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Running a small business isn't cheap. You might need capital to obtain real estate, manufacture products, acquire inventory or pay employees, along with a whole host of other expenses. While some entrepreneurs are lucky enough to have personal savings or investors to cover these costs, many small business owners require financing. There are numerous forms of business financing out there, but loans are one of the most common types. To get a small business loan, you typically need to have solid credit, steady income and, in some cases, at least a year or two in business. Here's what you need to know about obtaining a loan for your small business.
Check Your Personal and Business Credit
Before you start looking for a business loan, it's smart to know where your credit stands since this is one of the key factors lenders look at when evaluating your loan application. You can dispute any errors and see if there's anything you can improve before you apply.
When you apply for a personal loan or credit card, lenders just look at your personal credit report. But when you're applying for a small business loan, lenders also review your business credit report. Yes, you have a business credit report. It helps lenders get a sense of your enterprise's creditworthiness and financial history, including any past collections, liens, judgments or bankruptcies. It also includes background information about the business and any Uniform Commercial Code (UCC) filings.
Research Different Types of Small Business Loans
There's not just one type of small business loan—you have several different options to choose from. Here are a few:
- SBA loans: These loans are backed by the U.S. Small Business Administration, but offered through private lenders. There are a few types of SBA loans, with the most common being term loans. The government sets interest rate caps on these loans, so they usually have lower interest rates than non-SBA loans. However, they can be hard to qualify for, and the application process is long and intense.
- Term loans: If you can't qualify for an SBA loan, you can apply for a regular business term loan. Some banks and credit unions offer them, as do an increasing number of online lenders that make the process even faster and easier. Like SBA term loans, you get a lump sum upfront and repay it in fixed installments over time, making it ideal if you have large expenses that require upfront payment.
- Line of credit: Rather than a lump sum you receive with a term loan, a line of credit is revolving, much like a credit card. You receive a credit line you can repeatedly draw from for business expenses, and as you repay it, you can re-borrow the funds. You only borrow and pay interest on what you need. A line of credit is more ideal than a loan if you have smaller recurring expenses or just need a cash cushion.
- Other options: If you're struggling to get one of the small business loans mentioned above, there are some other financing options to explore, including personal loans, business credit cards, invoice factoring, merchant cash advance, inventory loans and equipment loans.
See if You Qualify
Not sure if you're eligible for a small business loan? To qualify, you have to meet certain criteria, though it varies quite a bit depending on which type of loan you're applying for. For example, SBA loans require the business to be for-profit and of a certain size. In addition, as the business owner, you must have invested equity and exhausted other financing options.
Some lenders will require you to put up collateral, such as real estate or equipment, especially if you're a newer business or otherwise deemed risky. This means if you default on the loan, the lender can take ownership of those items. That makes it even more important to only take out a loan that you can afford to repay.
While business loan requirements vary, lenders typically look at:
- Your credit score: The minimum credit score allowed varies significantly depending on the lender. For example, SBA loans typically require a minimum personal credit score of 620 to 640, but some SBA lenders require higher scores. Keep in mind that the better your credit, the lower interest rate you can qualify for. On the flip side, worse credit can land you a higher annual percentage rate (APR).
- Your business income: It's common for small business lenders to require your business to have a certain amount of income or cash flow. This is to help confirm that you'll be able to repay the loan. If your business isn't very profitable or income is inconsistent, it will be harder to get a small business loan.
- Your time in business: Some lenders may not have a minimum requirement for how long your business has been around. But others won't entertain your application if you're not an established business. For example, SmartBiz, an online SBA loan lender, requires two or more years of business history.
Gather Required Documents
Small business loans are usually for much larger amounts than personal loans, so in the application process, lenders typically require significant amounts of documentation. This helps them decide whether you and your business have the stability and income to repay the loan on time.
To expedite the loan process, it's smart to ask your lender what documents you'll need and gather the required paperwork in advance. The documents you'll have to provide will likely include:
- Business bank statements
- Personal and business tax returns
- Business financial statements
- Information on any business debts
- In some cases, a business plan
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Know Before You Go
Applying for a small business loan can be time-consuming, so before you go to a lender and start the process, check your personal credit report, which you can get for free from Experian, in addition to your business credit to know where you stand. If it doesn't appear up to snuff, spend some time improving your credit before applying for a small business loan, or start looking into alternative financing options.