By DeVry University
November 3, 2022
10 min read
Small businesses have often been described as the backbone of the American economy. According to the U.S. Small Business Administration (SBA), they’ve accounted for 62% of net new job creation since 1995, and make up nearly half of the private workforce in the United States.
For startups and small businesses alike, small business loans can be a lifeline when it comes to financing new equipment or sourcing the supplies you need to make your company run.
So how do small business loans work? Understanding how to you can get approved for a small business loan is much easier when you’ve done your research and become familiar with the options available to you. It’s important for small business owners and managers to develop an understanding of how business lending works, the different types of small business loans, the lenders offering them and some of the costs involved with loan repayment.
What Is a Small Business Loan?
A small business loan is a type of commercial financing that qualified businesses can obtain from traditional lenders like banks, or non-traditional lenders such as online lenders or credit unions.
This type of loan can be used for many different purposes, but the borrower must let the lender know what the money is to be used for when they apply. Some common uses of the capital from a small business loan include covering the cost of starting or acquiring a business, commercial real estate purchase or remodeling, cash flow, debt consolidation, purchasing equipment or inventory, finding a business expansion or providing the money to meet other short-term obligations while you get your business up and running.
In general, business lenders will not allow you to use business loans to cover personal expenses like a home, vehicles for personal use or other items unrelated to the needs of your business. Regardless of the type of loan you receive, paying the loan back on time should be a top priority to preserve your personal credit and protect any assets you may have had to put up as collateral.
Type of Business Loans
Every small business owner should be familiar with the different business credit options available, some of which are:
Accounts receivable financing
Also known as factoring, this is a form of short-term financing. It involves selling your receivables – the invoices you’ve sent to customers that are unpaid – to a lender so you can receive payment now, rather than waiting for customers to pay you.
The lender takes on the risk and provides your business with cash in exchange for a fee. The goal here is improved cash flow, but you may end up paying more in the long run for this type of credit.
Working capital loan
Meant for the short term rather than long-term investment needs, these are used to finance the day-to-day operations of your business. This type of loan is typically linked to your personal credit, so be sure to stay current with your payments.
Small business term loan
Here you’ll get a lump sum of capital that you’ll pay back at a fixed interest rate over a specific period of time. In many cases, this type of loan is repaid in five years and used to fund a specific small business investment.
This is a form of small business lending that helps you replace existing equipment or finance new equipment to help a business grow or diversify. A manufacturer, for example, might use an equipment loan to buy new machinery to expand its production capacity.
Equipment loans typically require less documentation than other small business loans so the funding can be secured relatively quickly.
Small business credit card
This is similar to a personal credit card but may include additional reporting features that help the small business owner categorize purchases and track spending. It may also feature a rewards program to help you save money on regular purchases like office supplies.
An SBA loan is a small business loan guaranteed by the U.S. Small Business Administration, which matches you with a lender that fits with your company’s size and needs. The guarantee means that if you can’t repay the loan, the SBA will pay out the guaranteed amount. Because of this guarantee, SBA loans can be tougher to get than other kinds of business loans, but they can be helpful to small business owners because they often come with benefits such as flexible down payment options, lower overheads requirements, longer terms and lower payment rates.
Business line of credit
This is an offering typically given by traditional banks. As with a credit card, you can borrow up to a certain limit and pay interest only on the amount you’ve borrowed.
After opening a business line of credit, you’ll be able to draw funds and repay them as often as you’d like, as long as you don’t exceed your credit limit.
How to Qualify for a Small Business Loan
Qualifying for a business loan involves several important factors. By understanding your lenders’ minimum requirements, you can work to increase your chances of qualifying for a small business loan. Most lenders require borrowers to meet certain benchmarks, which may include a minimum credit score, annual revenue and years in business.
Even though the money you’re borrowing for your business will not be used for personal expenses, potential lenders use your personal credit score as a measure of your creditworthiness. The higher your credit score, the less risky it is in the eyes of the lender to lend you money. A score of 700 or above is considered good, while a score of 800 or higher is excellent. Free copies of your credit reports can be obtained from the major reporting bureaus – Experian, TransUnion and Equifax.
If you’re starting up a new business, getting a loan may be more challenging because many traditional lenders require you to be in business for at least two years. This is where non-traditional financing, like a short-term loan from an online lender, might be a viable alternative.
Some lenders will require you to provide collateral such as real estate, business inventory or equipment to secure the small business loan. If you’re concerned about losing assets or don’t have any, an unsecured loan might be an attractive option, but may come with less-attractive repayment terms, like a higher interest rate or fees.
The Small Business Loan Process
The process starts with being realistic about your business’s ability to obtain financing and the various types of loans for which you might qualify. According to the Forbes Advisor website, the process of obtaining a small business loan can be broken down into five steps:
1. Begin by deciding why you need the financing
Do you need money for expansion? For day-to-day operating expenses? To purchase new equipment or expand your shop? If so, one or more of the different loan types described earlier should suit your needs.
2. Determine if you qualify for a business loan
Different lenders have different minimum eligibility requirements and loan terms. Know your credit score and the impact it can have on your eligibility. How long have you been in business and how much revenue has your business generated over the last three years? Take some time to think about your finances and look carefully at your business’s income and cash flow to determine how much you can afford to apply to loan payments each month.
3. Compare business lending options
There are several places where you can find small business financing, including online lenders, traditional banks, credit unions and microlenders. Compare lenders by looking at their Annual Percentage Rate, or APR. APR is a good way to measure the total cost of a business loan because it includes calculations for all loan fees in addition to the interest rate. Other factors, like how quickly you can have the money, may also come into play with small business loans.
If you lack collateral and time in business but need funding quickly, an online lender could be an option. If you’ve been in business for at least two years, have good credit and can wait longer to get the cash, a business loan from a traditional lender like a bank or credit union might be a better option. Traditional lenders typically offer term loans, lines of credit and commercial real estate loans at lower interest rates than online lenders. If you have bad credit, no credit history or are new in business, microlenders – nonprofits that typically make short-term loans of less than $50,000 – may be interested in working with you.
4. Gather all the required documents
You’ll need various legal and financial documents to complete your loan application. Typically, these may include:
- Your driver’s license
- A voided business check
- Bank statements
- Profit and loss statements
- Business and personal tax returns
- A business plan
Why include a business plan? It provides a buttoned-down prospectus of how you intend to use the money and how you believe it will help your business grow. The plan typically includes a business description, product or service description, market analysis, management team, sales and marketing strategy, implementation methods, financial plans and financial projections.
5. Submit your application
Once you’ve done your homework and submitted your application, you’ll have to wait for an approval. If your small business loan is approved, the lender will send you an agreement to sign before issuing you the funds or opening a business line of credit you can draw from.
How Much Should I Borrow?
How much you should borrow with your business loan is up to you and your business’s needs. How much you can potentially be approved for can also be affected by several factors, including your business’s annual gross sales, existing debt and creditworthiness. What lenders are willing to lend out can also vary according to your business’s annual revenue. Your company should be cash flow positive after accounting for all debt payments.
Do I Qualify for a Small Business Loan?
Whether or not your able to get approved for a business loan will vary based on a number of factors. If you have a strong personal credit score and a profitable business that’s been operating for at least two years, lenders may consider you worthy of applying for the loan. Remember, this is just a place to start with no guarantee of approval.
How Do I Avoid Predatory Business Lenders?
A predatory lender is one that puts profits ahead of concerns about the borrower’s ability to repay the loan. When evaluating a potential lender, keep an eye on how they behave with you regarding the loan. Does the loan sound too good to be true? Are you being pressured to sign the loan agreement? Another sign can be extremely high interest rates on short-term loans.
Credible lenders run a credit check on the borrower and ask them to verify their income to determine what monthly payments they can afford. Predatory lenders make their money with high interest rates, fees and are often less concerned with the borrower’s ability to repay the loan.
A Google search for the lender should reveal any consumer complaints. Also check with the Consumer Financial Protection Bureau, an agency that implements and enforces federal consumer financial law and ensures that markets for consumer financial products are fair, transparent and competitive.
How Can I Find the Best Business Loan Rates?
Understanding how small business lending works, the costs involved and what loan options will work best for your business takes time and research. Be sure to do your homework and don’t forget to compare the APR, which, mentioned earlier includes the interest rate and any associated fees.
Is the Business Loan Application Process Difficult?
Borrowing for business needs like expansion, real estate acquisition, equipment or working capital can be a detailed process, but if broken down into a simple step-by-step process, it’s not as daunting as it may seem. Each lender will have their own process for potential borrows to follow. The five steps outlined earlier in this article are a good place to start in understanding what to expect from this process.
Obtaining small business financing begins with the borrower having a basic knowledge of the fundamentals of business management. The business owner should have the demonstrated ability to run a profitable business and put together a strong business plan to present to lenders. Small business owners should conduct extensive research to determine what types of business loans are appropriate for their needs and which loan type might be the best option for them.
Develop Your Entrepreneurial Skills at DeVry
With courses that focus on customer relations, budgeting, forecasting, e-commerce and other small business topics, our Small Business Management and Entrepreneurship Specialization can be an excellent way to help you prepare to start your own venture or put other companies on a pathway to success. This specialization can be earned 100% online as part of any of our Bachelor’s Degree in Business Administration, our Bachelor’s Degree in Management or our Bachelor’s Degree in Technical Management.
Why are small business loans so hard to get? ›
The level of difficulty a small business faces when applying for a loan depends on several factors, including its cash flow, time in business, credit score, business plan and desired loan amount. The more that a small business is able to prove that it is able to repay the loan, the easier it will be to get the loan.How much of a small business loan could I get? ›
How much of a business loan you can get depends on your business's annual gross sales, creditworthiness, current debts, the type of financing, and the chosen lender. In general, lenders will only provide loans up to 10% to 30% of your annual revenue to ensure you have the means for repayment.Why are loans good for small businesses? ›
Loans help your business grow: Whether your plan is to hire more employees, expand into a new market, offer new products or grow an existing location, your business needs cash to do so. A business loan will cover the upfront costs of expansion, allowing you to pursue profitable growth.How hard is it to get a small business loan from SBA? ›
SBA loans typically have lower rates and longer terms than you could qualify for with a conventional loan. Although it's easier for a small business to qualify for an SBA loan than a conventional loan, the application requires you to provide extensive documentation of your finances.Why do banks reject small business loans? ›
Poor credit scores or lack of credit history are among the most common reasons businesses get rejected for business financing. Credit scores help banks and other lenders determine your creditworthiness – or how likely you (or your business) are to pay them back.Is it hard to get a business loan with an LLC? ›
If you have good credit and can meet the lender's eligibility guidelines, getting a business loan with an LLC can often be easy. But new businesses and businesses with limited revenue may have difficulty getting approved, especially with traditional banks and credit unions.What do you need for a first time business loan? ›
You'll want to have a great personal credit score, strong business financials (or at least an impressive business plan,) as well as ample collateral to qualify for a first-time business loan from a bank. If you have a few years in business and solid annual revenue, you'll be even more likely to qualify.Do banks give loans to start a business? ›
So yes, banks do make loans to startups – provided they demonstrate the ability to repay them. Generally, that means: Strong collateral. Lenders expect borrowers to put up something – usually their home or other significant asset.How long do you have to pay back a business loan? ›
How long do banks give business loans for? Bank loans often require repayment in 1-3 years for short-term loans and 3-10 years for long-term loans, though products and terms vary by lender. The loan repayment schedule will depend on several factors, including: Type of loan.What are the 3 reasons why businesses borrow money? ›
- Small businesses can use loan funding to meet a variety of needs without having to tap into cash reserves or drain cash flow.
- Some of the most common uses for small business loans include purchasing real estate or equipment, expanding operations, and stocking up on inventory.
What are the pros and cons of business loans? ›
|Businesses typically not approved for traditional loans could qualify||Collateral could be required|
|Capped interest rates||Personal liability if the business defaults|
|Small and large loan amounts offered||Slow approval process|
One of the most common ways to raise capital for your business is to take a business loan. A loan is also a better source of capital for a profitable business in comparison with the share capital as you can have a better leverage.What disqualifies you from getting an SBA loan? ›
Ineligible businesses include those engaged in illegal activities, loan packaging, speculation, multi-sales distribution, gambling, investment or lending, or where the owner is on parole.What is the easiest loan to get approved for? ›
The easiest loans to get approved for are payday loans, car title loans, pawnshop loans and personal loans with no credit check. These types of loans offer quick funding and have minimal requirements, so they're available to people with bad credit.What are the disadvantages of an SBA loan? ›
- Strict underwriting requirements. SBA loans come with some of the strictest underwriting requirements small business owners can face. ...
- Extensive paperwork. ...
- Long application timelines. ...
- Personal guarantee or down payment may be required. ...
- Flaws with COVID-19 funding.
They'll consider household income, business revenue, cash flow, outstanding debt, unused credit lines, and the amount of money the owner has personally invested into the business. All these variables will help lenders calculate the ability for an owner to repay the loan.Can you get a small business loan with zero down? ›
Can you get an SBA loan without making a down payment? Yes, the SBA offers some loan programs that do not require a down payment, such as the SBA disaster loan program. Keep in mind that lenders that do not require a down payment will likely place more weight on your business plan and financial statements.What happens if I get a business loan and it fails? ›
But if your business fails, you might have no choice but to default on your commercial loan. If your loan goes into default, your lender will attempt to collect the money you owe. For loans that have gone into collections, a collection agency will contact you about the overdue payments.Can I use my EIN to get a loan? ›
Can I Get a Loan with Just My Business EIN? Yes, there are certain circumstances where a lender will not use your personal credit score, but only your EIN as a factor in lending to you. Note that they won't just use your EIN in isolation, as there are many factors that go into qualifying for a small business loan.Does an LLC have its own credit score? ›
Does an LLC Have Its Own Credit Score With The Rating Agencies? Yes, a business has its own credit score and credit report. When you start your business and start applying for credit, your personal credit history and score will be taken into account.
How much of a loan can a new LLC get? ›
LLC Business Lines of Credit
Business line of credit amounts can range from $10,000 up to $1 million. Repayment terms typically fall between three and 18 months. Lines of credit are ideal for working capital needs, as well as emergency funds.
Getting a startup business loan can be more difficult than getting approved for financing as an established business. This is because most lenders gauge their risk of borrowing based on the financial stability and history of an applicant's business.What is usually required for a business loan? ›
Qualifying for a business loan usually requires an operating history of at least two years. Additionally, you need to meet minimum revenue, personal credit, and business credit requirements. If you're applying for a secured loan, your assets will also have an impact on your eligibility.What is the easiest SBA loan to get? ›
This term loan or line of credit offers fixed or variable SBA loan rates as well as the easiest SBA application process, quick approval times, flexible terms, and lower down payment requirements than conventional loans.
- First, Build a Real Relationship. ...
- Know the Numbers. ...
- Explain How You Made Your Forecasts. ...
- Show How They Get Their Money Back. ...
- Personally Guarantee the Loan.
- 1.SBI (Small Business Loans) ...
- HDFC Bank (Company's Growth Loans) ...
- ICICI Bank (Commercial loan) ...
- Citibank (Commercial Loans) ...
- IDFC (Commercial Loans) ...
- Kotak Bank (Commercial Loan) ...
- Bajaj Finserv Loan (MSME) ...
- IndusInd Bank.
Some loans will require you to pay the full amount of interest you would have paid if you'd taken the entire loan term to pay off your debt, for example. Other loans may force you to pay a prepayment fee for paying off your debt earlier than expected.Does a business loan count as income? ›
Is a business loan considered income? If you take out a business loan, it's unlikely that it will be counted as income because you have to repay the amount you borrow. The most common exception to this is if you negotiate with a lender or creditor to reduce your debt. You will owe taxes on any debt that is forgiven.How much is a 100k loan per month? ›
Assuming principal and interest only, the monthly payment on a $100,000 loan with an APR of 3% would come out to $421.60 on a 30-year term and $690.58 on a 15-year one.Why do the rich borrow money? ›
Billionaires multiply their wealth by borrowing against their assets to pay for new investments. But they aren't the only ones who can use leverage to their benefit. In 2021, a ProPublica article revealed that some U.S. billionaires pay little to no tax.
What 5 things must you consider before deciding to borrow money for your business? ›
- The purpose of the loan: What do you need the money for? ...
- The repayment schedule: How often will you need to make payments on the loan? ...
- The interest rate: What is the interest rate on the loan?
You could end up in debt for a long time.
This can be a big risk, especially for small businesses. If you can't make your loan payments, you could end up defaulting on your loan, which could ruin your credit and make it hard to get financing in the future.
if your business is just starting, an investment by you as the owner allows the business to use your money without the obligation to have to pay you back right away. If your business is established and has good cash flow and a good credit rating, making a loan arrangement may be better.Does your credit matter for a business loan? ›
Loan requirements vary depending on the loan product you want and the lender you work with. However, a minimum credit score is almost always a factor in determining eligibility for a business loan. Credit scores are a way to assess a borrower's creditworthiness and the lender's risk in offering a loan to a borrower.What is the minimum credit score for a SBA loan? ›
The SBA does not state specific credit score minimum requirements, but business mentors recommend entrepreneurs have a credit score in the mid to high 600s. Some loan products, like the SBA microloan program, may have SBA loan credit requirements on the lower end.Does everyone get approved for SBA? ›
In general, eligibility is based on what a business does to receive its income, the character of its ownership, and where the business operates. Normally, businesses must meet SBA size standards, be able to repay, and have a sound business purpose. Even those with bad credit may qualify for startup funding.Does SBA verify income? ›
All COVID EIDL applicants are required to submit a signed and dated Form 4506-T authorizing the IRS to release business tax transcripts for SBA to verify their revenue.What credit score is too low for a loan? ›
Generally, borrowers need a credit score of at least 610 to 640 to even qualify for a personal loan.Can I get a loan with a weak credit score? ›
You can still get approved for a personal loan with a less-than-stellar credit score. Having a personal loan can help boost your credit score by strengthening your credit mix, but you must remember to make your payments on time each month. Late and missed payments show up as negative marks on your credit report.Why is it so hard to get approved for a loan? ›
The most common reasons for rejection include a low credit score or bad credit history, a high debt-to-income ratio, unstable employment history, too low of income for the desired loan amount, or missing important information or paperwork within your application.
Can you use your SBA loan for anything? ›
SBA loans and SBA express loans can be used for a wide range of expenses. According to the SBA, you can use these loans for “most” business purposes, including start-up, expansion, equipment purchases, working capital, inventory or real-estate purchases.Why are banks rejecting SBA loans? ›
Common Reasons SBA Loan Applications Get Denied
Credit score is too low or not long enough, or credit history contains other red flags like a recent bankruptcy. Issues of character (e.g. a criminal record) Not enough collateral. Not enough business revenues or capital to repay the debt.
SBA loans have a 49% approval rate at small banks. SBA loans only have a 25% approval rate at large banks. 33% of small business owners struggle or fail due to a lack of capital. In 2020 the SBA distributed over 14 million loans worth $764 billion to small businesses.What disqualifies you from getting a business loan? ›
Ineligible businesses include those engaged in illegal activities, loan packaging, speculation, multi-sales distribution, gambling, investment or lending, or where the owner is on parole.How can I increase my chances of getting a business loan? ›
- 1 – Get your credit score in check. ...
- 2 – Don't get multiple quotes from multiple lenders. ...
- 3 – Reduce negative balance days. ...
- 4 – Choose the right lender. ...
- 5 – Create a perfectly written business plan. ...
- 6 – Be open to alternative funding options.
You have a low overall personal or business credit score, or a poor credit history. You do not have sufficient collateral or assets to secure your loan. You do not have enough free capital or cash flow to meet loan repayments. You have too much already outstanding debt.Why do small businesses fail SBA? ›
The most common reasons small businesses fail include a lack of capital or funding, retaining an inadequate management team, a faulty infrastructure or business model, and unsuccessful marketing initiatives.What are the easiest loans to get approved for? ›
The easiest loans to get approved for are payday loans, car title loans, pawnshop loans and personal loans with no credit check. These types of loans offer quick funding and have minimal requirements, so they're available to people with bad credit.What happens to business loan if business fails? ›
But if your business fails, you might have no choice but to default on your commercial loan. If your loan goes into default, your lender will attempt to collect the money you owe. For loans that have gone into collections, a collection agency will contact you about the overdue payments.How do I guarantee approval for a business loan? ›
- Know Why You Need the Money. ...
- Know How Much You Need. ...
- Determine How Much You Can Afford to Borrow. ...
- Research Types of Business Loans. ...
- Find a Lender and Learn their Requirements. ...
- Build Your Credit Score. ...
- Work to Meet Other Loan Requirements.
How do I convince a bank to give me a business loan? ›
- First, Build a Real Relationship. ...
- Know the Numbers. ...
- Explain How You Made Your Forecasts. ...
- Show How They Get Their Money Back. ...
- Personally Guarantee the Loan.
So yes, banks do make loans to startups – provided they demonstrate the ability to repay them. Generally, that means: Strong collateral. Lenders expect borrowers to put up something – usually their home or other significant asset.Can I spend my SBA loan on anything? ›
SBA loans and SBA express loans can be used for a wide range of expenses. According to the SBA, you can use these loans for “most” business purposes, including start-up, expansion, equipment purchases, working capital, inventory or real-estate purchases.Is it hard to get a business loan to start a business? ›
Getting a startup business loan can be more difficult than getting approved for financing as an established business. This is because most lenders gauge their risk of borrowing based on the financial stability and history of an applicant's business.Will an SBA loan hurt my credit? ›
Even though a borrower must personally guarantee the loan, it is not reflected on a personal credit report.What are 2 financial reasons that small businesses fail? ›
Lacking startup funds and being unable to come up with adequate financing are common reasons for failure, but this speaks to the importance of research, realistic projections, and thorough planning up front. If you lack the cash or assets to start on your own, like most businesses, you will need to borrow.How many businesses fail in the first year SBA? ›
According to data from the Bureau of Labor Statistics, as reported by Fundera, approximately 20 percent of small businesses fail within the first year. By the end of the second year, 30 percent of businesses will have failed. By the end of the fifth year, about half will have failed.What is the success rate of small business? ›
Data from the BLS shows that approximately 20% of new businesses fail during the first two years of being open, 45% during the first five years, and 65% during the first 10 years. Only 25% of new businesses make it to 15 years or more.