Starting or expanding a small business can be a very difficult task. Most small business owners do not have the funds to lift their businesses off the ground without additional help. Small business loans allow new business owners to fund daily business operations and pursue new business ventures. Depending on what you need the money for, there are a variety of small business loans to choose from, as well as different types of lenders. It is important to understand what all of your options are so you can choose the type of loan and lender that best suit your needs.
Types of Lenders
There are several types of lenders you can choose from when pursuing a small business loan. Each lender will have its own advantages and disadvantages. Furthermore, each lender will offer different types of loans.
- Bank Loans
Conventional bank loans can be very appealing as they generally have the lowest interest rates. Additionally, the approval process does not involve a federal agency. This means that the approval process can be carried out much more quickly.
On the other hand, bank loans have several downsides. First, they often have shorter repayment terms than other types of loans. Moreover, conventional bank loans can be very difficult to get approved for. However, if you are able to get approved, bank loans are often the best option available.
- SBA Loans
The SBA, or Small Business Administration, offers a variety of funding programs for small businesses. Rather than lending money to businesses, the SBA partners with banks and other institutions and sets guidelines that reduce the risk for lenders. These guidelines generally cover 75% to 90% of the loan, essentially guaranteeing that it is paid back.
Long approval times
Alternative lenders include pretty much any institution that isn’t a bank and doesn’t operate through the SBA. Alternative lenders may directly loan you money, or they may pool multiple smaller loans from a lending marketplace.
One of the main attractions of these alternative lenders is that they can have incredibly fast approval times. Many alternative lenders offer online applications and make their approval decision in a matter of hours. From this point, you can expect to receive your money in just a few days. Furthermore, the requirements for these loans are often very lenient and can be used for a variety of expenses.
However, be sure to be scrutinous when reading over the terms of these loans. Many alternative loans have much higher interest rates than bank loans or SBA loans. As the requirements for alternative loans aren’t generally strict, they are much riskier for the lender.
Types of Small Business Loans
The types of small business loans available depend on which lender you choose. As such, it is important to be aware of your options before choosing a lender.
- Professional Practice Loans
Professional practice loans only apply to certain businesses. These loans are meant for small businesses that provide a service such as healthcare, legal, accounting, veterinary, and other services. Professional practice loans are generally offered to people who intend to purchase a new practice, refinance debt, purchase equipment, or buy real estate.
- Working Capital Loans
These loans are designed to be used to fund standard business operations. They are short-term solutions that are available from both banks and alternative lenders. Working capital loans allow small businesses to keep their companies afloat as they look for alternative funding solutions. Be wary of the high-interest rates and short repayment terms that are often accompanied by these loans.
- Franchise Startup Loans
Franchise startup loans are typically used to pay franchise fees, build new locations, purchase equipment, or to fund business operations. These loans are designed for people who need funding to start their own franchise.
Lines of credit are meant to help small businesses fund daily business operations, much like working capital loans. Depending on what is offered by your lender, they can be short- or long-term solutions. However, they are not meant to be used for large purchases. This type of loan is typically unsecured and can help you improve your credit. However, credit can also dramatically increase your business’ debt if you are not mindful about what it is being used for.
- Equipment Loans
Equipment loans help small businesses purchase necessary office equipment and supplies. These can be used to buy things such as computers, copiers, desks, machinery, and other equipment. Rather than paying for these items at once, businesses can make monthly payments on their equipment. These can be very easy to be approved for as the equipment being purchased is often what is used as collateral.
Types of SBA Loans
- 7(a) Loans
This is the SBA’s primary loan program. 7(a) loans are the most common and flexible type of loan offered by the Administration. These loans can be used as working capital, to purchase equipment, to buy real estate, to refinance debt, and a plethora of other things. 7(a) loans are generally available in amounts up to $5 million and can be repaid in up to 25 years. The loan repayment terms depend on what the money is being used for.
- Disaster Loans
Disaster loans are pretty much exactly what they sound like. Business owners can use SBA disaster loans to repair property, equipment, or inventory that was damaged or destroyed in a declared disaster. These loans are typically very low-interest and are offered in amounts up to $2 million.
Microloans are offered to new small businesses to pay for supplies, furniture, equipment, machinery, or to be used as working capital. However, microloans cannot be used to purchase real estate or refinance debt as other loans can. Microloans are offered in amounts up to $50,000 and can be repaid in periods up to six years. Your loan terms may be dependent on your needs, what you intend to use the loan for, how much you need, and other requirements determined by the lender.
- Equipment and Real Estate Loans
Businesses can obtain long-term, fixed-interest loans through the CDC/504 Loan Program offered by the SBA. These loans can be used to purchase existing real estate, refinance debt, purchase new machinery, renovate property, and other large purchases regarding the expansion of your small business. Generally, you will cover 10% of the cost with the SBA covering 40% and a lender covering the remaining 50%. These loans are offered in amounts up to $5.5 million and cannot be used for inventory or working capital.
How to Apply for a Small Business Loan
First, you need to determine your eligibility for an SBA loan. Eligibility requirements include:
A 680+ credit score for all primary business owners.
While SBA loans do not always require a lot or any collateral, it will make it easier for you to get approved.
You will need to make a down payment of 10% or more to purchase a business or real estate.
You need to demonstrate that you have the cash flow to cover your loan(s).
Your business needs to be profitable and you cannot have any defaults or delinquencies on debts owed to the government.
It is more difficult to be approved if your business has not operated for at least two years.
Once you have determined your eligibility, you need to get your paperwork in order. You will need:
Business financial statements
Personal financial statements
Profit and loss statements
Projected financial statements
Income tax returns
Loan application history
Ownership and affiliation records
Business certificate and license(s)
And any other documents required by the lender
Once you have these documents, you can begin your application. The application can be found on the SBA website. Be prepared to answer questions regarding your reasons for applying for a loan, what the funds will be used for, who your owners and management are, and other inquiries.
Applying for Loans from Banks and Alternative Lenders
Applying for a conventional bank loan or a loan from an alternative lender requires much of the same paperwork as an SBA loan. You will need to provide a complete financial history of your small business, as well as your personal financial records. You will have to demonstrate financial competence and your ability to repay your loan. Additionally, you need to show how a loan will aid your growth plans for your business.
Moreover, you need to explain exactly what the money will be used for. If you plan to purchase equipment and supplies, you should submit quotes for how much the items in question will cost.
When applying for an alternative loan, there are a few things to consider. First of all, you need to consider interest rates. Your interest rate is the main determinant when evaluating the long-term cost of your loan. Be mindful of variable-interest rates which can seem appealing at first, but may drastically increase over time. Only take on an interest rate which you can afford right now. Do not agree to an interest rate which grows over time that you don’t expect to be able to afford in the future.
You will likely also be subject to credit checks to ensure your financial responsibility. The required credit score will vary from lender to lender, however, the 680+ required by the SBA is a good benchmark to aim for before applying for bank or alternative loans.
Tips for Applying
- Get Pre-Approved
Pre-approval is a great way to get started when looking for any loan. This primarily applies to conventional bank loans and alternative loans. SBA loans, on the other hand, have fairly straightforward requirements and terms.
Pre-approval can help you get preliminary loan offers. You can use these to get a better idea of what you can expect and what you can afford. Taking this step can help you narrow down your list of potential lenders before investing too much time in lenders that don’t suit your needs.
- Plan Your Investments
As previously mentioned, you’ll likely be required to submit a detailed outline of what you plan to purchase with your loan. Having a detailed list of the items you plan to purchase and what they cost can make it much easier to obtain a loan. It can also help you be sure that you do not borrow more than you need to expand your small business.
- Have a Growth Strategy
Not only do lenders want to know what you plan to purchase, but they also want to know how it will help your business become more profitable. At the end of the day, lenders only care about being repaid. A solid growth strategy can help convince potential lenders that a small business loan will help your business turn a larger profit and pay them back in a reasonable timeframe. You need to explain exactly how your investments will generate growth opportunities for your business.
- Compare Offers
As the loan approval process can be time-consuming, it can be tempting to take the first reasonable offer. However, it is important to do your due diligence before selecting a loan. You should carefully examine all offers and loan terms to ensure that the one you choose is favorable to you and your business. Many loans are attractive as they offer low-interest rates up front, however, they often include significant fees and fast-growing interest rates you might not be prepared to take on.
Best Small Business Loan Lenders
Choosing the right ender can be a difficult choice. Ultimately, it comes down to what you can afford, how much you need, and what you need the money for. For example, the SBA disaster loan is a very specialized type of loan which you may not be able to obtain from alternative lenders.
While choosing the right lender depends on a variety of factors, there are a few things to consider. First of all, you should be aware of potential interest rates to ensure that you can pay off your loan as quickly as possible. This will help you avoid accumulating excessive interest charges. Additionally, you should be aware of how a lender’s repayment policies will affect your available cash flow. Lastly, be sure to read ratings and reviews of various lenders to ensure that your lender is reliable. Try looking for lenders that have a high rating with the Better Business Bureau.
This piece from U.S. News is a great place to begin your search. Their list is comprised of some of the best lenders for business owners in a variety of circumstances. While your ideal lender may not be on this list, it is a good starting point to begin your search.
Frequently Asked Questions
- Does it Cost Money to Apply for a Small Business Loan?
This is entirely dependent on your lender’s policies. Some lenders will charge you for your application. Furthermore, some lenders may not charge you to apply, but will charge for certain items in the application process. For example, you might be responsible for the costs of running a credit check or appraising assets. Talk to potential lenders before applying to make sure that you are aware of any and all application fees.
- What if I am Denied?
If you aren’t approved for a small business loan, you might have a few other options.
Applying for a business credit card might be an option if you are unable to obtain a loan. Business credit cards can help you cover operating expenses while you pursue other financing options. Business credit cards give you access to revolving credit and may offer rewards. While they are easier to get than loans, they typically have much higher interest rates. As such, a loan is generally a better option if possible.
Additionally, you might consider taking out a personal loan. Personal loans allow you to use the money on whatever you need. You will not be limited on what it can be applied to, but you need to be in good financial standing to obtain a favorable personal loan. Moreover, you will likely have to put up an asset or assets as collateral.
Lastly, you may be eligible for a small business grant. If your business performs scientific research, for example, you may qualify for federal grant programs. Furthermore, there are small business grants available exclusively to women and minorities who want to own and operate a small business. In some cases, these grants even include business mentorship and workshops to help your business be successful.
- How Long Does it Take to Be Approved?
Again, this depends entirely on your lender. Alternative lenders, in particular, typically have very fast turnaround times for approval.
In most cases, you can expect a response in a matter of a few days, but many lenders will actually respond within hours of your application.
- When Will I Receive My Funds?
If you have already been approved and signed a loan agreement, you can expect to receive your funds very quickly. Most lenders will disburse funds within a few business days post-approval.