High interest rates have made getting a small business loan more expensive than it was a year ago, but that hasn't curbed borrowing activity. "There's no shortage of people looking for loans. American entrepreneurship is strong and thriving," says Stephanie Dunn, president of SBA lending at Grasshopper, a digital bank and commercial lender.
But securing business financing can be an intensive process, with lenders requiring a lot of information about your company.
"If the borrower shows up prepared and the bank understands what the borrower is asking for and the industry they're in, the process should be smooth and efficient and quick," Dunn says.
Here's five steps to getting a business loan.
1. Determine the type of business loan you need
The best way to determine what type of loan you need is to get clear about what you plan to use the money for.
If you need to bridge a gap in payroll, pay suppliers or otherwise cover a temporary shortage of funds, a business line of credit may be the best choice. It gives you access to cash for a specific period and you only pay interest on the amount you use—much like a home equity line of credit. Since you only pull from the well when you need cash, a line of credit can help you avoid overborrowing and keep your monthly payments low.
Good to know
You may also get a much lower interest rate on a line of credit than you would on a business credit card, and could avoid transaction fees for charging certain expenses (such as payroll).
If you need to pay for a specific project, such as remodeling a warehouse, or buying a piece of machinery, such as a delivery truck, a fixed-term loan might make more sense than a line of credit. A fixed-term loan gives you a lump sum upfront that you repay in installments, typically monthly. Repayment periods on fixed business loans generally last anywhere from five to even 25 years, in some cases, compared with five years or less on a line of credit.
Compare small business lending options
Here's a summary of common types of small business loans.
2. Confirm your eligibility
Small business loans are issued by private lenders, such as national and community banks, as well as credit unions and fintechs. Each determines its own lending requirements, but qualification generally hinges on your personal credit score and your business' viability.
Conventional business loans and lines of credit
If your business has been around for at least two years and you have strong personal credit, you're probably a good candidate for a conventional business loan. These generally require less paperwork than other business financing options and get approved more quickly. Average interest rates run between 9% and 12%, but borrowers with great credit may qualify for lower rates.
Bank of America, the top business lender in the U.S. by volume, has small business loan offerings that require $250,000 in annual revenue and a 700 minimum personal credit score, among other criteria. There are no established borrowing limits, though, and existing Bank of America customers may qualify for a discounted interest rate.
Another business lender, Agility Bank, a minority- and women-owned community bank in Houston, Texas, offers loans and lines of credit to businesses that are at least two years old, with a maximum borrowing limit of $500,000. The minimum credit score to qualify for financing is slightly lower (670) than with Bank of America, and the full application is online. Bank of America and other large national lenders often insist on in-person meetings or phone calls to gather information.
Conventional business loans that require collateral-i.e. secured loans-may be easier to get approved for than noncollateralized loans and enable you to qualify for a lower interest rate.
For example
Many equipment loans are secured by the equipment itself. So if you default on the payments, the lender can seize the item you’re financing. Equipment loans can be structured as a fixed-term loan or a line of credit.
SBA loans
If you or your business fall short of those minimum requirements-or you're launching a brand-new business-you likely won't qualify for a conventional loan. Your best option may be an SBA loan. Backed by the U.S. Small Business Administration, SBA loans protect lenders from borrower defaults and cater to businesses that meet certain size and revenue criteria.
Applying for an SBA loan requires extensive documentation and, in some cases, can take up to 90 days from application to funding. The upside is that many SBA loans have high borrowing limits and competitive terms, such as lengthy repayment periods, interest rate caps and low upfront costs, which are set by the federal government. Many lenders offer both SBA loans and conventional business loans. Some provide business banking services too, which is helpful for streamlining your business finances.
"The SBA product is really one of a kind. It is tailored for small-business owners that may have less cash to put down as a down payment, for example, or borrowers who need longer amortization periods so that they can benefit from monthly cash flow savings," Dunn says.
Alternative business financing options
For businesses that need cash immediately to pay suppliers or employees, there are alternative financing options to consider-though there are risks to be aware of.
A merchant cash advance, for instance, gives you an upfront lump sum in as little as 24 hours. In exchange, a company collects a portion of your future credit card sales, plus fees, which can be high. This may offer a near-instant solution for a cash shortage in a sales-heavy business, such as retail, but could cost more in the long run than a standard business loan. Another example is invoice financing, which allows you to borrow against money customers owe you and is secured by your accounts receivable.
In general, a business credit card shouldn't be used as a long-term cash solution, but it can work in a pinch. Particularly if you qualify for a 0% APR intro offer and have the funds to repay your balance before interest kicks in.
3. Compare lenders
Comparing offers from at least two or three lenders can help ensure you're getting the best deal on a small business loan.
If you can't qualify for an SBA loan or traditional business financing from a bank, you may want to look into a personal loan. Instead of filling out an application with individual banks, you can visit an online marketplace that will securely share your information-e.g. your desired loan amount, basic information about your business and personal finances and your credit history-with several lenders. At this stage, you won't need to submit all of your documentation, but accuracy will make the hypothetical rates you see more realistic.
When comparing loans, look at the interest rate, noting whether it's fixed or variable; the loan repayment term; any fees; and the loan size you're being offered. If you're getting a loan for real estate, compare down payment requirements. Remember, though, that these details may change after the lender takes a closer look at your current liabilities, assets and cash flow.
You should also find out whether a lender has expertise in a specific business niche or geographic location, Dunn says.
"When you're dealing with a bank that's a specialist in a certain industry, they understand all the nuances and the specific details of the program and can help you structure the loan where you can optimize it," she says.
4. Compile required documents and apply
Once you're ready to submit a formal application to one lender, you'll need to gather all of your relevant documents, which can vary depending on the type of loan you're getting.
Here's what you can expect to need, at a minimum:
- Two to three years of personal tax returns
- Personal balance sheet (aka net worth statement)
- Credit authorization form
- Two to three years of business tax returns, if available
- Business profit and loss statement and balance sheet
- Information about collateral, such as equipment or real estate
- Current debt obligations
- Résumé
- Your business license
You may need to submit additional paperwork or order third-party reports as the lender reviews your application and supporting documents. If your loan funds will be going toward a real-estate purchase, Dunn explains, the bank will need to order an appraisal of the property, which can add an extra one to two weeks to the closing process.
In general, SBA loans take longer to approve and fund than conventional business loans. The exception is if you're borrowing from a preferred lender, or PLP, which has the authority to approve and commit to loans without sending them to the SBA's general processing center.
5. Close on your loan and start paying
Your loan approval letter should explain the repayment structure, including how much you owe, when it's due and whether payments can change at any point (this can happen if the interest rate is floating, for example).
Most SBA loans are fully amortized, meaning every payment is made up of principal and interest. A loan for equipment, inventory or working capital will typically have a 10-year maximum repayment period, while a loan where more than half of the funds are being used for real estate may have a 25-year repayment period.
Conventional loan terms run the gamut, but it isn't uncommon to see interest-only payments for several years and a balloon payment when the loan term ends.
Make sure you understand exactly what your obligations are, because it isn't only your personal credit that's on the line if you fail to repay your loan-but your business's too.
FAQ
How long do you need to be in business to qualify for a business loan?
You typically need at least two years of business tax returns to qualify for a conventional business loan.
It's rare that a lender will take a chance on lending money to a new business. If you're looking for startup financing, an SBA loan may be your best bet-or your only option. If you have an established business, however, SBA loans require three years of business tax returns.
Does your business need revenue to qualify for a small business loan?
Most conventional lenders will require some amount of revenue for small business loan qualification, but it varies. SBA loans are more favorable for new businesses since they usually don't have revenue requirements.
What credit score is needed for a small business loan?
Most business owners applying for a conventional loan will need to have good or excellent personal credit-meaning a FICO score of around 670 or higher-and decent business credit scores. Since conventional business loans aren't backed by the government, many lenders are less likely to take the risk of lending to someone with poor credit or a history of not meeting their business's financial obligations, such as paying a supplier or making on-time loan payments.
How to get a small business loan with bad credit
Merchant cash advances may have lower credit score requirements, and invoice financing may not involve a credit check at all, though costs for both may be high relative to other options. Some online lenders offering personal loans for business use are also more willing to work with borrowers across credit profiles.
How much can you borrow with a startup business loan?
How much you can borrow depends not only on the type of loan and lender, but also on your credit profile-or your business's. SBA loans, for example, may be available in amounts up to $5 million.
Learn More: How Much of a Personal Loan Can I Get?
Meet the contributor
Tanza Loudenback
Tanza Loudenback is a contributor to Buy Side from WSJ.
