Applying for a small business loan can be a tricky process, as there are several requirements you need to meet in order to obtain one. Those requirements can be confusing, as lenders require everything from business licenses and cash flow history to business plans and personal financial statements. 

Whether you are applying for a business loan from a traditional bank, alternative lender, or credit union,  as a small business owner in need of financing, one of the ways you can untangle the process is to use the following small business loan checklist.  This checklist will help to ensure that you are ready to apply with confidence. Knowing what documents are needed for a business loan ahead of time will keep you organized and possibly help you get a reasonable interest rate on your loan. 

Things to Consider Before Applying for a Business Loan

Before even beginning to collect your business loan paperwork,  there are key factors you should consider:

Why do I need a loan?

This is perhaps the most important question you should ask yourself before applying for a small business loan. Getting a business loan just to have the money you borrowed sit around while you pay interest on it is obviously a bad idea. 

• Ideally, the proceeds of a business loan should be used towards growing your business so that it can increase its revenue. For example, if you need money to develop and market a new product; purchase or upgrade equipment; expand your business by hiring new employees; or adding to your inventory would all be ideal reasons to obtain a loan. 
• There are also financing products, such as working capital loans and business lines of credit, that can help your business operate during the offseason or when there’s a downturn in the economy. 

Can I afford a loan?

Everyone knows that loans carry interest rates, and those rates are, in part, affected by the current interest rate environment. The Federal Reserve has raised interest rates 10 times in the past year-and-a-half, and that’s going to make the interest rate on virtually every type of business loan you want to take out more expensive. If you can afford to wait, you might want to hold off on getting a business loan until rates drop again. 

What type of lender suits me best?

There are several types of lenders who can provide you with a small business loan. Those include traditional banks, alternative lenders, trade unions, marketplaces, and brokers. Each one comes with pros and cons that you should consider carefully. Some lenders, such as traditional banks and alternative lenders, offer financing products directly, while brokers typically offer you a marketplace of lenders. Also, some will demand higher business and personal credit scores than others, and some can deliver your funds more quickly than others. Carefully consider which one best serves your needs.

Can I get a grant instead?

There are, of course, several public and private business grants available to small businesses – some of which are backed by the US SBA. These grants often have specific criteria for applying. For example, some may be offered to small businesses in certain industries, and others may be offered only to women- and minority-owned businesses. Determine whether you qualify, but remember, applying for these can be a roll of the dice and you’re not guaranteed to win a grant. 

Do I have a plan B?

All small business owners have the best of intentions when applying for a business loan, but life happens, and sometimes it won’t go your way. Before you take out a loan, it’s a good idea to make a contingency plan if things go south and you find yourself struggling to keep up with debt payments. Bankruptcy should be a last resort. Do you have assets you can sell? Do you have a cash reserve that you can draw upon until you get back on your feet? 

Small Business Loan Documents Checklist

Go over this business loan documents list to make sure you are prepared for the sometimes overwhelming process of applying for a business loan. Doing so will simplify and hasten the process of getting the funding you need for your small business. 

Check your credit scores  

All lenders will pull both your personal and business credit reports. You can check your personal FICO scores online for free at the websites of the three main credit bureaus, Transunion, Experian and Equifax. You may have to pay a fee to get detailed reports so that you can check for errors. You can check your business credit score at the website of Dun & Bradstreet, the business credit bureau that is most heavily favored by lenders, for a small fee. 

If your personal FICO and business credit scores are less-than-stellar, you may want to consider taking 6-9 months to improve them so that you can increase your chances of being approved and get a better rate on your loan.

Prove that your business exists

All lenders will require documentation proving that your small business is registered as a tax entity. At the very least they will require your employee identification number, which is issued by the IRS, and proof that your business is registered as a LLC, “Doing Business As” (DBA) company, or an S or C corporation. Lenders will also require proof of identity, pay stubs, and your social security number as well. For an SBA 7a loan or a term loan from a traditional bank, the lists of documents required can be even longer and include items such as business licenses, business lease agreements, proof of equity injection and franchise, and licensing agreements if you plan to franchise your business.

Have a business plan

If you plan to apply for a term loan with a traditional bank or for a SBA 7a loan, chances are you will need to show your business plan. This is a plan that shows how your business is organized and typically includes a market analysis and what niche your products and services fill, how they differ from your competitors, and why you believe your small business will be successful going forward. In short, it details why you believe your business is going to make money.

Financial Statements

Almost all types of lenders will want to see your business’s financial documents that indicate it has a strong cash flow history, including, but not limited to 3-6 months’ worth of business bank statements, 2-3 years of tax returns, balance sheet statements and income statements. 

Run a cash flow analysis

Cash flow is one of the primary indicators that lenders use to understand the health of your business. Being able to show 3 to 6 months of positive cash flow can increase your chances of approval. It can even get you better financing terms for your small business loan. 

Collect your business bank statements 

Your business accounts are another good indicator of your company’s financial health. Generally, lenders want to see a positive daily balance on your bank statements for the past 3 to 6 months. 

Gather  supporting documents for unusually large deposits

Unusually large deposits can act as a red flag for lenders. While the  presence of these deposits can delay finalization of loans, they are not necessarily bad. Many businesses understandably have large swings in deposits and credits to their account. If your business is like that, you can expedite your loan application process gathering copies of your account receivables and future contracts to support these large deposits.

Take care of delinquencies

Many lenders only want to lend to people whom they believe are of high character. This is especially true when you’re applying for SBA loans. As such, if you have any tax liens or are late on child support payments, you should take the necessary steps to clear those up before you apply. 

Resolve any open tax liens

Unresolved open tax liens can hurt your ability to obtain financing. If possible, try to get a payment plan set up on any open tax liens you may have before you apply for a loan. A payment plan on a tax lien, along with a very strong positive cash flow will typically be considered by alternative lenders and even some SBA lenders for loan approval 

Assess any collateral you may have

Before you apply for a loan package, you may want to sit down with a business loan specialist or an accountant to see if you need to put up collateral. This includes real estate, investment holdings, savings and even your car or valuable pieces of equipment you may own. Traditional banks often want collateral if your business credit or personal FICO score is shaky. In rare cases, alternative lenders may ask for collateral. Even if you have good credit, it might be worth applying for a secured bank loan or business line of credit because you may be able to notch a lower interest rate and a higher credit line or loan amount if you put up collateral. 

Get trade references

If your business credit score is borderline, you can boost it by getting positive references from either your suppliers or, if you lease a physical space, your landlord. You can give these references to your credit bureaus and, if you’re using a traditional bank, to the loan officer. Having these could mean the difference between obtaining a loan or getting rejected. 

If you get Rejected

Getting rejected for a business loan isn’t pleasant, but it can be a valuable lesson on how to get accepted the next time you apply. Traditional banks and alternative lenders want to grant you a loan approval because it’s the way they make money. As such, they will be happy to give you a detailed explanation for why you were denied, and, usually, it will take a bit of time to improve your business to the point where you can obtain that business loan.

While every rejection is different, some of the most common reasons for getting rejected for a business loan are:

Your business credit score is not high enough

Some of the ways you can raise your business credit score include:

•  reducing the number of creditors you owe money to
• making sure you make debt payments on time for at least 6-9 months
• having a strong credit mix. 

Other steps include being in good standing with your suppliers and increasing the assets of your business. 

Insufficient time in business 

Traditional banks typically won’t lend to a small business that hasn’t existed for at least three years, while alternative lenders may want to see at least two years in business. If this is the case, hold off on borrowing until your small business has been in operation for a sufficient time. If you can’t wait, see if you qualify for an SBA CDC/504 or SBA microloan, both of which only require 6 months in business. 

Too much existing debt

This is actually a common reason why small businesses get turned down for a loan. If you already have outstanding loans, you can always try to retire them with a new loan. Additionally, if you have a line of credit that is close to being fully drawn, you should take steps to pay it down before applying for a new loan. 

Your cash flow is not strong enough

If your small business’s cash flow is tight (meaning you are spending almost as much money as you are taking in), take steps to fix it by finding ways to reduce your expenditures. 

Your industry is too risky

If your small business operates in an industry in which there are higher than average bankruptcies, or if it operates in what lenders may consider “vice” industries such as gambling, alcohol, or legal marijuana dispensaries, you will most likely get turned down no matter how financially strong your business is. A quick Google search, however, can most likely lead you to legitimate online lenders who specialize in lending to companies in your industry.

Don’t Get Frustrated

Remember, when applying for a business loan, patience and weighing the pros and cons of different lenders are often the keys to getting the funding that you need to help your business grow. Go down the checklist of items that you need to take care of in order to be ready to apply, and carefully consider the pros and cons of the different types of lenders out there so that you can get the financing that is exactly right for your business. 

Which is Best for Your Small Business?

The one ingredient every small business needs is capital – capital to grow, even out cash flow, and meet short-term expenses. The question of where you go to get a business loan, however, can be confusing, especially when it comes to choosing the type of lender. When it comes to financing, small business owners have two main choices for a lender: a traditional bank and an alternative business lender. Both come with pros and cons, different interest rates, different speeds at which funds are delivered, and different loan amounts offered so it’s important to fully know what your needs are and which type of lender is best suited for you. 

What are Alternative Lenders for Small Businesses?

Most business owners know they can walk into a brick-and-mortar bank and apply for a traditional bank loan, but since the 2008 financial crisis, alternatives have become increasingly popular. There are financial institutions that operate outside of the traditional banking sphere that typically offer financing applications entirely online, while giving borrowers the opportunity to speak to lending experts via phone or online channels. They are just as legitimate as banks and offer distinct advantages over them. 

Rise in Popularity 

While alternative lenders have been around since the late 1990s, their popularity began to soar after the 2008 financial crisis when many banks struggled for capital and tightened their requirements for getting loans. 

While alternative lenders were relatively obscure before the 2008 financial crisis hit, alternative business loans rose in popularity during the Great Recession. Before 2008, alternative lenders represented just 7% of the small business lending market, according to a study by the Federal Reserve. That figure rose to 12% after 2008. In 2016, 19% of small business owners turned to online lenders for their financing needs, and by 2019, the number jumped to 32%.

What is a Traditional Bank?

Traditional banks are the financial institutions in your neighborhood that can be regional or local banks or branches of larger banks such as JPMorgan Chase or Bank of America. They offer you face-to-face service with a loan officer specializing in helping small businesses. Depending on your FICO score, they usually offer slightly better interest rates than alternative lenders. Borrowing requirements, however, tend to be more rigid than alternative lenders, especially now that we’re in a high-interest-rate environment in which lending requirements have significantly tightened. 

Also, the application process is typically more complicated than with alternative lenders and, once approved, there could be a relatively long waiting period to get your funds. Still, if you have an excellent credit score, you most likely will notch a lower interest rate, which could save you significant money when it comes to your total cost of capital. 

Traditional Banks: Pros and Cons

Traditional banks are still the most popular types of lenders for small businesses and offer several advantages over alternative lenders, but there are also significant drawbacks as well. Small business owners should be aware of the pros and cons of using their neighborhood bank for a loan:

 Pros 

• Lower interest rates. While every bank is different, most offer lower interest rates on bank loans than alternative lenders. However, as interest rates are currently high right now, the difference in the interest rates on a small business bank loan between traditional and alternative lenders has tightened. 
• Face-to-face service. Many small business owners like to see a familiar, friendly face when they walk into a bank – a lending expert who is already familiar with their business – and this is a significant advantage traditional lenders have over their alternative counterparts. 
• Direct product offerings. Many traditional banks directly offer a full suite of financing products to small businesses, such as bank loans and equipment financing. Meanwhile, most alternative lenders are usually funded by asset-backed securities, so may not have the capital to directly offer a full suite of financing products, such as business lines of credit. This allows small business owners to directly negotiate the terms of their loans with the lending officer. Many alternative lenders, however, typically partner with several lenders to offer you a marketplace of financing options that they don’t directly offer.
• Offers other financial services. Small business owners can simplify things by having all of their financial needs met under one roof. This includes having a business savings and checking account, as well as a business credit card, all with one institution. Most traditional banks can provide this to you.

Cons

• Stricter lending requirements. While every lender has slightly different requirements, traditional banks generally have strict requirements for small business loans. You’re often going to be turned down if you don’t have an excellent FICO score (700 or higher). Also, to get a bank loan, your business usually needs to have higher annual revenue than what an alternative lender might want. Alternative lenders usually have shorter applications with fewer requirements.
• Longer application process. Traditional banks often require longer application processes than alternative lenders since they are generally more risk-averse.
• Slower funding times. In some cases, if you are approved for a loan from a traditional bank it could take several days or even weeks to get your funds. 

• May be Cumbersome to shop around. If you were shopping for an expensive item such as a new car, you’d probably want to visit several dealerships to get the best possible price. The same holds true for a small business loan. Shopping around for a loan from a traditional bank, however, means you may have to physically visit several local banks to get the best possible deal, and small business owners might not have the time to do that. Many large banks allow you to compare offers online. However, since alternative lenders operate almost entirely online, all you need is your laptop and an internet connection to compare offers. 
• Systemic risk. Systemic risk is essentially the risk that banks may collapse due to declining economic conditions. Banks shut down during the credit crunch of 2008, and recently, as interest rates have gone up, banks such as Silicon Valley Bank and Signature Bank were taken over by the Fed earlier this year in high-profile collapses. While this doesn’t happen very often, it’s still a risk when working with a traditional bank. 

Alternative Lenders: Pros and Cons

Alternative lenders have become a legitimate borrowing choice for small business owners since the Great Recession, especially when small business lending from traditional banks dropped by some 40% in 2009. These lenders offer significant upsides for small businesses, but they also carry some downsides as well. Here are some of the pros and cons of using an alternative lender:

Pros

• Relatively simple application process. Applying for small business financing from an alternative lender typically takes only a few minutes, and it can all be done online. With a traditional bank, there is usually far more paperwork involved and in many cases with regional banks, you need to visit a location as part of the application process. 
• Fewer requirements. Alternative lenders primarily judge you by your FICO score and cash flow history and require minimal paperwork compared to a traditional bank. Alternative lenders also sometimes require fewer years in business and less annual revenue than a traditional bank. Additionally, loan approval rates from alternative lenders remain far higher than traditional banks. If you’ve been turned down for a loan by a traditional bank because of a borderline credit score (let’s say in the 660 to 680 range), then you may still qualify for a business loan with an alternative lender if you have a strong cash flow history.

• Different Financing Products.  In addition to traditional business financing products, such as short-term loans, long-term loans and equipment financing,  alternative lenders offer some financing options that banks do not.  Including:
• Revenue-based financing. Revenue-based financing is when a lender gives your small business a lump sum of cash in exchange for a portion of your future receipts – a practice often referred to as factoring. This type of financing is often used when a small business needs cash for an emergency or to finance an unexpected growth opportunity. Most traditional banks don’t offer this, but many alternative lenders do, giving you another option when it comes to financing.
• Factoring. Factoring is a form of financing offered mainly by alternative lenders. A financing tool such as invoice factoring, for example, can give you cash based on your outstanding invoices. While this can be an expensive way to get quick cash, it is an example of the types of alternative financing that you can get with many online lenders.
• Rapid funding. If you qualify for financing with an alternative lender, you could receive your funds in as little as 24 hours, whereas with many traditional banks it could take several days or even weeks to receive your funds.

Cons

• Higher interest rates. Because alternative lenders are generally willing to take on a bit more risk when giving loans to small businesses, they typically charge a higher rate on those loans compared to traditional banks. However, in the current high-interest rate environment, the difference in the cost of capital charged by traditional banks vs. alternative lenders has dramatically tightened over the past year.
• Fewer direct products. Alternative lenders don’t borrow cash from the Federal Reserve, nor do they offer savings accounts upon which they can lend against. Therefore, many don’t typically don’t have the cash reserves to directly offer certain financing products such as business lines of credit or equipment financing. 

Many alternative lenders, however, do partner with banks and other lending institutions to offer a marketplace to small business owners seeking those products to get them the best possible deal. The potential drawback to this is that borrowers typically can’t negotiate directly with alternative lenders for the terms of certain financing products like they could with traditional banks. 

Key Takeaways

Small business owners in need of capital must make prudent decisions on where to apply for financing. Alternative lending and traditional lending each have pros and cons, so it’s important to be educated on both. Generally speaking:

1. If you have the time and meet the criteria, traditional banks are probably the best bet for financing. 
2. If you need funding fast, or have a borderline FICO score and a strong cash flow history, then an alternative lender might be the best choice for you to obtain capital.
3. While traditional banks generally offer lower interest rates on their loans than alternative lenders, the difference in those rates has tightened as interest rates continue to climb.
4. Traditional banks offer you the opportunity to conveniently have all of your financial services needs – including a business checking and savings account and business credit card – taken care of under one roof.
5. Alternative lenders have made great strides in providing personable customer service. Most offer small business financing specialists available by phone to help educate you and assist you in deciding which financing product is best for you. 
6. Whether you’re applying for a loan with a traditional bank or an alternative lender, make sure to have your paperwork ready. This includes past bank statements, tax returns, and an updated business plan. 

Before you decide how you want to get your business loan, it’s vital that you take the time to closely examine which type of lender best suits your small business needs. Make sure you know what to expect with both alternative lenders and traditional banks in terms of cost of capital and convenience. 

If you’re ready to take on a loan or any other type of financing for your small business, you should give yourself a pat on the back. That usually means that your business has grown to the point where you’re ready to take on additional growth opportunities or you just need funding to keep your operations running smoothly. Before you get that business loan, however, one of the most important questions you need to ask is, ‘what type of financing should I get?’

Various types of small business lenders offer an array of loan options and other financing products for different purposes, and it’s crucial that you determine which product best suits your needs as a small business owner. While nobody really wants to pay interest, each financing option will offer a different cost of capital. There are also those that offer different repayment terms, while there are still others that are designed to fund specific business needs. 

What types of loans are there and which one is best for you? You have an array of options, and which one you choose should depend on how you plan to use the funds, your business and personal credit scores, as well as the loan amount you’re seeking. 

Types of Business Loans

Here are the different types of small business loans you can seek for your small business and how they can help you the most:

Term loans.

Term loans are offered by both traditional banks and alternative lenders. It is a large chunk of money that you receive all at once and agree to pay back over time with interest. The proceeds of a term loan (also called a bank loan) typically must be used for a specific purpose, such as expanding your business, developing and marketing a new product, or consolidating debt. 

Traditional banks usually offer slightly lower interest rates than alternative lenders, but often demand that you have a good to excellent personal FICO and business credit score. The application process tends to be longer and more complicated than alternative lenders, and the funds may take days or weeks to be delivered to you. Alternative lenders typically charge higher interest rates but offer a simpler application process, typically have less stringent qualification requirements, and can deliver funds to you in as little as a day.

Small Business Administration (SBA) 7(a) loan

SBA 7(a) loans are essentially term loans given out by both traditional and alternative lenders, while the US Small Business Administration guarantees a large portion of them and sets the general borrowing requirements for small business owners. These loans typically offer the best interest rates when it comes to term loans, but come with a long list of requirements such as an excellent FICO (680 and above) and a business (80 or above) credit score. Also, it may take weeks to actually obtain the funds. 

Working capital loan

These loans are typically offered by online lenders and typically don’t require a personal FICO or business credit score as high as a term loan. They are usually meant for small businesses with seasonal or uneven cash flows throughout the year that need to keep operations going during the offseason or when there’s a downturn in the economy. Depending on the borrower’s credit score, the interest rate can be very high.

Non-Recourse Loan

Non-recourse loans are often used in commercial transactions in which the real estate itself acts as collateral. In a non-recourse loan, the lender may only seize the collateral in the event of default or bankruptcy, even if the collateral does not equal the full value of the loan. A non-recourse loan, in rare cases, can also be applied to a secured term loan. 

Lenders usually offer this type of loan with strict requirements, such as a very high credit score or performance guarantees. The SBA also offers some non-recourse loans through intermediary lenders, which also usually carry exceptionally strict requirements.

Commercial Real estate loan

If you’re a small real estate company seeking to invest in a property or a small business owner who’s decided that it’s in your best interest to purchase the property from which your business operates, a commercial real estate loan is your best option. It is essentially a commercial mortgage from a traditional bank in which the property being acquired becomes the collateral, so your credit score may not matter as much as your business plan. 

SBA Microloan

An SBA microloan is offered through intermediaries, many of which are not-for-profit and are geared towards young small businesses (at least 6 months in operation) and carry fewer requirements and lower interest rates than bank loans. In some communities, these loans are offered exclusively to women- and minority-owned businesses, or small businesses operating in underserved communities. The maximum loan amount is $50,000 with the average amount in 2022 being slightly less than $17,000. 

SBA CDC/504 loan 

Like the SBA Microloan, these loans are typically offered through not-for-profit intermediaries and are typically granted to small businesses for the purpose of enhancing their communities through storefront renovation and increasing local hiring. They can also be used for land acquisitions and equipment purchases, and carry less strict requirements than bank loans. Unlike the SBA Microloan, they do offer larger amounts, with the maximum being $5 million.

Equipment loan

An equipment loan, commonly referred to as equipment financing, is just that: a loan that pays for the entirety of a piece of revenue-producing machinery (such as a business vehicle, tractor or manufacturing equipment) for your business. This is offered directly by traditional banks and alternative lenders. This type of loan usually offers an interest rate that is less than a bank loan, depending on the credit score of the borrower, since the machinery purchased acts as collateral for the loan. The catch is that the interest rate on this loan will usually be higher than if you went directly to a dealer and financed that equipment. However, if you buy directly from a dealer, you usually have to make a large down payment. 

Non-Loan Business Financing Options

While there are a lot of different types of business loans, there are also financing products that are not technically considered loans, even though they involve lenders giving money to businesses in exchange for the principal and an interest rate or “factor” fees. These types of financing products can come in handy for specific purposes and sometimes can be more convenient than traditional loans.

Business Line of Credit (BLoC)

A business line of credit, offered by traditional banks and alternative lenders, gives your small business a predetermined amount of debt to draw upon for any business need. While conceptually similar to a credit card in that way, there are many differences. A BLoC often offers a lower interest rate than a business credit card but doesn’t offer rewards of any kind. Additionally, a BLOC has to be renewed, sometimes on an annual basis. It often has minimum withdrawal amounts; penalties for non-use and repayment terms that include full payment at various intervals. 

BLoCs, however, are very flexible financing tools for a small business owner – the money can be used for any purpose at any time, including meeting payroll during the offseason or for purchasing additional inventory when customer demand unexpectedly swells. 

Revenue Based financing (RBF) 

RBF is a contract-based financing tool typically offered by alternative lenders. A lender will give a lump sum of money to a small business owner in exchange for a predetermined percentage of the business’ future receipts. The contract is based on a factoring model, which means that the portion of each receipt will be factored as a percentage to give to the lender or factoring company. 

While this is usually a more expensive form of financing than a loan, RBF can be very useful if a small business owner comes across an unexpected growth opportunity or an emergency business expense. One positive is that factoring companies usually don’t consider your credit score as the most important qualifier when deciding to do business with you.

Invoice Financing 

Often referred to as invoice factoring, this is a financing tool in which an alternative lender gives you money upfront for your unpaid invoices. The money upfront will be slightly less than the combined value of the invoices, but this type of financing enables small business owners to unburden themselves of the risk of slow-to-pay customers never paying. The potential drawback is that the small business owner may be forced into a longer contract than desired, and depending on the terms of the contract, may be on the hook for a portion of the money if the customers never pay their invoices.

Purchase Order Financing 

Let’s say your small business receives a large order from a major retailer.  However, the cost to produce this order is beyond your reach right now or you’re just not comfortable using up that much of your available cash flow to fulfill the order.  This is where purchase order financing, another type of factoring product, can be incredibly useful. 

With purchase order financing – usually done through an alternative lender – the lender will pay your suppliers upfront for inventory in exchange for a small percentage of the purchases being made, which are referred to as factoring fees. While this can be a bit expensive compared to other types of loan products, the cost of purchase order financing is covered by the amount you would be paid when fulfilling the order. While it may eat into your profit a bit, that is profit you wouldn’t have had if you had to turn down the order due to a lack of inventory.  Additionally, high credit scores on your end will not be a requirement for this type of financing because the credit that is taken into account is the credit of your customer that made the purchase order. 

Consider a Checklist to Help You Select the Right Business Loan for You

Choosing from the different small business loans available to grow your small business, meet unexpected expenses, or keep your business running smoothly is one of the most important decisions you need to make as a small business owner. Before applying, you should go down a fundamental checklist of questions you should answer before seeking financing:

• Why do I need financing/what will the money be used for?
• How much am I willing to pay for business financing?
• Which types of financing are most convenient for me in terms of how I can use the money and how quickly will I receive it? 
• Which financing products am I most qualified for? 
• Do I have a realistic plan for making loan payments or paying the factoring fees? 
• Does my current cash flow justify taking on financing?

Answering these questions beforehand will help you make the wisest decision possible on what type of financing you need, what financing you’re able to afford,  and will – ultimately – help your small business flourish in the long run. 

Images: https://www.shutterstock.com/image-photo/businessman-using-computer-property-sales-listings-2016603413 

Metascript:

Deciding which type of small business financing you need may be one of the most important decisions you can make as a small business owner. Here is a suggested guide.

Meta: Choosing which type of small business financing you need can save you time and money. Here is a guide on how to decide

IMAGES:

Feature Image: Designity is going to make a customized image based on this: https://www.shutterstock.com/image-photo/real-estate-concept-business-home-insurance-2212858403

File Name: Types of Loans for Small Business

Alt Text:  Different Types of Small Business Loans

Title: Types of Business Loans

META: There are many types of small business loans.  Choosing the right one for your business is critical.  Here’s how to determine which business loan best suits your needs. 

There are many ways to describe what it’s like to start a business: exciting, ambitious, and passionate, to name a few. Almost every small business owner would agree, however, that there’s one word they would never use – easy. For all types of businesses, one of the most difficult challenges for any new small business owner is obtaining capital to launch your new endeavor. After all, some 47% of small businesses that fail after two years do so because they run out of money.

Apart from new dentists and doctors’ offices, traditional banks generally don’t offer loans to brand-new businesses, so startup business owners must look elsewhere for funding. The good news is that there are business loans available for new business owners, but each carries a different interest rate, terms, and personal credit score requirements, so it’s important to get educated on the different sources of funding available. 

How to Qualify for a Startup Business Loan

Before you begin exploring the best business loans for a startup, take steps to make sure you qualify. This means that you need to check factors such as:

• Your personal credit score. Much of your personal credit score (or FICO score) is determined by your debt repayment history, your debt-to-credit ratio, and how much outstanding debt you have compared to your income. As soon as you begin your application process for a small business loan, this is the first factor that lenders will look at. 

If you have less-than-stellar credit, some of the ways you can improve your FICO score are by making sure you are current on all of your credit cards; paying down as much of the outstanding balances as possible. It’s also crucial to check your credit report with the three major credit bureaus to get rid of any errors that may be on it. 

• Your Repayment Plan. Ask your potential lender for a detailed repayment plan on the types of financing you’re considering. You can impress your lender by showing them a detailed plan of how you intend to meet your payment obligations. This could be in the form of a simple document demonstrating the income you believe your business will achieve and how you believe you will be able to handle the repayment terms. 
• Potential collateral. Many private lenders will require collateral as a condition of approving the loan, especially for startup business owners with poor credit. If you own a house, have money in your personal savings, or own other items of high value, the lender may require that you put those up as collateral.
• Your sales pitch. If you need a loan to start a business, or you need working capital to fund your new business, you’ll need to convince a lender that your business is viable as part of the application process. This means explaining to your potential lender why you believe your business will make money, who your market is, and what differentiates your small business from your competitors. Lenders will be impressed if you show them that you’ve done a thorough evaluation of your market and have a sound marketing plan to sell your products and services. If your business has been running for a short time, it would also help to show your potential lender your financial statements to demonstrate a strong cash flow.

Assess Your Financial Needs

Before considering a small business loan or other types of financing for your new venture, you need to itemize what you need to spend money on, and what the general costs are. This will give you an idea of how much money you need to borrow and the type of loan you should consider. Once you’ve come up with your unique idea and product offerings for your business, assess what you will need to spend money on to make it happen:

1. Manufacturing and inventory. Whether your business is online or operates out of a brick-and-mortar location, it won’t get very far if you don’t have products to sell. Manufacturing your product and having enough inventory will cost money. It’s crucial that you realistically gauge the market and determine the amount of products or services that you expect to sell and figure out how much that will cost.
2. Marketing strategies. Your great product or service won’t do you much good if potential customers don’t know about them. Determine who your target audience is and devise a marketing strategy to reach them. This may involve having to purchase marketing software that enables you to reach your potential customers via SMS, email, social media, and search engine optimization strategies. Determine what software you need and estimate the cost.
3. A website. No matter what type of business you are running, having an online presence– even a rudimentary one – is crucial, as most consumers today begin their search for products and services online. Even if you use a website builder and hosting service such as Wix or Squarespace, there can be fees involved. Do your best to estimate the cost for this vital business component.
4. Equipment/machinery. If you’re planning to launch a new restaurant, construction company, or any other small business that offers physical services, you’re going to need equipment to run your business. Assess what equipment you’re going to need and the costs.
5. Rent money for a physical space. If your business will operate out of a physical location, shop around to determine the ideal location and price for your space, as well as the cost to design it.
6. Outside contractors. There’s no shame in admitting that you can’t do something, and if you have the means to do so, contracting outside help for things like logo and website design and marketing could make your life a lot easier and greatly improve your business. These services are expensive, so shop around and guestimate the cost if you feel bringing on contractors is necessary.
7. Employees. Whether you’re opening a plumbing business, small accounting firm, or construction company, you will probably need employees at some point. A small business loan can help you get started on payroll until your business is pulling in enough revenue to pay your employees.

Where to Get Start-up Business Loans

There are not many types of start-up loans available.  There are even less start-up loans for those with bad credit.  So, getting an unsecured loan for your startup business will be difficult but not impossible. While most traditional banks and many alternative lenders do not offer them, as many of them view startups as too risky, there are some options:

Startup Business Loan Options

• Online Lenders. There are online lenders that specialize in giving loans to startup businesses, even to new small business owners with less than stellar FICO scores. These finance options can include term loans, lines of credit, and equipment financing. 

Drawbacks: Because they are taking on so much risk, these lenders often charge very high interest rates – in some cases as much as 30% – to new small business owners, depending on their FICO scores.

• Personal Loans. Personal loans have become popular over the past decade as online lending has become more prevalent. They are often easy to apply for, have far lower requirements than a standard business loan, and funding is typically quick. They can be a good source of bridge financing to pay for the startup costs if your personal savings aren’t enough to cover everything.

Drawbacks: Personal loans usually don’t offer as much money as business loans, so you may not be able to borrow the amount that you need. Additionally, depending on your FICO score, the interest rate on a personal loan can be extremely high. 

• SBA Loans. The SBA loan program offers two specific types of loans that new small businesses may be eligible for: the SBA Microloan and the SBA 504 Loan. These loans have much lower requirements than the popular SBA 7a loan and pay relatively small loan amounts to new businesses and offer much lower interest rates than online or personal lenders. They are typically offered through not-for-profit intermediaries, often called community development companies (CDCs), although some for-profit private lenders may offer these types of loans as well.  

Drawbacks: These loans are usually offered to small businesses that have been operating for at least six months, with some form of working capital foundation, so if you can somehow be in business for that long, the loan may be worth it. Additionally, CDCs and lenders often only provide business loans for minorities, those that operate in underserved communities, and veteran-owned businesses. The biggest potential drawback is that the amount you borrow may not be enough to cover your costs – while the maximum amount you can borrow for a microloan is $50,000, the average SBA microloan size in 2022 was a little more than $16,000.

• Personal Credit Card. If you’re desperate for funding and have no alternative sources of capital, then your personal card gives you a line of credit to draw upon to fund any start-up expenses. Make sure to get receipts so you can separate your personal expenses from your business ones so that you can take advantage of business tax deductions. 

Drawbacks: Personal credit cards typically carry a much higher interest rate than a business loan. Plus, startup business costs are usually high, and this will cause you to draw down your available credit significantly. That, in turn, will affect your FICO score, as your credit utilization rate is a big factor when calculating your score among all three major credit bureaus. 

• Home Equity Line of Credit (HELOC). A HELOC allows you to establish a line of credit using the equity in your home as collateral. You can use the money for large purchases, such as the cost of funding your new business. 

Drawbacks: This might not be an option for you if you recently bought your house, as most banks require you to own a certain amount of equity in your home to use this type of finance option. Also, when you borrow against the equity of your home and are somehow unable to repay the debt, you could risk losing your home. 

• Friends and Family Loans. Hey, you can always remind your friends and family members that Michael Dell started Dell Computers with a $1,000 loan from his parents. Seriously, if you have family members and close friends who trust you and you’re possibly willing to share with them a piece of your future success, this is always an option.

Drawbacks: If you were a troublemaker as a kid or never paid back that $100 your friend spotted you back in the day, then asking your parents or close friends for a loan may not be an option, no matter how much begging you do. So, if you’re planning on asking, try to make amends with them beforehand.

What to do if You’re Declined

Rejection is always a bitter pill to swallow, but if you are turned down for a startup business loan, you shouldn’t see it as a failure, but as a valuable lesson. Lenders make money by giving loans and charging interest on them, so in most cases, they want to see your small business succeed. As such, if you are turned down, they will usually be happy to specify why they turned you down and give you advice on how to get approved next time. The most common reasons for getting turned down are credit score, lack of assets, and a poor business plan. The ways to improve this are:

Make sure you are caught up on your bills. Having at least six months’ worth of on-time payments toward your current debt will go a long way toward improving your FICO score.

Apply for new debt. This may sound counterintuitive, but a strong debt-to-credit ratio is a big part of your credit score. The more unused debt you have, the more favorably a lender will look upon you. 

Save money! Of course, this is easier said than done, but if you have savings and any other assets of value such as your house, lenders will see that you have potential collateral, thus making it easier for you to qualify for a loan.

Have a strong pitch! Improving your business plan to include careful market research will improve your chances of getting a loan. Some of the questions you need to answer are: What differentiates your products and services? How will your business turn a profit? Do you have a strong marketing plan? 

Other Financing  Options for Startups

If getting a startup loan isn’t an option, worry not, as there are avenues to explore to obtain capital for your new venture. 

1. Crowdfunding. Over the past decade, crowdfunding has become a popular way to raise funds for start-up businesses. It is the practice of raising funds through popular crowdfunding websites. Setting up a crowdfunding campaign is relatively easy and typically done through a crowdfunding platform.  Once you’ve set up your account on the platform, write up a compelling description about your company and its products, and indicate the amount of money you are seeking to raise and how you plan to use it. To attract investors, your business plan and products must strike an emotional chord.  One of the biggest perks of crowdfunding is that you can retain full ownership of your business.  While equity crowdfunding is an option, you can also focus on handing out rewards – such as discounts, special product releases, or profit-sharing – to your investors. 
2. Small Business Grants. There are several grants available for startups through both private entities and the federal government that could reward you with thousands of dollars in start-up cash, especially if you are launching a woman-owned, minority-owned, or veteran-owned business. 
3. Small Business Credit Cards. Since there are limited business loan options available for startup businesses, you may want to consider applying for a business credit card as a temporary alternative. Business credit cards issued to startups will require a strong FICO score, which helps to mitigate the risk the card issuer is taking due to your lack of time in business. Like with any credit card, interest is only charged on the amount you use.  As an added bonus, business credit cards typically come with perks – such as cash-back rewards, travel points and discounts with select vendors – helping you save money at the same time. 
4. Venture Capital. VC funds usually have the most stringent requirements, and only invest in companies that are in an industry with the potential for high-margin growth. To invest, VC managers will require a strong business plan, showing growth and revenue milestones you plan to hit and how you will accomplish them.  In return for investing VC managers may want high ownership stakes, a seat on the company board of directors, right of first refusal, and anti-dilution protection. VC funding is not easy to obtain.  There are hundreds to thousands of businesses vying for funding at any given time. To make their own selection process more seamless, most fund managers will only accept pitches through referrals.

Steps to Take Before Applying for a Startup Business Loan

Before you seek a loan to fund your startup, there are several steps you need to take first to set up and establish your new business. These include:

1. Making sure that the federal government knows your business exists. Okay, this may sound strange, but it’s really not – in order for your business to operate, get a loan and take tax deductions, the IRS must know that it exists. That means that you need to obtain a federal Employee Identification Number (EIN) from the IRS. This is a number needed for the IRS to identify your business. You can apply for one on the IRS website.
2. Registering your business. For tax reasons (and to also make sure your company officially exists), you should register your business within your state as a limited liability company (LLC), “doing business as” (DBA), or a corporation. Sole proprietors typically become LLCs or DBAs so that they can tie their business’ revenue with their personal incomes, which has tax benefits. Higher-margin small businesses that have multiple owners sometimes register as S corporations, which also have tax and legal benefits. Registration must be made in your state, and each state has slightly different requirements. Either a tax attorney or online legal companies such as legalzoom.com can assist you with this for a fee. 
3. Creating a business plan. Small business lenders may ask for a business plan before approving you for a loan. A business plan is like a resume for your business. It defines your business, what makes it unique, and states why you believe it’s going to make money, among other things. You can find templates for business plans online, or if you have the means, you can hire someone to do it for you. 
4. Getting your paperwork in order. Whenever you apply for a start-up loan it’s a good idea to get your paperwork in order BEFORE you start the application process. If you’re seeking to borrow for a startup business, lenders will probably want to see any financial statements you have at this point, your personal tax returns, and a business plan.

Hang in There

Creating a business from scratch is one of the most difficult – albeit rewarding – challenges that anyone can take on, and obtaining capital for your new venture may be the most difficult challenge early on. There are, however, borrowing opportunities and other sources of money that you can tap into besides your personal savings. Carefully evaluate your funding options to make sure you select the one that is right for your business.