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How to Get a Business Loan

You have big plans for your small business. But what if those plans require big money that doesn't exist in your bank account? A business loan can help. To get a business loan, start by determining how much money you need and what you'll use it for.

Research possible financing sources and learn what their requirements are. Once you know what lenders are looking for, you can prepare a loan application package that proves you've got what it takes. Here's a step-by-step guide to getting a business loan.

How Do Business Loans Work?

Lenders offer a variety of business loan options designed for different business needs. For example, you can find loans to use for purchasing equipment, financing expansion, buying commercial real estate or providing working capital. Business loans include:

  • Bank loans
  • U.S. Small Business Administration (SBA) guaranteed loans
  • Business lines of credit
  • Equipment loans
  • Invoice financing or accounts receivable financing
  • Merchant cash advances

Business loans may come in the form of installment loans or revolving credit. Revolving credit, such as business lines of credit, lets you borrow up to a set limit and either pay off your balance each month or carry it over ("revolve" it). As you repay the loan, you can borrow against up to the limit again with no need to get reapproved. With installment loans, you borrow a lump sum of money and repay it over time by making fixed monthly payments.

Short-term business loans are designed for short-term purposes, such as providing working capital to buy inventory. They typically last for six to 24 months. Long-term business loans usually last three years or more.

Secured business loans require you to put up collateral; if you can't repay the loan, the lender takes your collateral. Unsecured loans don't require collateral, so they're easier to get; however, they carry higher interest rates than secured loans.

Business loans are available from a variety of sources, including banks, credit unions, nonprofit or community organizations and online lenders.

Steps to Getting a Business Loan

To find the right business financing source for you and get the loan you need, follow these steps.

  1. Figure out how much money you need. When a lender asks, "How much money do you want to borrow?" the correct answer is not "As much as you'll give me!" Lenders want to see that you've carefully thought through your business goals, know how much you need to achieve them and have a specific plan to use the money wisely. Whether your goal is to open a second location or buy new machinery, run the numbers to see how much it will cost. Also calculate how loan repayments will affect your business budget going forward.
  2. Decide what type of loan best fits your needs. Once you know how much money you need, figure out what kind of loan suits your purpose. The most common kinds of business loans are:
    • Bank loans: These installment loans are repaid in fixed monthly payments. They can be short-term loans (generally six to 24 months) or long-term loans (typically three years and up). Secured loans tend to offer lower interest rates than unsecured loans.
    • SBA guaranteed loans: The SBA, a government agency that helps small businesses, doesn't make loans itself. It partners with selected lenders, including banks, credit unions and nonprofit organizations, to guarantee a portion of the loans they make to small businesses. The guarantees make lenders more willing to take a chance on small businesses.
    • Microloans: Do you need a smaller amount than a bank will lend? Then a microlender, who focuses on small loans, might be your best bet. SBA-guaranteed microlenders offer loans up to $50,000. Other nonprofit organizations offer microloans, often to disadvantaged business owners or businesses with goals that align with the nonprofit's mission.
    • Equipment loans: If you need to buy equipment or machinery, consider an equipment loan. These loans use the equipment itself as collateral (similar to a car loan) and are paid in fixed monthly installments. You can get equipment loans from banks, specialized equipment loan companies or directly from equipment manufacturers.
    • Business line of credit: Similar to a home equity line of credit, a business line of credit lets you borrow up to a set credit limit. As you repay the loan, the funds become available to borrow again. If your customers take a long time to pay you, a business line of credit can help ensure you don't run out of working capital while waiting for the payments to come in.
    • Accounts receivable financing: Also called invoice financing, this type of loan uses your business's receivables as collateral. The lender advances you money based on your outstanding invoices. You get the money right away without waiting for customers to pay you. Once customers do pay, you'll get the remaining percentage of the invoice, minus the financing company's fees and interest.

    When weighing your options, find out what criteria the lender uses when evaluating your loan application. For example, if a bank loan requires three years of business tax returns and you've only been in business for six months, you'll need to look elsewhere.

  3. Check your credit scores. There are two types of credit scores: business and personal. A business that's just starting out won't have much of a credit history. If it's a sole proprietorship, lenders might focus on your personal credit score when considering your loan application. Once you've been in business a while, your personal credit score won't matter as much, but it's still a factor in the loan decision. Before you start the loan process, get a business credit report and a free personal credit report and address your trouble spots. Getting your credit scores in tip-top shape before you apply for a business loan will help to boost your chances of success. Even if you have bad credit, don't despair.
  4. Put together the required documents. Once you know where you plan to apply for a loan, check with your lender to find out what documents and information you'll need to provide for the loan application. Banks generally have the most stringent requirements: They may ask for your business's financial statements (income statement, balance sheet and cash flow statement); three to five years' worth of financial projections; business bank statements; business tax returns; leases and business licenses. They'll also expect to see a written business plan. While other lenders may not require as much documentation, you should be prepared with whatever information the lender requests.
  5. Assess the value of your collateral. Putting up collateral will make it easier to get a business loan and help you get better terms. Business collateral includes equipment, vehicles, machinery, real estate, inventory or accounts receivable. If your business has no collateral, you may need to use personal assets as collateral. Personal collateral may include vehicles, valuables such as jewelry or fine art, savings or retirement accounts, and your home. Be very careful about pledging personal collateral; don't risk anything you aren't willing to lose.
  6. Shop around for the best business loan terms. If you're already in business, your business bank is a good place to start—but don't end there. Check out several lenders to compare loan terms. Factors to consider include the annual percentage rate (APR), amount and term of the loan, fees, penalties and how quickly the loan will go through. Consider the total cost of the loan and make sure the monthly payment fits your budget.
  7. Apply for a business loan. Depending on the lender, it can take weeks or even months to get a loan approved, so don't wait until the last minute to complete your application. Find out what documents the lender needs and have them ready. Missing or incomplete information can delay your loan approval, so review your application package to make sure you've included all the necessary information.

When Is It a Good Time to Take Out a Business Loan?

It's been said that the best time to get a business loan is before you need it. Having strong sales and healthy cash flow boosts your odds being approved for a business loan. If you don't need capital now but know you will need it in a year or so, now is the time to start researching loan options.

Good reasons to get a business loan include:

  • To buy assets that will add long-term value to your business or help to increase your revenues. Paying cash for equipment, machinery or real estate ties up funding you need to run your business. As long as the purchases are good investments, using a business loan to buy them makes sense.
  • To expand your business. Using a loan can help you finance expansion without draining working capital from the business.
  • To better manage cash flow. If you have customers who take 60, 90 or even 120 days to pay you, or you're in a seasonal industry with predictable slumps, a business line of credit or invoice financing can help you meet your working capital needs.
  • To help build your business credit score. Getting a business line of credit and using it responsibly can help a new business build a business credit history. Just make sure that the lender reports your payments to the major business credit bureaus: Experian, Equifax and Dun & Bradstreet.

When You Might Want to Wait Before Taking Out a Business Loan

Taking out a business loan isn't always a good idea. You should avoid taking out a business loan in the following situations:

  • When you've maxed out your current lines of credit. Using all or most of your available credit raises your credit utilization ratio, potentially negatively affecting your credit score. Lower credit scores make it harder to get approved for a business loan, so take steps to pay down your existing debt before taking on more debt.
  • When the loan terms don't suit your needs. If you can't find a loan with the terms you want, you're probably better off hitting the pause button. Spend some time improving your business and personal credit scores, then apply again to see if you can get terms that are more favorable.
  • When you're trying to salvage poor financial management. It's normal for cash flow to rise and fall in business, but if your business has continual cash flow problems, a business loan is not the solution. Without adequate cash flow, you're unlikely to be approved for a business loan. Even if you are approved, you'll probably pay high interest rates and may have trouble repaying the loan, causing an even bigger cash crunch.

Alternatives to a Business Loan

If you can't qualify for a business loan, investigate these options for borrowing the money you need.

  • Business credit card: If you don't need a lot of money, a small business credit card could be the answer. Getting a business credit card has other benefits: It can help you keep personal and business finances separate; may offer business-related rewards; and may have useful features to manage your money, such as tools to categorize spending. For new businesses, using a business credit card responsibly helps to build a business credit history, which can make it easier to get business loans in the future.
  • Personal loan: Personal loans are generally easier to get than business loans and are available in smaller amounts. You're likely, however, to pay more interest than you would for a business loan. Late or missed payments will hurt your personal credit score, and commingling business and personal finances could cause problems for your business come tax time.
  • Peer-to-peer lending: Peer-to-peer lending sites such as Prosper and Lending Club serve as middlemen for those who want to borrow and lend money. You apply for a personal loan, which is funded by money pooled from individual lenders. If your credit score is too low to qualify for a peer-to-peer loan, consider a lending circle such as the Mission Asset Fund. Lending circles are small groups of individuals who pool their money and lend it to each member of the group in turn.
  • Individual lenders: Do you have friends or family members who can afford to lend you money? You may be able to get better loan terms from them than from a bank. Just be sure to treat the loan as seriously as a bank loan: Draw up a loan agreement, make your payments on time and pay the loan in full.

A Loan at Last

The proceeds from a business loan can help your business survive a slow season, buy essential equipment or expand across the globe. Whatever your purpose, getting a business loan shouldn't be taken lightly. Before you apply for a loan, do your homework. Identify your business goals and how financing can help you achieve them. By taking the time to research the right loan option for your business, you'll improve your odds of getting the money you need.

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