Securing a business loan can be crucial to the growth of your company, but navigating the process can be confusing. Here are some tips to help you fully understand your options for small business financing and the process for getting a small business loan.
Do you qualify for a small business loan?
A critical first step is determining if you will qualify for a loan. There are many factors that go into whether or not you will qualify. Here are some questions to consider.
What’s your credit score?
Providing you with a loan is inherently a risk to the lender, so the lender will want to dig into your personal finances. You will need a good credit score to be considered. The credit score typically required for a small business loan is 680 and over for traditional bank or SBA loans, 630 and over for a business line of credit or equipment financing, 600 or over for short-term financing, and 550 or over for merchant cash advances.
The better your interest rate, the less you have to pay in the long run.”
If your credit score is on the lower end, take some time to build better credit before applying for a loan--it can really have an impact on your interest rate. The better your interest rate, the less you have to pay in the long run.
Are you a new business?
It can be difficult to qualify for a small business loan if your business is brand-new. Most lenders prefer to loan to operations that have been in business for at least a year. To qualify for a wider range of loan options, you need to have been in business for at least two years.
If you want to open a new business, don’t let this dissuade you! You still have options to get the doors open. It may take longer, and you may have to file or present more paperwork, but it is possible!
What kind of business are you running?
Every financial institution or lender has their own specific criteria for the kinds of businesses they lend to. Depending on the current economy, lenders may not be willing to lend to specific types of businesses, like retail shops or certain kinds of industries. If a lender doesn’t think you’re the right fit for them, you may be a better fit for someone else!
What is your business plan, and what will profit look like?
Whether you’re opening a new business or looking for a loan for your current business, you need to have a solid financial plan in place. Make sure you’re outlining monthly and yearly operating expenses and revenue projections. Financial institutions want to see that the loan will be put to good use and will result in profits.
Can you afford the loan payments?
There’s more than one reason to look at profits: lenders want to make sure you’ll be able to pay off the loan! There’s no better way to prove that than to outline your historic profits and current overhead. If your business is new, this is where projections are going to be especially useful.
Do you have collateral?
Depending on the amount, interest rate, and timeline, a business loan can require collateral. In other words, the lender may require you to provide an asset to recover, in case you stop making loan payments. Collateral can be property, inventory, cash reserves, or even equipment. Putting up collateral will increase the amount lenders are willing to loan you and can even get you a lower interest rate.
It’s possible to get a business loan without collateral, but it really depends on the lender, the amount, and other factors. Even without collateral, you will probably be asked to sign a personal guarantee. This document states that personal assets can be seized and sold if you default on the loan. If you have any co-owners that own over 20% of your business, their personal property may also be seized to pay off the loan.
What type of business loan do you need?
Once you determine if you are ready to apply for a business loan, you need to determine what type of loan you need. We’ve outlined some common loan types below.
Sometimes securing capital for a new business can be difficult. There are several options for startup financing, including crowdfunding, turning to friends for help, taking out a personal loan, and business credit cards.
Depending on the size and potential profits of your company, you might also consider venture capital. Venture capital is typically given in the form of a loan in exchange for an ownership share and an active role in the company, like a seat on the board. Venture capitalists look for businesses that are high growth, where they can take a higher risk in exchange for the potential for higher returns. Venture capital tends to have a longer investment horizon than traditional financing.
This is a fairly typical business loan. Your business will receive the whole amount up front, which you will then pay back within a certain period of time. While online lenders tend to have faster processing times, they also typically have higher rates than a traditional financial institution. Remember: shopping around for loan terms and rates is worth it! The investment maximum is typically $1 million.
Business line of credit
A business line of credit is a predetermined amount of funds you can borrow when you need to and pay back within a certain time frame. Unlike a term loan which has a fixed monthly repayment, a business line of credit typically allows you to pay back your line of credit any time, with no penalties for early repayment. This type of financing is good for businesses managing day-to-day business expenses like inventory, equipment, and operations. It is also good for navigating through cash flow challenges that may arise, like less sales during a slow season.
Government-backed SBA loan
A Small Business Administration (SBA) loan is a type of loan that is issued by private lenders but backed by the federal government. These loans have a higher investment maximum--up to $5.5 million.
There are several types of SBA loan programs, including:
- 7(a) loan program: SBA’s flagship loan program, used to fund working capital, expansion, and equipment purchases. Most 7(a) loans will allow businesses to borrow up to $5 million. The SBA will guarantee 85% of loans up to $150,000 and 75% of loans greater than $150,000.
- 504 loan program: Funds come from a combination of traditional lenders and Certified Development Companies. These loans are typically used to fund long-term fixed assets, like machinery, land, and facilities.
- Microloan program: Loans provided to help small businesses and certain non-profit childcare centers start up and expand. These loans are smaller--the maximum loan amount is $50,000, and the average loan amount is $13,000.
How To Get a Small Business Loan
Once you’ve ensured that you are likely to qualify for a small business loan and determined which type of loan is best for you, it is time to begin. Every lender will be slightly different, but we’ve outlined the general steps for you to take.
1. Gather your documents
The documents you will need to gather to apply include:
- Business and personal bank statements
- Business and personal tax returns
- Credit reports (the lender will also pull this)
- Business financial statements
- Business plan
- Legal documents (articles of incorporation, commercial lease, franchise agreement)
2. Research and apply
Once you gather your documents, it is time to look for your loan! Shop around and find a few options, looking at loan terms and annual percentage rate (APR). Of these options, choose the one that fits your needs, and apply with the documents you’ve gathered.
3. Work with a small business lender to get approved
Once you’ve gathered all these pieces and submitted them, it is time to wait to see if you are approved for a loan. This process may take time, so be patient!
You can expect some additional steps, including:
- A letter of intent, which a lender will send to let you know whether or not they will move forward with your application. The letter will explain the loan amount, rates, and terms you qualify for.
- Underwriting, where the lender asks for any additional information and documentation as necessary.
- The loan agreement, which will list all the information you need to know about your loan, including rates, loan term, amount, etc. During this time, you may be required to submit a deposit, which is typically a percentage of the loan’s principal.
Find the Right Loan for Your Small Business
A small business loan is a great way to support your growth and success. There are a lot of factors to consider along the way, and the process itself may be confusing. Breaking down the process into smaller steps can help make all of this feel more within reach. When you choose a lender, make sure they’re open to your questions as you proceed. At Amplify, we want our members to feel like they have all of the information they need to get ahead. The most important step in this entire process is to choose a loan and a lender that fits you and your business!