This article discusses the following:

  • How small business loans work
  • Types of business loans
  • How to get a small business loan

Small business loans are a necessary bridge toward owning your own business and have long been used by entrepreneurs at nearly every stage of the process, from starting a new business to leveraging growth opportunities and meeting operational expenses. Particularly in the beginning as you embark on starting a new business, you may wonder what it takes to get a small business loan. You’ll find all the answers you need and have a clearer path toward business ownership as you read through this article.

How Do Small Business Loans Work?

Before moving forward, it may be helpful to understand how business loans work. First, it’s important to know that business loans work differently than personal loans. Small business loans are usually obtained by a lender that specializes in loaning money to businesses.

There are many types of business loans, each having different terms insofar as repayment periods, loan qualifications, amount of interest charged, and fees go. Some types of business loans might require collateral or a down payment, whereas others won’t.

Adding to the complexity is that business loan terms and requirements vary by lender.

What are the Different Types of Business Loans?

At varying times in your business venture, you’ll need capital or funding to meet your business needs.

For instance, when you first start up your business, you’ll likely need a small business loan to support your startup, including using the cash for things like purchasing inventory or equipment, increasing working capital, covering operating expenses, hiring new workers, and perhaps even buying real estate for a brick and mortar location.

There are also multiple types of business loans that can help you with those individual needs at any time of your business journey.

Here are the most common funding options available to you.

Term loans

Term loans are the most common type of business loan. With a term loan, you typically get funding for a specific amount of capital upfront and make monthly payments to pay back the loan with interest over a set period until you’ve paid the loan off.

The great thing about a term loan is the flexibility upon which you can use the funds. You can use it to expand your business or buy a new location, purchase commercial real estate, remodel your existing business, or any other long-term business need.

SBA loans

SBA loans, like the SBA 7, are term loans that are backed by the U.S. Small Business Administration. These loans have lower interest rates than most other loans because by backing the loans, the SBA protects the lender should you default. These are often considered the gold standard in business loans, however, they can be difficult to get and it may take longer for you to receive the small business financing you need.

Equipment financing

If you need to buy machinery, equipment, computers, or even vehicles for your business, an equipment loan might come in handy. An equipment loan is a type of asset-based financing that can be used by new and existing businesses.

The important thing to remember about equipment financing is that you never want the repayment period of the loan to extend past the useful life of the items you’re purchasing. That is, if you’re buying equipment that will operate at capacity for two years, then you don’t want to still be paying on the loan past that time.

Equipment loans are usually easier to qualify for than some types of business loans because you can get one when your credit isn’t ideal. The reason for this is that the equipment is usually used as collateral for the loan.

Business lines of credit

A business line of credit is a popular option with small business owners. Sometimes your business just needs temporary help with cash flow, operating expenses, or an emergency.

Business lines of credit work similarly to credit cards. A lender extends your business a line of credit up to a certain amount or ceiling that you can draw from as needed. But you only pay interest on the amount of credit you use.

So, you may end up with a $20,000 line of credit, but if you only use $5,000 of your available credit, you only pay interest on the $5,000.

Merchant cash advances

If your credit is about as bad as it can get, a merchant cash advance might be an easier option to get funding for your small business.

Merchant cash advances should only be used when you don’t qualify for another type of business loan. That’s because the interest rates on merchant cash advances are probably among the highest of all types of business loans.

Merchant cash advances work by a lender approving a capital advance for a certain amount in exchange for purchasing some of your daily credit card sales and receipts. In other words, the way you pay back the loan is by giving the lender a portion of your daily card sales.

Getting a Small Business Loan

Now that you know more about the business loan options available to you, how do you go about getting one, and what are the eligibility requirements you need to know about?

Knowledge is everything when it comes to applying for a small business loan. The more information you have, the easier the application process will be and the higher the chance you’ll be approved for funding.

Here are some things that will be helpful for you to know.

Strengthen personal and business credit.

Your credit score illustrates how well you’ve done with your finances and in repaying your debts, such as your bank loans, car loans, credit cards, and mortgage. Most small business lenders would prefer to see you have a strong business credit profile.

But sometimes when you’re just beginning your business, you may not have established enough business credit yet. So some lenders will evaluate you to see if you personally have good credit before loaning you money.

For that reason, one of the best things you can do before applying for a business loan is to improve your credit on both levels.

Your personal credit score

It’s advisable to get a copy of your personal credit report and see what your FICO score is. This score can range anywhere from 300 to 850. The higher your credit score, the greater the indication is to a lender that you will repay the loan.

Most traditional lenders won’t finance a business loan with anyone having a personal credit score of less than 700 or so. But an alternative online lender such as Biz2credit will sometimes provide financing when your credit score is as little as 575.

You’re allowed a free copy of your personal credit score report once a year from any of the three major credit bureaus, i.e., Experian, Transunion, or Equifax.

Your business credit score

A business credit score is compiled differently than a personal credit score. Some lenders, like the SBA, look at the SBSS score, or Small Business Scoring Service, to look deeper at your business’s credit history. The SBSS score ranges from 0 to 300, and it’s not unheard of for a new business to fall very low on this scale, especially if you have low annual revenue.

As far as your business credit goes, you can build a credit profile by establishing lines of credit with vendors. It doesn’t even have to be a large vendor. It can be your local office supply store, provided they report your credit dealings with them to one of three business credit bureaus (Equifax, Experian, or Dun & Bradstreet.) You’ll have to register to get a DUNS number from Dun & Bradstreet to begin your credit profile with them.

One of the ways you can strengthen your business credit score is to create a business bank account and take out business credit cards that you consistently pay off.

The bottom line is you’ll want to work hard to pay your debts on time and dispute anything on your credit record that is inaccurate to avoid having bad credit.

Have a business plan and gather financial documents.

To demonstrate how you will use the loan, most lenders will want you to present them with a business plan and the required financial documentation.

Developing a strong business plan is like creating a roadmap to show where you intend to take your business. That means illustrating how you intend to make money from your business and what you will do to increase profit as your business goes on.

You will also need to provide the following in your business plan:

  • A description of your company and what it does
  • Descriptions of any products or services offered by your business
  • Information about key people who will run your business
  • An analysis of your business’s industry
  • Financial statements including a balance sheet, cash flow statement, income statements, tax returns, bank statements, and budget projections
  • Any business lease agreements
  • Your resume
  • A plan showing how you intend to market or promote your business
  • Your existing business assets

Your business plan will also need to show that you have enough cash flow to operate your business and pay your business loan installments.

It is worth noting that some online lenders require less documentation and have a more seamless application process, unlike a bank lender or the SBA who will want the most comprehensive documentation you can offer.

But the more you can show that you have a well-thought-out business plan, the greater the chance of being approved for a business loan.

Compare business lenders to determine your best option.

You have three primary options when it comes to choosing a lender: a traditional bank or credit union, an online lender, or the Small Business Administration (SBA).

Which loan is best for you will depend on the variables surrounding your business needs and your ability to qualify for a loan.

For instance, banks and the SBA are extremely rigid in their underwriting requirements. It is nearly impossible to get a business loan without almost perfect credit. The SBA and banks will also want to do business with a borrower who has been in business for at least 18 to 24 months.

Even then, the process is lengthy and can be exhausting. But if you have a nearly flawless credit record and higher credit score and don’t have an immediate need for capital, then their loan terms are best.

But if you haven’t been in business long, lack collateral, have less than ideal credit, or need funding more quickly, you’ll probably do better going with an online lender. Of course, even among online lenders, the loan terms and application process can vary widely.

Some lenders charge as much as 99% interest on their business loans, while others have much more favorable interest rates, sometimes on par with banks.

Each online lender will have different repayment terms and restrictions on how much you can borrow. Some might require collateral while others won’t. Online lenders also vary in their borrower credit requirements.

And finally, some online lenders have faster approval processes than others. For instance, Biz2Credit expedites its borrower applications and can usually approve most loan applications within 24 hours and have cash in hand to a borrower within a couple of days.

Just ask New Jersey pharmacist Tejas Gandhi about the fast turnaround he experienced with Biz2Credit. Tejas started evaluating his options when an acquisition opportunity became available to him. But it quickly became apparent that he could lose his chance if he waited the typical time it took most lenders to make a decision. Once he met with BizCredit, he was able to quickly seize his opportunity at acquiring his new pharmacy.

Prequalify to leverage opportunities faster.

Prequalifying for your business loan can pay off in huge ways. Imagine that there’s a real estate crunch where you want to open your business. By the time you find the perfect property to operate your business, it’s gone by the time you apply for your loan and receive your funds.

Prequalifying is the answer to that problem. It’s a seller’s market right now in many areas of the country. At times, there are multiple interested buyers on any given property. Naturally, a commercial real estate seller will sell to the first buyer that is ready to make a purchase.

Prequalifying can also get you funds more quickly when you urgently need money for operational expenses or working capital or want to expand your business.

It helps to build a rapport with a lender and establish a working relationship with them, as this can make the prequalification process easier.

The Takeaway

You’ll want to look at all factors when getting a business loan, beginning with what you need the funds for. That will help you decide which type of business loan is best for you.

Improving your personal and business credit scores should be a priority for anyone seeking a business loan. This will go a long way in helping you get funding for your project at the most favorable terms, as the financial institutions you submit your business loan application to will want to see a strong track record to ensure you can make your loan payments.

You should also have your financial documents in order and ready at a moment’s notice if a lender decides to review them.

It’s also wise to compare your options when choosing a lender. Sometimes the best option is the one that has cash readily available when your business needs it. Establishing a working relationship with a lender can also help facilitate the loan process.

Once you have laid the groundwork for your business loan, then you’re ready to apply for funding and take your business goals to the next level.

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