before applying.

4. Have You Explored Other Funding Options?

Loans are not the only way to fund a business. Depending on your needs, other financing options may be a better fit—especially if you are a startup or do not want to take on debt.

• Small Business Grants – Grants provide free funding with no repayment required, though competition can be high.

• Business Lines of Credit – A flexible option that allows you to borrow and repay funds as needed rather than taking a lump sum.

• Invoice Factoring – If your business has outstanding invoices, factoring allows you to get cash upfront rather than waiting for customers to pay.

• Crowdfunding or Peer-to-Peer Lending – Platforms like Kickstarter or Kiva can provide alternative funding without traditional debt.

• Angel Investors or Venture Capital – If you are scaling a high-growth startup, equity financing may be a better option than debt.

If you only need short-term financing, a business line of credit may be a better solution than a long-term loan.

5. Do You Understand the Loan Terms?

Not all loans are the same. Before signing any agreement, read the fine print and ensure you fully understand the terms to avoid costly surprises.

Key loan terms to review:

• Interest Rate – Determine whether the rate is fixed (stays the same) or variable (can change over time).

• Repayment Schedule – Understand how often payments are due and whether there are penalties for early repayment.

• Loan Fees – Look for origination fees, late payment fees, and prepayment penalties that could add to the overall cost.

• Collateral Requirements – Some loans require business or personal assets as collateral. If so, be sure you understand the risks if you default.

Comparing multiple lenders can help you secure the best terms. Never sign a loan agreement without reading and fully understanding all conditions.

Final Thoughts: Should You Apply?

A business loan can be an excellent tool for growth, but only if it aligns with your business needs and financial stability. If, after answering these questions, you are confident that a loan is the right choice, start by researching lenders, comparing terms, and preparing your application.

If you are still unsure, consider consulting a financial expert or small business advisor before making a final decision. The right funding strategy can set your business up for long-term success.

As always, AltCap is here to help answer your questions and discuss your business goals. Reach out to us at info@altcap.org to schedule time to learn more about our financing options.