Are you bewildered by the small business loan process? Unsure of what steps to take? Business owners often think that applying for a loan is a mind-numbing task full of applications and lots of paperwork—especially for newbies.
There’s a lot to know, from the types loans available, to navigating poor credit scores, to finding the best interest rate. However, it doesn’t have to be complicated. Master these ten simple steps to getting a business loan and find the right funding for your business.
Step 1: Create a business plan
You can’t hit a goal if you don’t know where it is. Likewise, if you aren’t clear about how a small business loan fits into your business plan you’re unlikely to get results—but you are likely to feel stressed while applying.
Before you begin, ask yourself three questions:
- What do you want to achieve with this loan?
- How much money do you actually need to achieve it?
- What are you going to do once you have it (e.g. amp up marketing, buy equipment or hire staff)?
Be very specific, because you don’t want to borrow too much and get stuck with a sky-high interest rate as a result. For example, If you need less than $50,000, you can apply for a microloan. If the loan is larger, you will have to research other options.
If you don’t have a business plan, make one. It will help you organize your ideas, understand your unique value, and pinpoint your opportunities. Importantly, it will help you understand your expenses and income so you can find a balance between how much you need to borrow and what you can pay back. Lenders love a business that, well, means business.
Step 2: Obtain free assistance
The loan process can be daunting, especially for a business owner going through the process for the first time. Several free resources can help guide you:
SBA — The U.S. Small Business Administration is dedicated to helping small businesses and works with lenders to provide loans. The agency also has at least one branch office in each state. In addition, the SBA’s website also has links to a national network of 100 women’s business centers.1
SCORE — SCORE has a network of business mentors who provide guidance at no cost, so that you can locate an expert in your type of business or service.
Small Business Development Centers — The 900 U.S. Small Business Development Centers have free business resources and also provide guidance from professionals and professionals.2
Step 3: Audit your risk profile before applying
The borrower’s credit and risk profiles are the most important factors that lenders rely on when deciding whether to approve a small business loan. Therefore, it is crucial to study the following considerations before applying for a loan.
Credit score/credit report — Lenders will examine any outstanding loans and debt to calculate if your company’s cash flow will cover existing loans and obligations, along with the payments for the new loan. Therefore, it’s advisable to obtain your personal and business credit reports before applying for credit or a loan. It’s crucial to find any inaccuracies or problems so you can address them before completing your loan application.
How to qualify when you have poor credit or low income
Banks and other lenders consider credit that falls below 670 to be bad. Business owners with a FICO score of 530 to 670 can apply for a “bad credit business loan,” albeit with less favorable terms and loan options.3 There’s no need to despair, though. Business owners with poor credit scores can either build up their credit or try alternative or online lenders.
As far as low income, a small business has a few options: equipment financing and short-term loans, along with invoice financing and SBA microloans.
Equipment financing may be an excellent choice for someone with low income because the equipment is the collateral for the loan, and the lender will not be as concerned about low revenue. Short-term loans may not provide as much cash — about $2,500 to $25,000 — as the borrower desires, but they can be a good option for those with low income. Interest rates usually start at 10%, and repayment terms are weekly over a period of three to 18 months.
Assets owned by the business — Banks and other lenders will assess the business’s assets (especially current assets such as cash and accounts receivable) to ascertain if there are sufficient assets to claim if there is a loan default.
Corporate history — Lenders prefer to lend to companies that are well established and have been in business for several years.
Financial Statements — Lenders will scrutinize your financials so you must be confident that all your books and other documents will pass muster.
Step 4: Understand your different financial options
You will want to start by understanding your options for funding your small business:
Traditional bank loans — A traditional bank loan will be a great fit if you have good credit or a history of successful business dealings. If you have experience getting a consumer loan, then you’re already familiar with the process of obtaining a bank loan, although some of the requirements will be stricter.
Alternative lenders — Additionally, some alternative lenders focus specifically on new small businesses or those with bad credit. You can apply online with no upfront costs, but be mindful that they often set high interest rates.
SBA loans — Other potential sources of non-traditional funding are SBA loans, which are loans of $500 to $5.5 million guaranteed by the U.S. Small Business Administration. The SBA does not loan funds directly to small businesses. Rather it works with lenders, who in turn, provide the money to small business owners. On its site, the SBA describes several benefits of SBA loans: SBA-guaranteed loans generally have rates and fees that are similar to non-guaranteed loans, some loans feature continued support to help entrepreneurs start and run a business, and the loans include other benefits such as lower down payments, flexible overhead requirements, and some loans do not require collateral. Potential downsides include long wait times to process the application.
Credit unions — Credit unions are nonprofit organizations that operate like banks: they accept deposits, provide financial services, and make loans at reasonable interest rates.4 On the other hand, their financial options are more limited compared to traditional banks. (And they’re not known for being tech-savvy.)
Crowdfunding and P2P lending — Outside of financial institutions, there is also crowdfunding and peer-to-peer lending. Unlike credit unions, these sources rely on social media. Businesses that have successful crowdfunding campaigns are few and far between because they need to become viral to gain momentum.
PPP Loans — Established by Congress as part of COVID 19 stimulus, the Paycheck Protection Program (PPP) is a loan designed to provide encouragement for qualified small businesses to keep their workers on the payroll and other expenses such as rent or utilities. Borrowers may be eligible for PPP loan forgiveness if they follow a few rules and requirements. The government will lend up to 2.5 times the average monthly payroll for most businesses and up to 3.5 times the average monthly payroll for hotels and food services businesses. The SBA is currently offering PPP loans until March 31, 2021. About $670 billion in Paycheck Protection Program (PPP) loans were distributed in 2020 alone.
Accounts Receivable Financing — Accounts receivable financing enables companies to obtain loans on their outstanding invoices, thus helping businesses cope with cash flow difficulties. For this financing, the accounts receivable company provides funds based on the money that is owed to a company after providing products or services to a customer. The business invoices become the collateral for the cash advance.
Microloans — Microloans describe relatively small (i.e., up to $50,000), short-term loans that generally have low interest rates. These loans are usually given to self-employed individuals, startups with low capital requirements or small businesses with only a few employees. The most-common microlenders are nonprofit organizations that have a mission to lend to women, minorities and other under resourced entrepreneurs. The SBA offers microloans of up to $50,000, but the loans average $13,000.
Step 5: Prepare for a successful application
Benjamin Franklin once said, “By failing to prepare, you are preparing to fail.” And we’re not going to argue with him. Take the following steps to make your small business loan process easier:
- Make sure to register your business and obtain an official tax ID.
- Stop mixing up your personal and business expenses and make sure that your business has its own accounts and credit card. That way, you can start building your business’s credit history while keeping it separate from your personal finances.
- Find out your credit score from your credit card company, financial institution or loan statement.5 If it’s below 670, get your credit score higher by making sure your finances are up to date, making all payments on time (e.g., on your loans and credit cards). Remember that there’s always room for improvement because a high credit score will qualify you for better offers and lower rates.
- Prepare the documents you’ll need to apply. These typically include (but are not limited to), your personal financial statement, borrower information, statement of personal history, federal personal tax returns, business plan, financial projections, your personal identification card, and management resume.
Step 6: Decide on security or guarantee to provide
To improve the chances of receiving the green light for a loan, a borrower can provide a security interest to the lender on company assets such as corporate equipment, property or accounts receivable. With the security interest on a loan, the lender has a legal claim on collateral designated by the borrower. Thus, the lender can repossess the collateral and sell it if the borrower defaults on the loan.
While the security interest can help secure a loan, it is best to avoid a personal guarantee when applying for a loan. That should be avoided because it places personal assets, not just business assets, at risk.
Step 7: Be prepared to state how much you want to borrow and how you will use the funds
Right off the bat, the lender will ask how much you want to borrow and how the loan proceeds will be earmarked. For example, the lender may ask if you plan to purchase equipment or use it for other capital expenditures. The lender may also want to know the specific use of the funds such as expanding your company or hiring additional workers. Other purposes for the loan may include:
- Boosting the size of your inventory
- Increasing sales and marketing efforts
- Devoting funds to new research
- Developing new products and technology
- Expanding into new facilities or territories.
Lenders may favor companies borrowing money for purposes that contribute long-term value to the business, such as the purchase of equipment, machinery or real estate. Expanding your business is another worthwhile use for a loan because you can manage to expand without taking out working capital from the business.
Finally, taking out a loan to better manage cash flow is also a worthwhile use for the funds. If your customers typically take 60, 90 or 120 days to pay invoices, or your company is seasonal with several down months a year, then a business line of credit or invoice financing can assist you sustain your working capital needs.
Step 8: Applying for a loan
Once you’ve narrowed it down, apply only to your top choices. Every time you go through a credit check, it slightly hurts your credit score.This adds up, so make sure only to select a few lenders that work best for you.
Pro tip: Once you get a few offers, compare them and see if there is room for negotiation. If you have a lender in mind, ask them if they can match another, more favorable offer.
Applying to a small business loan can be challenging, but it will pay off (literally) when you build a solid business foundation, access financing options, and experience business growth.
Step 9: Loan comparison tools
After applying for loans, you may receive a few offers. To compare the loan offers, several sites offer loan comparison tools. The tools enable you to examine each lender’s origination fees and interest rates. Other factors include the interest rate and if it will vary over time, how often the interest must be paid, and other costs such as underwriting fees, administration fees and loan processing fees. Finally, it’s important to know if the loan’s balance can be paid off early without a penalty.
Step 10: Wait for an answer and reapply if necessary
Lender processing times for business loans generally vary based on the type of loan and amount of money that was requested. Approval for some loans can require weeks or months, while others take just a few days. If you are turned down for the loan, it may be prudent to inquire why you were not approved and how you can improve your chances the next time. You may want to assess why your application was rejected and research lending resources that are better suited to you and your business’s circumstances.
The best way to improve your opportunity to obtain a business loan is to research the lending process and the various types of lenders before applying for a loan. If you need to improve your credit or cash flow, you must take appropriate actions before completing an application. Once you are ready to apply for a loan, carefully assess your options to find the appropriate lender and loan for you and your company.
- U.S. Small Business Administration. “Find local assistance.”
- Small Business Development Centers. SBDC Services
- US News. Bad Credit Loans for Small Businesses.
- MyCreditUnion.gov. What Is a Credit Union?
- Equifax. How Can I Check My Credit Scores?