Small Business Administration loans
SBA loans are funded through small business lenders but guaranteed by the U.S. Federal Government. Because the Federal Government backs the loan, your small business is more likely to get approval than if you went directly to lenders. SBA term loans range from $500 to $5.5 million.
Who can apply?
For-profit businesses that operate in the U.S. or U.S. territories can apply. The business must have existing equity investment from the owner, and not have loans or financing from other lenders. There are also certain size standards to be eligible to apply.
SBA loans offer flexible amounts and terms. Both short-term loans and long-term loan options are available, and SBA loans typically offer some of the lowest interest rates.
The SBA loan application process is long and difficult. Business owners may be required to disclose personal credit information and approval can take months. Because SBA loans offer attractive terms and rates, they are often limited to those with a strong credit history, financial records, and enough collateral to back the loan.
Traditional business loans
You apply for traditional business loans directly to the lender or financial institution. Loan amounts range depending on the lender requirements, lender size, and your business’ industry, size, and history.
Who can apply?
There is no one-size-fits-all answer here—you can spend days researching small business loans and find seemingly endless options. To narrow down your options for a traditional business loan, focus your search with your company size, balance sheet, history, and personal risk in mind.
Flexibility is the key benefit to traditional business loans. You can apply for loans that fund general business purposes, or loans specific to capital investment (for example equipment, inventory, additional employees). The sizes of loans available also vary. But keep in mind, the larger the loan your request, the more information you will need to provide.
If you don’t have good business credit, a solid business history, or don’t want to personally back your business loans, you may have trouble gaining approval for traditional business loans.
Business lines of credit
A business line of credit is similar to a loan because you apply for access to a specific amount of money. Once approved, you have access to the funds. Unlike a loan, though a business line of credit allows you to withdraw only the amount of cash you need, and you only pay interest on that amount of money.
Who can apply?
The application process is similar to a traditional bank loan; however, the process is more in depth, usually requiring you to provide both business and personal records to the lender.
Lines of credit are a great way to make sure you have cash available when your business needs it. At the same time, you don’t pay interest unless you use the available cash.
In exchange for the credit line approval, you will likely restrict your ability to receive debt financing from other sources. The credit line agreement may prevent you from offering your business collateral to other creditors, including suppliers and financial institutions.
Invoice factoring, also known as invoice financing, is a practice where your business sells your accounts receivable to a third-party company (the factoring company). The factoring company immediately pays your business a large percentage of the invoice amount—often 80% to 90%.
Your customers pay the invoice amount to the factoring company according to the invoice payment terms (30 days, 45 days, 60 days, etc.). Once your customer pays the factoring company the invoice amount, the factoring company pays your business the remainder of the invoice, minus their fee.
Who can apply?
Factoring is generally available to companies that have a large customer base that pays consistently through invoices. If this sounds like you, your business may be an invoice factoring candidate.
Your business gets immediate access to cash due on each invoice. Instead of waiting 30, 45, or 60 days for invoice payments, your business gets the majority of that receivable immediately. This immediate payment from the factoring company increases your cash flow.
You never receive 100% of your accounts receivable. Even if the factoring company is able to collect 100% on the invoiced amount, you will have to pay them a fee for their services.
Speciality small business loan programs provide funding for certain people, groups, or causes. For example, the SBA’s Office of Women’s Business Ownership and Women’s Business Centers help female business owners find loans. The U.S. Department of Agriculture (USDA) helps small business owners in rural areas get loans.
Who can apply?
Specialty loans are available to business owners that meet certain requirements or businesses that do a specific kind of work. To see if you qualify for specialty loans, search for loans based on your unique criteria (age, gender, ethnicity, disability) or industry (non-profit, agriculture, medical, research).
The average small business will not be eligible for a specialty loan. Specialty loans exist to bolster underserved demographics or causes. If you qualify for a specialty loan, you will face less competition in the approval process.
Specialty loans can require extra paperwork to prove your business meets the criteria, and the loan may restrict your ability to utilize funds. For example, if you receive a USDA backed loan, you may be able to buy farm equipment with equipment financing, but not use the money to buy new computer equipment.
Alternatives: Microloans, marketplaces, and credit cards
If you can’t qualify for a business loan or line of credit, you may consider loan alternatives: microloans, business loan marketplaces, or credit cards.
Microloans offer less money than standard loans. Depending on the lender or lender marketplace, microloans can range from fifty dollars to a few thousand dollars. Microloans are often funded through crowdsourcing platforms and don’t always require the rigorous approval process associated with traditional loans. Individuals may not be able to fund an entire business loan, but if their money is pooled with others they may be able to collectively fund a loan.
A small business that cannot get loan approval from standard lenders may be able to secure a loan from a loan marketplace. A pool of individual lenders is more likely to approve a risky loan because the risk is spread across the multiple lenders that come together to fund it. For these reasons and others, business loan marketplaces have been steadily growing in popularity.
Finally, don’t forget about credit cards. It may seem strange, but even if your business doesn’t get approval for a $10,000 small business loan, it may get approved for a $10,000 business credit card limit. Many credit card issuers have specific programs tailored to small businesses.
These three loan alternatives might be good options (or the only option) for businesses that cannot obtain a business loan. If you have trouble getting approved for a business loan, consider your credit card options.
All three offer your business buying power when your business is unable to secure a traditional business loan.
Microloans, loan marketplaces, and credit cards all tend to carry higher interest rates than small business loans.
How to get a small business loan
- Determine how much money you need
- Decide if a loan is the right method
- Select the type of loan that fits best
- Review the lenders available
- Review each lender’s requirements
- Collect information and apply
How much money do you need?
It may seem obvious that you should figure out how much money your business needs before you start looking for a loan. But, there are three very important reasons you shouldn’t skip this step.
First, the bigger your loan, the more interest you will pay. Your loan is an interest-bearing debt that will weigh on your balance sheet. You want to pay off your loan as efficiently as possible. The more you pay, the quicker that loan will disappear from your business liabilities.
Second, remember that lenders make money on your interest payments—they want you paying interest for as long as possible. If you know how much money you need before you talk to the lender, it’s less likely you will be convinced to take out more money than you actually need.
Finally, most loans affect your credit score. Too much debt negatively impacts that score. The less debt you take on, the less likely the loan will bring your credit score down.
Is a loan the best way to fund your business?
Before jumping into debt, consider your other options. Would it be better for your business to bring on an additional owner or partner in exchange for equity capital?
Instead of taking on a loan to higher additional employees, is it possible to outsource the work to a freelancer and avoid the need for a loan?
Loans aren’t necessarily bad, and they are a normal way to raise capital for businesses of all sizes. However, many businesses weigh down their balance sheets with so much debt that they can’t recover. Make sure a loan is the right fit for your business before committing to one.
What’s the best loan for your business?
As mentioned, there are plenty of loan options for your business: SBA loans, traditional small business loans, specialty loans, lines of credit, and loan alternatives. How do you determine which one is the right fit for your business? Go through a list which each loan to determine suitability for your business:
- Interest rate
- Loan terms
- Impact on credit
Make sure to take a careful look at the loan requirements to see if your business qualifies. If you qualify, review any restrictions that might apply to the loan. If restrictions prevent you from using the funds the way your business needs, the loan is not a fit.
Look for any early pay penalties that may apply in the event that you can pay off the loan before the end of the term. Remember, lenders make their money on interest!
Finally, think about the impact of the loan on your business credit score. Some debt can help your credit rating, but too much debt will pull that number down.
Find the best lender available
Once you find the type of loan that fits best for your business, find applicable lenders. Think of your business as a customer during this process. Shop around and search for the best deal possible. Because lenders make their money on interest, they may not offer you their best rate right away. Don’t be offended by this. Push back. Let the lenders know that you are shopping their rates and terms against competitors.
A word of caution as you shop lenders: If you give a lender permission to check your credit score, the check will show up on your credit history. You don’t want your credit score checked too often in a short amount of time. Get as many details as possible from a potential lender before you give permission to check your credit score.
What are the lender’s requirements?
Once you’ve narrowed down the list of lenders, make sure you understand their requirements before applying. For example, most lenders require collateral to secure the loan. Collateral is an asset that your business owns. Typical collateral includes inventory, equipment, accounts receivable, and other business assets that have a value which is easily calculated. Understand collateral minimums, and any other loan requirements, early in the process. Give yourself time to determine what risks you are willing to take to secure your loan.
In the legal documents to finalize the loan, you will offer your business collateral as the backup. If you don’t pay the loan, the lender has the right to take your collateral, and then sell it to repay your debt.
If the lender is not satisfied with your business collateral, it may require that you find a co-signer with better collateral who will be financially responsible for your loan. In this case, you want to find a co-signer before the loan documents are ready for signing. Asking for a co-signer to risk his or her collateral to secure your loan is no small thing, so they’ll need to consider the risks and make an informed decision.
What documents and information do you need?
The documents required to secure a loan vary from lender to lender and are based on your business history.
If your business carries enough cash to cover the entire loan, you likely won’t need much more than a balance sheet and some recent financials. However, the fact that you are considering a loan probably means you don’t have that much in the bank. In this case, you will need a few years of business financials, a written business plan, your business credit history, personal financial information, contact information, references, and possibly more.
For example, if you run a law firm, construction business, accounting firm, medical practice, or real estate agency, the lender may require you to show your professional licenses that prove your qualifications. If you are building new property or developing land, the lender may want to see surveys, blueprints, or other documents related to the project.
The more business information you have available, the more prepared you will be. If specific licenses, qualifications, or permits tailored to your business exist, have the documentation ready when you apply for a loan.
Qualifying for a business loan
- Basic loan requirements
- How to improve your business credit score
- Tips for getting approved
There are some basic requirements and documents you’ll need to secure a loan:
- Credit history
- Business history
- Business plan
Credit history is ideally your business credit history. However, if you are a startup, lenders may require documents showing your personal credit history. In this case, make sure that you understand what your personal responsibility is if the lenders ask to check your personal credit history. If you co-sign a business loan, you are personally responsible for the debt incurred by your business.
Your business history is a brief description of your business and its financial track record. Prepare at least five years of financials and bank statements if you have been in business this long.
Lenders will want answers to questions like:
Is your business growing? Is your business profitable? If your business isn’t profitable, is it on a trajectory of profitability? The more information you can provide, the better your chances of getting approved.
They’ll want to know how you will use the funds. Unlike your pitch to investors and customers, lenders aren’t concerned with your groundbreaking ideas. Your pitch to lenders should specifically address how you will apply the funds and how your business will pay off the loan.
For example, they want to hear that you will hire software developers with the loan money, and the applications the developers build will start generating revenue within six months of hire. They don’t care about the software itself, only that the software will allow your company to pay interest when due for the life of the loan.
Finally, lenders need a clear understanding of your business collateral. If you don’t pay off your loan, the lender needs to know how it will get back the money it loaned you. Collateral in cash form that is easily converted to cash is most attractive to lenders. Because your equipment, inventory, and accounts receivable all change in value as you operate your business, most lenders will require multiple types of collateral to finalize a loan.
How to improve your business credit score
Your business credit score serves similar purposes as your personal credit score. However, because your business conducts more transactions than you do, there is more data available. Examples include transactions, daily balances, outstanding debts, and payment history.
- First, to start improving a bad credit score, start by obtaining your current scope through an agency Equifax or Experian. Start paying your bills on time. Your creditors can and will report bad payment history. Pay on time.
- Second, improve your credit utilization ratio. Your credit utilization ratio is the amount of credit used compared to the credit available to you. Some suggest a 15% credit utilization ratio to improve your credit score while others suggest 30%. This range is acceptable, but do what you can to lower the number by:
- Paying off balances
- Increasing credit limits
- Decreasing debt and credit card spending
- Paying bills on a more frequent than required basis
- Third, open credit accounts with suppliers when possible. The more suppliers you pay on time, the better your business credit score will become.
If your business ends up in collections, make sure you pay off the amount as soon as possible and ensure that the collection agency deletes the negative report from your credit report.
A good business credit score is key to getting loans that you need. Consider these steps to improve your score.
Tips for getting a small business loan approved
Preparation is the single best thing you can do to increase your chances of getting approved for a business loan. Start the process as early as possible. Research loan types, loan terms, and loan requirements before you actually need the money.
The same goes for your credit history. Know your business credit score now and start taking steps to improve it. When it comes time to apply for the loan, hopefully you will have already improved your initial score.
Get your finances in order and your business plan together. Talk to others who have gone through this process. Lenders are always changing what they look for. The more information you have walking into the loan application process, the better your chances.
Think about the business loan application process as you would a conversation with potential investors or customers. After all, it is a business transaction. The lender needs to believe you will pay the interest and the principal to make sure the deal makes sense from their perspective. Be prepared. And, as a final tip, be wary of merchant cash advances. Known for having high interest rates, defaulting on merchant cash advances can also make your credit score plummet and even lead to a lawsuit.
Applying for a business loan
Once you have narrowed down the loan type for your business and determined you are qualified, it’s time to apply. To apply for a small business loan, you need:
- Reason for the loan
- Credit history
- Business plan
- Annual revenue
- Tax returns
- Financial statements
Not only should you have identified the reason for the loan, but you also should have ruled out other capital-raising options, and made sure you aren’t asking for more money than you need. You should have a very specific number in mind and a plan for using the funds.
Besides your current credit score, you’ll need documents outlining your credit history. Your credit history and credit utilization ratio should be improving, and you should be paying your bills on time. Don’t forget to clean up any negative reports on your credit report with the credit agencies.
You should be on the third or fourth draft or your business plan. This draft should include updates from experts and others who have been through the business loan process. Ideally, you know someone in the lending space who can give some tips as well.
Finally, your documents should be mostly prepared. If you are a startup, you won’t have that many business documents, so have your personal documents ready to go.
Applying for a business loan can be intimidating. But, with some preparation, you can increase your chances of approval and get the money you need to take your business to the next level.
QuickBooks Resource Center: Small business financing options: Loans, literature and more