The Complete Guide to Getting a Business Loan
Financing a business, whether it’s a startup or an established business seeking to expand, can make your dreams come true. But it isn’t easy. The multiple business financing methods available to small business owners can become confusing if not fully defined. And the choices you make could lead to affordable payments or payments which cripple your business.
When starting your funding search, you can look at your personal network, government options, and lending options through traditional and alternative lenders.
Your Personal Network
Friends and Family
Borrowing money from friends and family is a tried and true way to finance your business. Start by making a list of the people in your network that you think might have capital to lend. Put together a business plan and have a good idea of the amount of funding you need, and then put together your proposal.
Will you pay back investments with interest, or do you want an interest-free loan from your parents? How soon will you be able to repay the money that they’re lending you? And why should they risk lending you money? Think about what you’d ask a friend before lending them money and be prepared to answer those questions. If you are not able to answer those questions, your business plan might need some work.
Be realistic about both your needs and the likely pool of funds in your network. Complicated businesses which require large investments will find it difficult to fully fund their business from a personal network.
Crowd-funding sites have become a ubiquitous method for new businesses to raise funds. These are not loans from traditional banks or alternative lenders. Again, you are soliciting funds from friends, family, and your network, or strangers who believe in the product you want to sell or your business.
Gofundme and Kickstarter are two of the biggest crowd-funding sites, but they take a percentage of the funds raised. Donors often expect rewards or incentives in exchange for contributions. Some require that you meet your goal before you can get any money. Research beforehand and pick the best site for your business’ goals.
Personal Credit Cards
It’s not uncommon for startups and small businesses to draw on personal credit cards for funding needs. According to the Small Business Administration, 13% of startup owners use their personal credit cards for startup capital.
There are advantages to using a personal credit card, particularly if you need cash in a hurry. The line of funding is already open, so there’s no waiting to find out if you’ve been approved for a loan or business credit card. If you pay off the balances, you can use it over and over again for funding needs without having to apply for a new loan. And if you have a rewards card you will receive other benefits, such as airline miles.
Small Business Administration/SBA Loans
Credit available: $150,000–$12,500,000
Average rates: 5%–10%
Small Business Administration loans or SBA loans, are backed by the Small Business Administration department of the government. The government partially guarantees a portion of the loan, but you apply with a traditional lender. The fund are issued through a bank who is an approved SBA lender, such as Bank of America. This guarantee functions like a co-signer. However, SBA loans are only available to individuals who meet stringent criteria, and thus are often not an option for many people.
Banks and traditional lenders who offer SBA loans require excellent credit, a business history and revenues. During the application process, you’ll likely be asked to complete documentation for both the lender and the SBA office. Requirements could include, and are not limited to, business and personal tax returns, financial statements, a business plan, one year’s projected cash flow, and bank statements. Note that often lender require down payments of 10% to 25% of the loan’s total amount.
One of the downsides of applying for an SBA loan is that the process is not fast. It takes time to collect all the required materials, and you might need to involve your CPA. If that is the case, the loan application process alone will have a cost to you in terms of professional fees.
There are different types of loans under the “SBA” banner. 7a loans give business owners funding up to $750,000. Low documentation, or “lowdoc”, versions of these loans, with faster turnaround on approval, are available for amounts under $150,000. If you’ve already borrowed and repaid an SBA loan, you might be able to qualify for the Express program for up to $250,000 in funding.
504 loans are more restrictive. Capital can only be used for purchasing assets like land or equipment, building improvements, and building new facilities. Funds cannot be used for working capital needs, to consolidate or refinance debt, or for real estate speculation. They often require a personal guarantee.
If you think you might qualify for an SBA loan and want to learn more, we recommend checking out this article on the SBA’s website.
Small Business Investment Companies (“SBIC”)
Credit available: $100,000–$250,000
Average rates: 5%–10%
Investment funds which are privately-owned but licensed as a Small Business Investment Company, or SBIC, lend to small businesses. They require that the business have revenues. Investment funds licensed as Small Business Technology Transfer funds, or STTR’s, only work with science and research companies. The SBA matches money put in by investors at a rate of $2 to every $1 of investor money in order to magnify its effectiveness.
Community Development Financial Institutions (“CFDI’s)
Community Development Financial Institutions, or CFDI’s, are institutions sponsored by the government which lend to low-income or disadvantaged individuals in distressed communities. You must already be in business and located in a community which qualifies for this funding. Like SBA loans, the government provides the money to a CFDI in your area who, in turn, lends to you.
These institutions focus on low-income and underserved communities, such as Native Americans. They also provide incentives to local banks to invest. An example of a local CFDI would be Invest Atlanta, a fund which lends to encourage development and growth in the city of Atlanta, with a particular focus on minority and women-owned businesses.
Many state loan funds utilize capital provided to them from the SBA to loan to businesses within their states. Google “SBLF” plus your state to find one that could help your business, or check out the SBA’s resources.
Grants are given by organizations, businesses, or persons for a particular purpose. Reasons that they offer grants vary but are often tied to community-building goals and supporting minority and women-owned businesses. Grants can be to support women or refugee-owned businesses, to promote growth in specific industries, or to incentivize businesses to open in geographic areas that are economically distressed.
Grant applications often have rolling deadlines throughout the year, and will then close to applications for a period of time while the selection committee reviews applications. Their qualification requirements could get quite specific as to type of business and other factors. Grant programs through the government include grants for veterans, disabled veterans, and grants meant to expand inter-state trade and export. If approved for a government grant, your business may be subject to audits and might have to report back to the government on how the funds are being used.
States and local governments also distribute grant money to encourage economic growth within their communities. Your local library, Better Business Bureau, or local government website, may have information. Similar to SBA loans, you will have to prepare application packages, which could include writing essays and grant proposals detailing how you will use the funds disbursed.
Traditional and Alternative Lenders
Traditional Term Business Loans
Credit available: $5,000–$250,000
Average rates: 5%–10%
Traditional term business loans are lump sums of capital that are disbursed to borrowers in one distribution. If you pay down the loan, there is no drawing on the loan again. They are repaid over a set period of time, the loan’s term, and have a fixed interest rate. Because of this, you will always know what your monthly payment will be. Intermediate-term loans are loans with repayment periods less than and up to three years. Long-term loans can have a term up to 20 years. Term loans are most commonly used for a specific, one-time business purpose.
Traditional lenders such as banks and similar financial institutions will have the lowest interest rates and best terms, but also the most stringent requirements. Expect to complete a thorough application, including bank statements and tax returns, a credit score, and likely a business plan. For more information on what might be required, read our article here(everything you need for business loan application).
Payments will be spread over a fixed term, which means that they will be lower if you have a long term. Because they are fixed payments, if your business has large cash flows up and down you could struggle to make payments during low months. In that case, a business line of credit which you could pay down during good months might be a better fit for your business.
Even if you have a less favorable credit score or business financials, a term loan may not be out of reach. Alternative lenders also lend term loans to borrowers that don’t meet a traditional lender’s requirements. Also, working with alternative lenders has its advantages.
Alternative Short Term Business Loans
Credit available: $5,000–$1,000,000
Average rates: 10%–45%
Alternative lenders are a business funding resource for individuals that are looking for a business loan but do not meet the traditional financing standards. They require less documentation and smaller applications as they are private business loans, so you don’t have to spend as much time preparing to get a loan and will receive funding faster. They will consider borrowers with lower credit scores, weighing a business’ revenues and history when making a lending decision. Interest rates will be higher than at a traditional bank, which reflects their risk. However, they still approved 56.6% of all loan applications in 2018.
Business Line of Credit
Credit available: $5,000–$250,000
Average rates: 5%–10%
A business line of credit has a credit maximum, say $100,000, like a credit card. You can draw against the line up to that amount whenever needed and only pay interest on what you have borrowed. Business lines of credit can be secured by collateral, in which case you’ll likely pay a lower interest rate, or unsecured. Collateral can be real estate, savings or retirement accounts, or equipment.
How does a business line of credit work? You might borrow $20,000 for new computers and another $5,000 to cover a late invoice. Then, after you’ve paid that back, the full $100,000 is available to help you open a new location. They are great for filling working capital needs.
The advantage of lines of credit is that they’re very flexible. You can use them for just about whatever you want and, once you’re approved, you can access that money very quickly. They are great to have open to cover short-term cash shortfalls. Often, you can write a check on the line of credit, use a card which accesses the line, or pay a bill out of the line of credit online.
You may have difficulty getting a business line of credit if your credit score is bad. In these situations, it’s best to be upfront with your lender and tell them why you have bad credit and how you’re working to improve the situation. Alternative Lenders like Shield Funding often offer bad credit business loans to small business owners with lower credit scores.
Credit available: $10,000-$500,000
Average rates: 5-30%
Small businesses often need funds for specific purposes. If your business needs new equipment, whether it’s a backhoe or commercial mixer, than equipment financing could be an option. Equipment financing loans can be used to purchase one large fixed asset or multiple smaller items. They will cover vehicles, computers, and machinery both new and used.
Equipment financing loans have shorter terms than most traditional term loans, lasting two to six years, typically the depreciable life of the asset purchased with the loan. Because the equipment serves as collateral for the loan the paperwork is less burdensome than a term loan. Approval times are faster than traditional term loans as a result.
The amount that you will qualify for depends upon the equipment’s value, your credit score, and your business history. Rates can be fixed or variable, based upon prime. Lenders are willing to work with borrowers who have lower credit scores because of the collateral involved, down to a score of 500.
While you might have to supply bank statements and tax returns, a unique requirement for equipment financing applications is an equipment quote. A quote or documentation of the equipment’s cost is needed for the lender to establish the value of the loan’s collateral. Traditional lenders often employ appraisers to appraise high-value purchases.
Depending on the lender, you could need a down payment on the equipment. Others will finance up to 125% of the equipment’s value in order to cover “soft costs.” Soft costs are charges like taxes and delivery. Keep in mind that traditional lenders prefer that you have been in business for a minimum of two years, and that higher value loans will have more stringent loan qualifications. Some list annual minimum revenues of $250,000 on their websites. Many equipment financing loans offer a 90-day grace period before you have to make payments.
Taking out an equipment loan allows you to preserve working capital to cover day-to-day operations. Some lenders will structure payments to align with your income and seasonal revenue streams, giving you more flexibility. Often, lenders specialize in certain industries such as construction, healthcare, transportation and more. If your industry has unique features, particularly in its revenue streams, try to find a lender who knows your business.
In addition to loans, equipment can be financed through leasing. At the end of the lease, you do not own the asset (unless your lease contains a lease-to-own provision), which can actually be advantageous. If it’s an asset that needs frequent replacing or quickly becomes outdated you do not want to own a bad asset at the end of a loan’s period. Leases, too, will offer flexible payments and fixed or variable interest rates. Rates are comparable to equipment financing loans.
Note that one of the previous advantages of leases, holding them off balance sheet to improve financials and ratios, no longer holds true. With a new accounting pronouncement, Topic 842, all leases longer than a year must be on your balance sheet. They will now have an impact on your financial ratios.
Business Credit Cards
Credit available: $10,000-$500,000
Average rates: 13.49-24.99%
Loans charge lower interest rates than business credit cards, which is why many small business owners try applying for a loan first. But for those with poor personal credit, a newer business, or other reasons that traditional loans aren’t an option, business credit cards can fill your funding needs.
With a business credit card, you’ll have a grace period of up to 25 days before payments come due or purchases begin to accrue interest.
Rates for business credit cards depend on your credit score and the prime rate. Rates often calculate off Prime, or a base rate, because that is the rate that lenders pay to access funds. If that rate goes up, they want to be able to pass the rate increase onto you. Sometimes credit card companies offer 0% introductory APR’s, but if you do not pay off the balance in full by the time the promotion expires you will pay interest.
If you have less than stellar credit, an alternative lender might be willing to work with you in opening a credit card, but it might be necessary to pledge collateral or obtain a co-signer. You will pay a higher interest rate, but only if you carry a balance month to month.
Invoice Financing and Factoring
Credit available: $10,000-$500,000
Average rates: 10-79%
If you have a large balance of past due receivables, you might be able to get cash in a hurry. Waiting to get paid is one of the most frustrating aspects of being a small business owner. If customers are behind on their bills you still have to pay yours. Invoice factoring, or accounts receivable (“A/R”) financing lenders help you smooth over the cashflow bumps.
When you work with an A/R financing lender, you pledge the value of your past due receivables as collateral. Your personal credit will not be a factor, however, the lender may ask for credit information about your customers. Invoice factoring is when the invoices are sold directly to the lender; invoice financing is when they are pledged. Both let you turn your receivables into quick cash, but in turn you will not get the bill’s total amount once the customer pays.
The lender takes a percentage or flat fee of the past due invoices as payment on the loan. If you pledged a $100 receivable, for example, and the factor rate you were charged is 10%, once collected the lender would only remit to you $90. The remaining ten dollars would be their fee. The factor rate often rises over time, so the longer the invoice has been outstanding, the higher the lenders’ fee.
When an invoice financing lender advances the sum to you, they also hold an amount in reserve in addition to their fees. After deducting their factor fee, they then will advance you a percentage of the invoices remaining value. This percentage is usually in the 80-85% range.
Note that if you choose an invoice factoring lender and sell your invoices rather than borrow against them, it is the lender who will collect on them. This might create some confusion with customers, or give the appearance that your business is not doing well. With invoice factoring, you give up control of the customer interaction, so you should take care that the factoring lender will treat your customers respectfully.
With invoice financing, instead of your personal credit being an issue, your customer’s credit could become an issue. If they have poor credit, you might not receive a higher advance or could be charged higher fees to offset the risk they represent. Rates can be quite high, ranging from 10% to 79%, so think carefully about the trade-off between short-term cash now and the risk of giving up a significant chunk of your cash flow.
Check out companies such as BlueVine, Fundbox, and DealStruck if you think this type of business loan could fit your needs.
Consider Credit Unions
Credit unions offer many, if not all, of the same products that traditional banks and alternative lenders provide. They are owned by members, and typically you must join in order to use their services. Because they are member-owned they work to support member’s financial needs, such as small business loans, rather than to return profit to shareholders. They have higher approval rates than traditional lenders. Credit unions approve 40.2 percent of loan applications, versus traditional banks 26.5% in September 2018.
Other Forms of Loans
Personal Loans and HELOC’s
Credit available (Personal Loans): $5,000–$75,000
Average rates (Personal Loans): 7.49%–25.47%
If you’re a startup with no revenues, or a small business that has only been operating for a short time, it will be very difficult to get a business loan. Traditional lenders are almost guaranteed to turn you down, and even alternative lenders need revenues and business history. Your personal finances, and personal guarantees, are typically how you will be able to access capital.
Personal loans are granted on the strength of your income, credit score, personal assets, education level and job. They are often used to consolidate higher-interest credit card debt, and have fast approval and turnaround times. Some lenders, such as Lending Club and Avant, loan to individuals with credit scores down to 600 if they can prove that their income will cover the payments.
Homeowners might be able to obtain a home equity line of credit (“HELOC”) to draw upon to finance your small business. You’ll need at least 20-30% equity in your residence. While your home serves as collateral, your personal credit score will still be considered in the loan application process. A lower credit score won’t lead to an automatically disqualification, however, because of that collateral.
Peer to peer lending is a form of private lending. Individuals with capital choose to lend in the hopes that they’ll receive a higher rate of return than they could get in the stock market or through other investments. Platforms match lenders with borrowers. Sometimes all that’s required are for you to verify your identity and income; they don’t even perform a credit check.
To qualify, your monthly income should be enough to cover payments. It’s likely that you’ll have to submit your last two paystubs, but there could be other qualifications such as a business plan or revenues.
Credit available: A percentage of your total 401K
Average rates: Prime plus 1%
If you are currently working for an employer who offers a 401K, and have over $10,000 in that 401K, you might be able to take out a loan against this balance. You are borrowing money from your retirement savings, rather than working with a traditional or alternative lender, to fund your business now.
Not all employers offer this option to their 401K participants. Contact the company who services your 401K, and ask if loan options are available to you. You can only take out a loan against the vested amount in your 401K. If your employer has deposited funds 401K match funds which have not yet vested, you can’t borrow against them.
Loans must be repaid through payroll deductions, which is why you have to currently work for the company. If you lose your job while repaying the loan the entire amount will come due in full or face significant tax penalties.
Jewelry Business Loans
Credit available: Based on item’s worth
Average rates: 3% – 36%
If you have valuable jewelry sitting around gathering dust, it’s possible to turn it into funding for your business. These online, short-term loans are available on fine jewelry, loose diamonds, luxury watches and gold and silver.
The process works by having you fill out an online application describing your jewelry. While you apply online, you will have to ship the item to the lender for it to be held as collateral. They will evaluate it and make you an offer. If you do not like it, they return the item free of charge.
Other websites, such as worthy.com, are auction services which do the same. After determining the item’s value they will give you the option to list the item at auction. You can set a floor. Diamond jewelers bid on the item and you will receive the highest bid less fees. It’s a straight sale, however, and you will not get the item back.
Multiple Lender Platforms and Broker Aggregators
Credit available: $25,000-$500,000
Average rates: 4.99% and up
Instead of applying for a loan with just one lender, apply for funding from many lenders with just one loan application. There are online platforms through which institutional investors lend funds to small businesses in order to diversify their portfolios and get a better return.
Platform lenders like Boefly, Funding Circle, Biz2Credit are one-stop application centers that submit your application to multiple local and nationwide lenders. Instead of filling out multiple applications at several local banks, which takes valuable time, you complete one application which is submitted to many lenders. They promise loan decisions in 24-48 hours and funding within as little as 24 hours to 5 days. A quick approval and funding process is one of the advantages of working with a multiple lender platform.
Similar to traditional banks, they will want to know your annual revenues, how long you’ve been in business, and your credit score. Because multiple lenders are reviewing your application it increases your chances of being approved and getting a more competitive rate.
Find an Association to Help
If you’re having a difficult time finding the right lender for your business, talk to an association. Associations are not lenders; instead they help you find a loan. They may be able to put you in touch with resources in your community such as local banks, credit unions or non-profits who give out grants.
The National Federation of Independent Business, or NFIB, is one such association. Members receive benefits such as discounted rates and waived fees with many online lenders. A local chamber of commerce can also be an excellent resource, as well as providing networking opportunities that could introduce you to potential investors. Look for industry and trade show associations, as well, who will have access to information about lenders who specialize in your industry.
Join a Small Business Forum
Other business owners can be a great resource when you are looking for funding options and advice. Check out the Small Business Administration’s blog for tips on the types of financing available, how to determine your funding needs, and more. Credit card companies such as American Express or Bank of America host small business forums for owners to connect and share expertise. The National Small Business Association hosts events and provides information for small business owners.
As you can see securing a business loan can come in various ways. The availability of many of the options will be determined by a borrower’s credit score; however, there are quite a few alternative lenders that offer bad credit business loans or higher interest rate credit cards if you do not meet the requirements of more conventional financing options. There are also associations and forums that can help provide information to guide you through the business funding process.