How To Get a Small Business Loan
Small business owners tend to come from pretty resilient stock.
Running your own company ain't for the easily spooked, after all. Even under perfect circumstances — the business is growing; its reputation is glowing — you face a million little decisions you'll have to confidently stand behind.
Taking out a small business loan creates about a million more. How much money do you need? How much money can you get? Do you need collateral? What IS collateral?
Whether you're a solo entrepreneur or leading a staff of 100, here’s everything you need to know about getting the best small business loan.
Reasons to get a small business loan
Running a small business requires sufficient funds to unlock growth opportunities. The main purpose behind getting a small business loan is to secure immediate funding that can be used to increase profits and then use those profits to repay the debt.
There are various reasons why you might consider taking out a small business loan, such as:
- Enhancing cash flow
- Purchasing inventory
- Acquiring equipment
- Expanding business operations
- Refinancing existing debt
- Reducing tax obligations
Should I get a small business loan?
First things first: Taking on debt brings uncertainty and risk, and small business loans aren’t any different.
If you’re a new business owner, an accountant — and also a financial advisor, preferably — can help you determine what loans you qualify for, how much debt you can afford to shoulder, and whether or not it’s a good idea to take it out in the first place.
You'll also want to think about your specific business needs before you submit a loan application. Is your company still getting off the ground? Are you in growth mode? Do you need extra cash flow to keep payroll and other expenses out of the red? Figure out your "why," and be prepared to put it in writing.
Types of small business loans
Small business owners have lots of different financing options:
Business line of credit
A “line of credit” is a popular one, though it technically isn’t a loan at all. This borrowing option functions much like a credit card, with lower interest rates and higher utility (some small business owners tap lines on credit specifically to pay their vendors who don’t take credit cards). Lines of credit can be used to pay for just about any business expense, up to a certain dollar limit, and interest is paid on funds drawn.
Installment loans
“Installment loans,” or “term loans,” follow a more traditional borrowing structure. The full amount is doled out in a lump sum when the contract is signed, and is tied to an agreed-upon repayment period. Short-term loans can be paid out in a few months; long-term loans are often paid over the course of several years — typically three to 30-year terms.
Other types of small business loans include microloans, equipment loans, working capital loans, startup loans and commercial mortgage loans. You may also want to look into alternative financing options like invoice factoring, small business grants, merchant cash advances and crowdfunding.
SBA Loans: What Every Business Owner Should Know
Many loans (of all types) are backed by the U.S. Small Business Administration (SBA), which works directly with banks and other financial institutions.
SBA loans make the relationship between borrowers and lenders less risky by guaranteeing a portion (generally about 50% to 85%) if it goes into default. Taking out an SBA-backed loan helps borrowers avoid predatory lending and exploitative interest rates.
Small business owners can apply for an SBA 7(a) loan (the agency’s most common loan option), 504 loans and microloans. Those seeking disaster relief can also turn to the SBA for financial support. The Paycheck Protection Program outlined in the CARES Act was created specifically for businesses impacted by COVID-19, but emergency SBA funding isn't new to 2020 — hurricanes, wildfires, and other natural disasters have sent small business owners to the SBA for years.
The quickest way to find traditional SBA loans is through the agency's online Lender Match portal. For emergency loan programs visit the SBA's disaster assistance website.
How to apply for a small business loan
If you decide to apply for a small business loan, follow these steps to ensure a straightforward process.
Step 1: Start with a breadth of research
The SBA website, your community bank or credit union, and online search engines are all great resources for sussing out what kind of funding is available. Use a spreadsheet to track what you find — keep a close eye on interest rates, fees, repayment terms, prepayment penalties and qualifications for every lender you come across.
Step 2: Gather all your documentation
The application process varies by lender, but they’ll likely ask you to provide your personal and business bank statements, balance sheets, income and cash flow statements, credit score, income tax returns and any required business licenses and permits. You will also need to fill out an official application form.
If you’re applying for a small business loan with a bank or credit union, you’ll also be asked to submit a business plan outlining how you plan to use the loan funds.
Step 3: Choose the best lender for you
Some small business loans are easier to secure than others (search for “bad credit loans” online and you’ll find plenty of examples). Online business lenders like Kabbage and Lendio can disperse money in a flash, but beware of sky-high interest rates and steep (sometimes hidden) fees sprinkled throughout the fine print.
Credit unions and traditional banks are usually a safer bet, though you’ll come across higher hurdles. Bank loans typically require a good to excellent credit score and a minimum annual revenue, and the businesses must be at least two years old. You’ll also have to wait a few business days to access the funds once the loan is approved.
How does “collateral” factor into small business loans?
To get a lower interest rate, some business owners provide lenders with personal or business assets as collateral. These are called “secured loans,” and come with an extra layer of risk — if you can’t pay back your loan at the end of the agreed-upon term, those assets will be seized and sold.
For small business owners, collateral typically includes inventory, equipment and commercial real estate. In some cases, businesses also use treasury and corporate bonds, certificates of deposit, outstanding invoices and stocks as collateral.
A loan without any business or personal guarantee is called an unsecured loan and even the best unsecured business loans will have higher annual percentage rates (APR) than secured loans.
What if my small business loan application doesn't get approved?
People get rejected for small business loans all the time. This can be discouraging, but it doesn’t have to be the end of the road.
If your application was denied due to a low or nonexistent business credit score, read up on how to strengthen that number.
Business credit cards are a great way to build business credit but you can also build credit through your relationship with vendors, suppliers and service providers such as your internet, phone or cable provider. Finding a cosigner with good credit, someone who agrees to take over your loan payments if you fail to make them, can also improve your chances.
Consider hiring a small business coach or consultant to help prepare your next application. Score, a nonprofit organization, offers free business counseling throughout the country. And if you’re a woman, a person of color, or another small business owner facing systemic barriers to funding, organizations like the Foundations for Business Equity and the Local Initiatives Support Corporation are chock-full of additional resources.
How to get a small business loan FAQs
Is it complicated to get a small business loan?
What is the minimum credit score needed to qualify for a small business loan?
There's no exact minimum personal credit score to secure small business financing; each lender sets its own credit score policy. However, a higher credit score offers more lender options, favorable terms and lower interest rates.
While most traditional lenders want a credit score above 700, online lenders may provide loans even with scores in the 500s. The interest rates and fees associated with these loans are very high so think carefully before choosing this funding option
How can I get approved for a small business loan?
Lenders consider small business loans to be high risk compared to loans for established businesses. To improve your chances of approval, it is crucial to demonstrate your ability to repay the loan and meet interest obligations.
Lenders will look at your credit history, annual revenue, existing loan balances and tax returns, among other factors. If you meet the eligibility requirements, you will be approved for a small business loan.
Summary of Money’s guide on how to get a small business loan
Running a profitable small business is a challenge and a small business loan is a way to expand your business and increase your chances of success.
There are several types of business loans and lenders to choose from including bank-backed financing and fast business loans typically serviced by online lenders.
Bank-backed financing is generally a safer bet but startups might have a hard time meeting the eligibility requirements. Online lenders are more lenient with the applications they’ll approve but they offset this risk by charging higher interest rates and fees.
Make sure you fully understand all of the benefits and risks involved with taking on a small business loan, and then decide if it is the right option for you. Check out our best small business loans of the year for recommendations.