How to Get a Small Business Loan in 7 Simple StepsIt’s all about the Benjamins—and the paperwork. Here, we break down the seven essential steps in finding a lender and securing a bank loan for your small business.
Barring an unforeseen inheritance, a lottery windfall, or an unexpectedly successful Kickstarter campaign, your small business is probably going to require a bank loan at some point. Money comes from growth, but growth takes money, and small-business loans are among the toughest lines of capital to obtain. You should thoroughly prepare before you even approach a bank; it could mean the difference between getting what you need and getting back in line for another Powerball ticket.
That preparation begins here with these seven crucial steps for nailing down a business loan.
1. Establish your reason for the loan
The lender is going to hand over a significant amount of money to your business, and they’re going to want to know how and why it’s being spent. It’s a valid concern: how you invest the loan will affect your business’s income and ability to pay it back. Stocking up inventory or covering payroll would pass a bank’s smell test; purchasing a recreational 3D printer for the breakroom or consulting a psychic . . . not so much.
General rationales for small businesses seeking loans include management of daily expenses, expansion or purchase of equipment, building a cash buffer against possible future shortfalls, or just starting a business. Also, determine exactly how much money you’ll need to borrow—don’t ballpark it and end up with too much to pay back or too little to cover expenses.
2. Learn how banks assess you
Banks and lenders have their own formulas to determine if a loan will likely be paid back. In the case of small businesses, the formula usually involves—but isn’t limited to—five factors for consideration. Since small businesses also tend to be newer operations, they’re probably not going to excel in every area, but if they’re strong in at least three of the five, that can help level the bank’s assessment. Factors to pay attention to include the following:
- Credit score and history. If you’ve repaid loans responsibly in the past, the potential lender will find out—they’ll also find out if you haven’t. Banks can assess business and personal financial histories through a variety of avenues; most loan processes begin (but don’t necessarily end) with a credit review.
- Collateral. What do you own that could cover the loan in case of default? Most banks and lenders will require something of value to shield the lender. Typical business items that qualify as collateral include real estate, buildings, vehicles, equipment, inventory, and accounts receivable.
- Cash flow. The more money your business is currently making, the less of a loan risk it’ll be to the lender—simple math. Banks and lenders will not only look at the amount of profit you’re bringing in but also examine how you’re managing it. If the cash flows out as quickly as it flows in, it’s not a good look.
- Time in business. If you’ve been functioning as a business for several years, you’re probably doing something right. Startups and newer businesses won’t have time on their side, but a solid, executable plan for reaching milestones will go a long way toward evening the odds in the lenders’ eyes.
- Industry. What’s the forecast for your line of business? Technological and regulatory environment predications aside, geographical glut could also hinder your business’s growth. If you had a successful local brewery last year but six more are fermenting in the area this year, chances are they’re going to cut into your business.
3. Determine the type of loan you need
Small-business lenders will only go so small; most have requirements that your enterprise be somewhat established, with a certain number of months or years already in your ledgers. If you’re just starting out with no revenue or collateral, you could apply for a personal loan or a business credit card—but be aware that the interest rates are usually much higher, and personal loans don’t factor into building a business credit history.
Established businesses, on the other hand, have several options available to them:
- Bank loans. Term loans from banks are familiar and straightforward: after qualifying, business owners receive a lump sum of money from the bank, which they’ll repay over an agreed-upon span of time, with interest. Bank loans are best for established businesses with solid credit that need expansion cash quickly.
- Medium-term loans. With a payback schedule between one and five years, medium-term loans are popular with businesses that need to borrow relatively smaller sums of money (under $500,000) with fixed interest rates. Medium-term loans require an excellent credit score or significant collateral.
- Microfinancing. Microloans, or short-term loans under $50,000, can help business owners build their credit score as well as their cash flow. Also, a microloan can be approved in as little as 14 days, as opposed to months.
- SBA loans. The U.S. Small Business Administration backs bank loans that meet strict borrower guidelines, and this backing instills the confidence in banks and lenders to take chances on applicants who’ve previously been turned down. SBA loan interest rates are low, but the approval process can take months.
- Business lines of credit: Less rigid than a bank loan, a business line of credit gives you access to as much capital as your credit limit will allow, but you pay interest only on the cash drawn. Business lines of credit work well for covering short-term expenses or annual downtime for seasonal businesses.
- Commercial real estate loans. As the name implies, commercial real estate loans are for the purchase, development, and construction of business structures—offices, storefronts, hotels, etc.—typically for lease or rent to other businesses. Terms for these loans range from less than five years up to twenty.
- Invoice factoring and financing. With invoice factoring, you sell your business’s as-yet unpaid invoices to a factoring company, which then becomes responsible for collection from your customers. Conversely, invoice financing uses those invoices as collateral for a loan. Both generate cash fast.
- Equipment financing. When you take out a loan to buy business-related equipment, the equipment itself becomes the collateral, and the terms of the loan are determined by the expected lifespan and value of the equipment. As long as it doesn’t become outdated, owning it is good for building equity.
- Merchant cash advances. If your business makes considerable and consistent credit card sales, a merchant cash advance can be a quick source of capital. After the lump-sum loan is made, it’s paid back through a daily withholding of your credit and debit card sales or weekly bank account withdrawals.
4. Decide on a lender
But wait, there’s more: after settling on which type of loan you’ll need, you’ll then have to choose a lender, or an alternative lender, to approach. Not all business financing venues, or even traditional lenders, are the same. zhulitouzi.com has reviewed and rated several of the best lenders for small businesses, including options for those with bad credit, most of which come in the following national funding varieties:
- Direct lenders. Rather than going through a private equity firm, direct lenders—usually wealthy investors or asset-management firms, in addition to credit unions and other traditional lenders—deal one-to-one with borrowers. At zhulitouzi.com, we recommend direct lenders Kabbage, OnDeck, and Accion for small businesses in dealing with financial institutions.
- Peer-to-peer lenders. A form of direct lending that lives almost exclusively online, peer-to-peer lending is like a dating app for borrowers. Investors browse borrower profiles and choose businesses they’d take a chance on, and a P2P loan can come from one or several investors. We recommend Lending Club and Funding Circle.
- Lending marketplaces. As another online exchange, a lending marketplace aggregates loan options from networks of business funders, including traditional banks. Online lenders typically have a fast turnaround but require decent credit scores. zhulitouzi.com is particularly impressed with Lendio.
- Brokers. Market-knowledgeable, connected individuals who arrange loans between borrowers and the loan officers of direct lending institutions for a commission are known as brokers. If you’re going to be opening a business in a new, unfamiliar geographical location, a broker who knows the area can be helpful.
5. Get your documentation in order
Whichever kind of lender you go with, or whatever type of loan you apply for, you’ll need to present your full financial self, which involves more than just your credit score—though it still plays a large role. You’ll also want to compile and organize the following items (where applicable):
- Business and personal financial statements
- Business and personal credit report
- Business and personal tax returns
- Business plan
- Business forecast
- State registrations and licenses
- Legal documentation (articles of incorporation, commercial leases, franchise agreements, etc.)
6. Apply for the loan . . . then hurry up and wait
If you’re applying for a substantial amount of money, you’ll want to allow your business plan plenty of lead time. Depending on the loan and lender, the loan application process can take months. Using some avenues, like lending marketplaces, can speed up the application and approval course, but in most cases, actually getting the money isn’t an overnight proposition for startup business loans.
Beyond the loan amount itself, tacked-on fees can take you by surprise if you’re not paying attention. Keep an eye on loan application fees, SBA loan guarantee fees, early repayment fees, and late repayment fees, as they’ll eventually affect your annual percentage rate (APR). By now, you should have a reasonable level of comfort with your ability to repay the loan on time and with the payment schedule, the APR, and the included fees. If there’s also a tiny bit of trepidation, that’s natural—you’re a small business owner; it comes with the territory.
7. Keep building your financial profile
Improving personal credit, establishing business credit, paying down existing debts, maximizing income, expanding assets—these are all ways to build up your financial profile for future growth. It may seem backward, but banks prefer lending to businesses that don’t desperately need the money; it’s in your best interest to negotiate from a position of capital power.
The experience is also a major plus. You’ll be more prepared for your next loan, which could come years down the road or—curb your anxiety—much sooner due to an emergency or another unforeseen circumstance.
While running your own operation doesn’t necessarily get easier, your future small-business loan processes will become more painless going forward, now that you’ve begun building your financial profile. Establish and build your business credit, and then you’ll be able to rely upon yourself rather than Powerball odds.