Many small business owners ask how to get a small business loan, but there is no single answer. There are many types of businesses at varying stages of development and a wide range of lenders. We’re here to offer insight and information describing how to get a small business loan for your business.
Banks and traditional lenders require intensive amounts of information and have a slow process for reviewing applications. Successful applicants may also use the Small Business Administration or a state agency to provide a loan guarantee. The new generation of online lenders offers faster processing and standards that take the entire business situation into account.
To maximize the chances of success, owners must consider the costs of credit, the terms they can afford and the best way to present their business to lenders. The options for business loans include government-assisted loan providers such as the U.S. Small Business Administration, the Department of Commerce Economic Development Agency, and state and local economic development agencies.
The best form of funding is a business grant because the typical conditions do not require repayment; instead, the purpose is to achieve a specific or general result such as increased economic activity or new sources for employment. Grant funds are scarce, and when the need for funding occurs, you must act.
Business grants have tremendous advantages over loans, and as a result, there are typically far more applicants than available funding. Most grants are competitive, and you will have to invest time and effort to find them and to apply. The application process requires information about the proposed activity and the organization.
The combined federal grant portal is grants.gov, and the Small Business Administration has two prominent programs for innovation and technology transfer: SBIR and STTR. SBIR or Small Business Innovations Research grants invite applicants to compete for grants in the designated funding categories.
Upstart funding uses the owner’s assets and requires repayment to the owners. Owners should consult with an accounting professional to see if their state and local rules permit upstart funding as business loans. This may offer favorable tax treatment for repayment.
The typical sources for business loans include commercial banks, thrift institutions, commercial lenders and online lenders. Lenders have requirements for small business loans, and banks typically offer the lowest business loan rates but with the most difficult standards. Online lenders have more relaxed rules and faster business loan processing but slightly higher business loan rates. Online lenders, particularly those that provide unsecured loans, offer a refreshing change from traditional banks.
When seeking business loans, owners must balance their need for the funds with the costs or business loan rates that apply. If they cannot achieve funding through grants or bootstrap methods, then business loans become the best option. Unsecured business loans offer the advantages of responsive loan application processing and not tying up assets.
Applicants must understand the requirements for business loans, prepare a solid business plan, gather documents and records, provide collateral or personal guarantees and use credit effectively.
Qualifying for a Small Business Loan: Lender Requirements
Lenders have requirements for small business loans, and when completing an application, you should use the requirements as a guide. You must meet the lender’s minimum qualifications to get full consideration of your request for funding.
- SBA Loans have some additional requirements for SBA-backed business loans under section 7(a).
- SBA Microloans: After failing to get commercial loans, small firms can apply for an SBA-backed microloan. While limited to $50,000 or less and averaging around $13,000 per loan, the microloan can bridge a start-up period or a tight cash episode.
- Your business must be eligible; ineligible businesses include banks, real estate and insurance.
- Your business must be for-profit and have substantial owner equity and investment of 20 percent or more.
Personal Credit Scores and Business Ratings
Personal FICO scores range from 350 to 850, and lenders use it as a gauge of ability to pay personal and household debts such as credit cards, car loans and mortgage loans. The FICO score has five basic factors as listed below. Lenders use personal credit reports to assess how well a borrower handles debt and payment obligations.
- Payment history: 35 percent
- Total credit debt: 30 percent
- Length of credit history: 15 percent
- What kind of credit you currently use, such as trade accounts: 10 percent
- Number of credit inquiries: 10 percent
Personal credit scores are the universal starting point for business loans. One should always bear in mind that the score is a snapshot, not a fixed figure. It can change daily, and it can swing up and down over a period. You can act to build a stronger credit score. Some helpful tips include paying bills early and never late. You should review the current credit information and challenge any debt that seems irregular. Disputing the information can help your credit rating particularly if the information contains erroneous negative information.
Businesses may have an easier time getting an application approval from an online lender. Their standards are not as rigid as the bank standards are, and online lenders work faster than banks to complete their reviews. Online lenders consider the same basic set of credit factors such as credit history and credit scores, but they may factor in things like bankruptcies with supporting or explanatory material presented by the borrower. Online lenders may accept applications with some problems, but the trade-off is in higher business loan rates.
Banks require some form of collateral for business loans. These secured loans are the type with the lowest average business loan rates. The business loan rates determine the costs of borrowing, and strong credit and valuable collateral are the best combination for getting the lowest available rate.
SBA rules require personal guarantees from all 20 percent equity owners and full collateral security for section 7(a) and most loan guarantee programs. The personal guarantee requires a strong personal credit rating, and it requires a pledge of all personal assets.
Some online lenders make loans on the basis of the owner’s personal guarantee, credit score and other information on the business and its potential. These loans involve a blanket lien that supports seizure of personal and business assets in the event of default.
Preparation for Business Loan Application Process
The first step is to work with the lender to identify its requirements for a business loan. Then, you should begin the careful process of gathering financial records and legal documents.
Lenders can ask for nearly every kind of business information in their review of an application. As you prepare for a loan application, the initial step is to review and assemble the basic business documents needed for credit and loan applications. The documentation required for business loans can include the items listed below:
- Personal identification documents including driver’s license, passport and proof of citizenship. You should have a detailed resume that highlights experience in the business field for which you seek funds.
- Three years or more of personal and business tax returns. You may also be asked to show bank statements, retirement funds, an investment portfolio and insurances.
- Corporate or business information including the articles of incorporation, commercial leases, facilities leases, contracts and business licenses. You should provide a balance sheet and income statement.
Financials for Limited Operating History
New businesses with short histories or startup businesses typically do not have a set of audited financial statements at their disposal. Unless the new business springs from a larger existing business, there may be no yearly financial record for presentation. The usual solution is to develop and present a pro forma income and operating statements. The accounting function can certify the methods and accounting procedures in the pro forma statements. These statements project the planned operation, cash flow and profits from a defined period of business.
The business plan is a valuable document before, during and after you form your business. When done properly, the business plan presents a big-picture look at all aspects of your company. The plan describes your organization and the path you’ve laid out to meet its goals. Business loans depend on your business plan as the best statement of your intentions, results and efforts. Be sure to include the following elements:
- Organizational Description: The vision of the owner is an important item in presenting the organization for financing and other business purposes. This includes a prominent focus on the organizational goals. They may be as simple as becoming the leading supplier of a beauty item or as complex as installing a non-polluting process in a heavy pollution business process like paints and dyes.
- Physical or Virtual Goods, Products and Services: Advances in information technology and the internet have extended the range of deliverable goods, products and services to include virtual objects and services. Some firms can now offer blockchain and digital platforms, and objects can be real, digital, virtual or mixed.
- Talent and Management: The lender is like an investor when appraising the likelihood of repayment. Lenders must assess the strength of the talent resources and management capability.
- Industry and Disruption Analysis: Today, the touchstone of many essential businesses is not in traditional industry patterns but in disrupting them with innovative ideas, approaches and technology.
- Operations Plan: The planned method of operation is a time-phased document demonstrating that the necessary parts exist and work well together to produce the product or service in a timely and cost-efficient manner. The business must not only operate smoothly; it must operate at a profit. The operating plan is a key assessment for a lender as it demonstrates several of the other essentials like marketing and management capability.
- Marketing Strategy: The target customer base must know of the organization, have access to its products or services and agree on the value by spending money. Few businesses have a natural or organic customer base; nearly every business must reach out and grow an audience and convert it into referrals and customers. Particularly in the digital age, marketing is an essential function and a predictor of long-term success.
- Critical Assessment of Strengths, Weaknesses, Opportunities and Threats: There are many ways to perform a critical self-assessment, and it requires a framework for measuring progress beyond financial information. The SWOT analysis is a broad assessment tool because it looks to both the internal and external business environments, including the internal strengths and possible weaknesses of the organization. The second part of the analysis examines the industry situation including positive and negative trends that offer opportunities or threats to the organization.
Summing Up: Small Business Loans
When considering how to get a small business loan, owners must spend time researching the various sources and the requirements among available lenders and their business loan rates. If there appears to be enough financial strength, assets and credit score, then banks typically offer the lowest interest rates and fees. Bank loans work with SBA loan guarantees to decrease the lender’s risk and enhance your application substantially both as to the amount of the loan and the repayment terms. If you decide that your chances would be better with online lenders or commercial lenders, then you must shop for the best terms and business loans rates. You should consider the risks involved with personal guarantees when using online lenders and unsecured loans. Ultimately, the goal is acquiring funding for your organization that is easy to repay given the scope of your business.
Chris Fuller went to the University of South Florida and has worked in the financial sector for over 20 years. He has extensive experience in all aspects of personal and small business lending, from personal loans, equipment finance to cash flow based solutions for small mom and pop businesses, and large corporations.