Starting or expanding a business often requires financial support, and one of the most common ways to secure funding is by applying for a business loan. Business loans can help you cover various expenses, from purchasing equipment and inventory to funding day-to-day operations. If you've never applied for a business loan, the process might seem daunting. However, with a clear understanding of the steps involved and the necessary preparations, you can increase your chances of success. In this comprehensive guide, we'll walk you through each step of applying for a business loan, including deciding on your financing needs, checking your eligibility, comparing lending options, gathering required documents, and submitting your application.
Step 1: Decide Why You Need Financing
Before you start the process of applying for a business loan, it's essential to determine why you need financing. Your specific funding needs will influence the type of loan that's most suitable for your business. Here are some common scenarios and the appropriate loan types:
Buying New Equipment:
- Equipment Loan: This type of loan is designed to help you purchase business equipment, such as machinery or office furniture. The loan is secured by the equipment itself, which means the lender can seize it if you fail to repay the loan.
Borrowing a Small Amount:
- Microloan: The U.S. Small Business Administration (SBA) offers a Microloan program that allows qualified applicants to borrow up to $50,000. Additionally, not-for-profit organizations like Kiva and the Women's Microfinance Initiative provide microloans.
Establishing a New Business:
- Business Credit Card: If you're just starting out, you may find it easier to qualify for a business credit card than other types of business loans, as approval is based on your personal credit score.
Covering Day-to-Day Operations:
- Working Capital Loan: This is a short-term loan used to cover daily expenses, like rent and payroll. It helps address temporary cash flow problems.
Borrowing Money As Needed:
- Business Line of Credit: If you're uncertain about the exact amount you need to borrow, a business line of credit allows you to withdraw funds as needed, and you only pay interest on the amount you borrow.
Funding Turnaround Time:
When considering different financing options for your business, it's crucial to take into account the speed at which you need to receive your funding. Different loan options have varying turnaround times after you submit your application. If you require quick funding, some options may be better suited to your needs.
- Traditional loans from banks and credit unions can take 30 days or more to be funded. However, this can vary based on the lender and your application, including any assessments required for assets backing the loan.
- Some SBA loans can be funded within 10 days, making them a good option for businesses in need of a faster turnaround. Additionally, online lenders can provide fast business loans, with some being funded within a day in certain cases.
Step 2: Check Your Eligibility
Business loan requirements can vary significantly, but there are some common factors that lenders are likely to consider when reviewing your loan application. It's crucial to understand these factors and how they might affect your eligibility:
- Lenders will review both your personal and business credit scores to assess the likelihood of you repaying the loan. A higher credit score generally increases your chances of loan approval and may result in a lower interest rate.
Collateral and/or Personal Guarantee:
- Some lenders may require you to pledge collateral, which is something of value like equipment or inventory that they can seize if you default on the loan. Additionally, a personal guarantee may be necessary, meaning you must secure the loan with personal assets like savings, your home, or other valuable possessions.
Time in Business:
- Traditional banks usually require a business to have been in operation for at least two years. Online lenders, on the other hand, often require only one year of operation. If your business is less than a year old, some online lenders may still approve qualified applicants who have been in business for six months.
- Your total annual sales are also a significant factor. It's essential to ask the lender about their specific requirements and review your business finances to determine if you meet them.
Step 3: Compare Business Lending Options
Once you've assessed your financing needs and eligibility, it's time to compare different business lending options. There are various sources where you can find small business loans, and understanding the pros and cons of each can help you make an informed decision. Here are three common types of lenders:
- Online lenders offer a range of loan products, including term loans, merchant cash advances, lines of credit, and microloans. While loan approval rates may be lower for online lenders compared to traditional banks, they often have less stringent requirements, making it easier to get approved, especially if you have less-than-stellar credit. Online lenders also tend to have faster turnaround times, with some providing funds on the same business day. However, they often charge higher interest rates compared to traditional banks.
- Traditional banks provide similar types of business loans as online lenders. The primary advantage of applying for a business loan with a bank is that they generally offer lower rates for well-qualified applicants. On the downside, banks often have stricter eligibility requirements. If you have a low personal credit score (FICO score less than 580), you might have difficulty qualifying without a co-signer. It's worth noting that smaller banks tend to have more satisfied customers and shorter wait times compared to larger banks.
- Microlenders are typically not-for-profit organizations that issue microloans (up to $50,000) to qualified applicants, often targeting business owners who don't qualify for traditional loans. Microlenders usually have less stringent eligibility requirements, making them an option for those with limited credit history or lower credit scores.
When shopping for loans from various lenders, using a business loan calculator can help you calculate the costs of each loan, making it easier to find the most cost-effective financing option.
Step 4: Gather the Required Documents
Before you submit your business loan application, it's crucial to gather the necessary documents that lenders will typically request. Having these documents ready will streamline the application process. The required documents often include:
- Personal and business tax returns
- Business licenses
- Articles of incorporation
- Personal and business bank statements
- Profit and loss statements
- Financial statements
- Business plan
- Building lease (if applicable)
If you're unsure about the specific documents needed by a particular lender, it's advisable to contact them before applying to ensure you have everything in order.
Step 5: Submit Your Application
The final step is to submit your small business loan application. Depending on the lender you've chosen to work with, you may have the option to apply online or in person. When completing your application, be prepared to provide the following information:
- Your name
- Business name
- Social Security number (SSN)
- Desired loan amount
- Loan purpose
- Business Tax ID
- Annual revenue
After you've submitted your application, you'll need to wait for an approval decision. If your loan is approved, the lender will send you a loan agreement to sign before issuing your funds or a line of credit that you can draw from.
Choosing the Best Business Loan:
Selecting the best business loan for your specific needs comes down to comparing loans you qualify for and determining which one is the right fit. To make an informed decision, consider the following loan factors:
- Annual Percentage Rate (APR):
- The APR represents the total cost of a loan on an annualized basis, including interest and fees. Comparing APRs allows you to assess which business loans are most and least affordable.
- Lenders may charge upfront fees to process your loan application. Projecting these fees and factoring them into your decision-making process can help you compare the overall costs of different loans.
- Repayment Terms:
- Business loans can have terms ranging from one year to 25 years. Longer loan terms can lower your monthly payments but increase the total interest you'll pay over time. The right loan term depends on your business goals and your ability to manage installment payments.
- Funding Speed:
- While loans from major banks might offer competitive rates for borrowers with strong credit, the application process can be time-consuming. If quick funding is a priority for your business, online lenders often provide faster access to funds.
How to Get a Business Loan from Banks:
Securing a business loan from a bank can vary depending on the financial institution. Some major banks offer online applications, while others may require you to visit a physical branch. The information you must provide to initiate an application can include your business name, the date your business started, gross annual revenue, and annual household income for all owners. Keep in mind that brick-and-mortar banks typically have more stringent eligibility requirements compared to online lenders, often requiring strong credit and financials to qualify.
Types of Business Loans:
Depending on your business's specific needs, one type of loan may be more suitable than another. Here are some common types of business loans:
- SBA loans are small business loans guaranteed by the Small Business Administration. These loans include SBA 7(a) loans, 504 loans, CAPlines, Microloans, and others, each serving different purposes. SBA loans often come with lower interest rates and down payments than other options but may require your business to be established to qualify.
- Term loans are traditional installment loans repaid over predetermined terms. Banks, credit unions, and online lenders offer these loans, and they can be used for various business-related expenses. Term loans are typically available up to $500,000 with APRs starting around 9%.
Lines of Credit:
- A business line of credit allows you to draw funds on an as-needed basis, making it a good option for ongoing cash flow issues. The borrower has access to the line of credit for a set period up to a predetermined limit, and repayment occurs after the draw period, typically with interest. APRs for lines of credit typically range from 10% to 99%.
Invoice Factoring and Financing:
- Invoice factoring involves selling outstanding invoices to a factoring company at a discount. This can help your business get paid for outstanding invoices quickly, rather than waiting for customers to pay. APRs for invoice factoring are typically between 10% and 79%.
Merchant Cash Advance:
- A merchant cash advance involves giving a lender a portion of your future sales, making it suitable for businesses with a high volume of sales that need quick cash. The lender provides funds to your business, and repayment is made through a percentage of your daily or weekly sales.
- Equipment financing funds the purchase of equipment or machinery, with the equipment itself backing the loan. These loans can be used for anything from office furniture to manufacturing equipment, and terms can extend up to 25 years with loan limits of up to $1 million.
Applying for a business loan can be a critical step in the growth and success of your business. By following this step-by-step guide, you can make the process more manageable and increase your chances of securing the right financing for your needs. Carefully consider why you need financing, assess your eligibility, compare lending options, gather the required documents, and submit your application. Additionally, take the time to evaluate the best loan based on factors like APR, fees, repayment terms, and funding speed. Whether you're looking for a traditional bank loan or exploring online lending options, there are loans available to suit your specific business goals and financial circumstances.