You have big dreams for your small business. But do you have the big bucks in your bank account to achieve those goals? If not, a business loan could help.
Start your search for a business loan by determining how much money you need. Then do your homework to explore various loan options and find the best fit for your purposes. Once you've narrowed down the possibilities, gather the information you need to impress the lender and complete your loan application. Here are eight easy steps to getting a business loan.
1. Know How You'll Use the Money
Lenders want to know that you have a well-thought-out plan for using their funds. Common reasons for seeking a business loan include:
- Startup capital for a new business
- Working capital for short-term cash flow needs
- Expanding your business with a new location, market, product or service
- Purchasing equipment, machinery, real estate or other assets
Your reason for borrowing also helps you determine the best type of business loan. Short-term needs call for short-term loans, while longer-term goals require longer loan terms.
2. Calculate How Much Money You Need
Based on your plans for the loan, figure out how much you need to borrow. Also estimate how the impact of the loan will affect your revenues. For example, if you're borrowing money to expand into a new location, how soon can you expect that location to become profitable? Use cash flow projections to help you estimate the loan payments you can afford.
3. Determine What Types of Loans You Qualify For
There are several different loan options for funding a small business.
Bank Loans
Traditional bank loans are installment loans repaid in fixed monthly payments. Banks offer both short-term loans (generally six to 24 months) or long-term loans (usually three years and up). Bank loans can be secured by collateral, such as equipment or a building, or unsecured. Secured loans usually have lower interest rates than unsecured loans.
SBA-Guaranteed Loans
The Small Business Administration (SBA), a government agency that helps small businesses, guarantees a portion of loans made by its partner lenders. SBA guarantees reduce lenders' risk, so they're more willing to take a chance on small businesses.
Microloans
Businesses seeking very small loans can turn to microlenders. Typically nonprofit organizations, microlenders offer business loans ranging from a few hundred dollars to $50,000. Some microlenders offer SBA-guaranteed loans. Others focus on disadvantaged business owners or businesses whose goals align with the nonprofit's mission.
Equipment Loans
Similar to auto loans, equipment loans use the equipment you're financing as collateral. Equipment loans are typically repaid in fixed monthly installments and are available from banks, specialized equipment loan companies or equipment manufacturers.
Business Line of Credit
A business line of credit is often used for working capital needs, but can be used for any business purpose you choose. You can borrow against your credit line as needed, up to your credit limit, and pay back only what you borrow. Most business credit lines are revolving credit: As you pay down the loan, funds become available to borrow again, similar to a credit card. If you're seeking less than $250,000, a business line of credit is often easier to get than a loan.
Invoice Financing
Businesses that invoice customers and wait a long time to get paid can benefit from accounts receivable financing. This type of loan uses your business's receivables as collateral. The lender advances you money based on the value of your outstanding invoices, so you get cash immediately instead of waiting for customers to pay. When the lender collects payment from your customers, you receive the remaining percentage of the invoice, minus the financing company's fees and interest.
4. Check Your Credit Scores
Lenders typically consider both business credit scores and personal credit scores when evaluating your business loan application. If your business is a sole proprietorship or is new and doesn't yet have a business credit history, your personal credit score will weigh more heavily.
In general, higher credit scores mean lower loan interest rates and better loan terms. Before you begin applying for loans, check your business credit report and credit score, as well as your personal credit report and credit score. Addressing any trouble spots you find, such as bringing late accounts current, can help improve your scores, which could make it easier to qualify for a loan.
5. Assess the Value of Your Collateral
Putting up collateral to secure a loan reduces the lender's risk. If you can't repay the loan, the lender can take your collateral. You may be able to use business or personal collateral to secure a business loan. Business collateral includes equipment, vehicles, machinery, real estate, inventory or accounts receivable. Personal collateral can include vehicles, valuables such as fine art or jewelry, savings or retirement accounts, or your home. Be cautious when pledging personal collateral; you should never risk anything you aren't willing to lose.
6. Gather the Necessary Information
The documentation needed for a business loan application can vary from one lender to another. Banks tend to require the most information and typically want to see the following:
- Your business's financial statements
- Business tax returns and bank statements
- Business licenses or leases
- Several years' worth of financial projections
They may also ask for a written business plan. Online lenders usually have less stringent requirements. They may just want to see your business bank statements or connect with your accounting software to review your cash flow.
7. Shop Around and Compare Loan Terms
Your existing business bank is a good place to start looking for a loan, but don't stop there. Check with several lenders who offer the type of financing you seek. You can typically get prequalified or preapproved to get an idea of the loan terms you may qualify for.
Prequalification usually requires sharing some basic information, such as revenues and desired loan amount. Preapproval generally involves a more in-depth review of your documentation. Neither guarantees your loan request will be approved, but they'll give you a good idea of the terms different lenders are offering.
As you compare loan terms, consider annual percentage rates (APRs), terms, fees, penalties, how much you can borrow and how quickly you can receive the funds. Also review the total cost of the loan and determine whether the payments fit your business budget.
8. Apply for a Business Loan
When you've chosen the best loan offer, it's time to complete an application. Depending on the lender, it can take weeks or even months to get a loan approved. Having the correct documentation ready will speed things up. Be sure to review your application before submitting it to make sure you haven't left out any essential information.
Frequently Asked Questions
How hard it is to get a business loan depends on a variety of factors, including your business's cash flow, time in business, amount you're seeking, collateral and the type of loan you're applying for. In general, traditional bank loans or SBA loans offer the lowest interest rates and are the most difficult to get. They typically have strict lending criteria and a lengthy application process requiring lots of documentation.
Loans from online lenders are usually easier to get and require less documentation. They rely more heavily on your cash flow and time in business to determine your creditworthiness.
Good personal and business credit scores generally make it easier to get any type of small business loan. Although you may still get a business loan with poor credit, you will likely pay more interest rates and receive smaller loan amounts.
Both business and personal credit scores are a factor in business lending decisions. Traditional lenders typically require a personal credit score of at least 650 to approve a business loan. Online lenders usually have more flexible requirements: You may qualify for an online business loan with a personal credit score as low as 500. However, you'll probably pay a higher interest rate than if you had a score of 600 or more.
The three major business credit reporting agencies, Experian, Dun & Bradstreet and Equifax, each use different credit scoring methodologies. Checking your credit report with each of these credit bureaus will give you a good idea of where your business credit score stands and what you can do to improve it if necessary.
Good reasons to get a business loan include:
- Financing expansion into new markets, locations, products or services
- Purchasing assets that add long-term value to your business, such as equipment, real estate or machinery
- Obtaining working capital for cash flow needs, such as buying inventory or making payroll during slow seasons
- Building a business credit history by paying off a line of credit or small loan
Loan repayment terms vary depending on the purpose of the loan. Here are typical time frames:
- Invoice financing: 30 to 90 days
- Merchant cash advance: Three to six months
- Line of credit: One to three years
- Bank loan: Three to 10 years
- SBA loan: Five to 25 years
The Bottom Line
The right small business loan can help your business expand nationwide, purchase critical equipment or get through a slow season. To boost your odds of success, take time to do your homework, research loan types and lenders and compare your options. Maintaining a solid business and personal credit score can help increase your chances of getting a loan—and making your business dreams a reality.