How to Get a Business Loan
At some point, practically all entrepreneurs need to inject cash into their businesses. This is true at all stages of enterprise development, from newly minted start-ups to well-established companies. However, if your financial needs don’t line up with the resources you have on hand, a business loan is your most likely solution.
Loan options for business owners encompass a wide range of options, ranging from familiar standards like term loans to innovative and emerging alternatives like invoice financing and merchant cash advances. This guide will walk you through the steps you should follow to secure a business loan that satisfies your cash requirements while minimizing your costs and risks.
How Business Loans Work
Conventional and alternative lenders offer a wide range of loans, financing options, and financial products to business owners. These include revolving forms of credit, like business credit cards and lines of credit. However, for the purposes of this guide, we will focus on repayable private loans that advance you a fixed sum of money for business use.
Your main options include:
- Term loans: These loans deliver a fixed sum of money, which must be repaid over a specified period of time known as the “term.” Over the course of that term, interest accrues on the loan. You must pay back the loan principal plus interest and any applicable fees.
- Equipment financing loans: Equipment financing plans function much like term loans, except that they are usually configured so that the loan term lines up with the expected lifespan of the equipment you’re buying. The equipment also doubles as collateral for the loan, so these specialized options usually carry advantageous terms compared to standard loan structures.
- Invoice or accounts receivable financing: This option is available to borrowers who have regular clients with a history of reliable, on-time payments for products or services rendered. With invoice financing or accounts receivable financing, you essentially “sell” an unpaid account to the lender in exchange for a set percentage of the invoice’s value (usually in the range of 80% to 95%). The lender secures the right to collect payment from your client, pocketing the difference plus applicable fees.
- Merchant cash advances: Businesses that process card-based customer payments can also get a specialized loan known as a merchant cash advance. With this structure, you agree to pay the lender a set percentage of your daily card payments in exchange for the loan. The daily payments continue until you have repaid the loan plus interest and fees.
Application processes and documentation requirements vary among lenders, but they typically include the following:
- Your business tax ID number and/or your personal Social Security Number
- Two to three years of business and/or personal tax returns
- Income statements and other verifiable documents that illustrate the company’s financial situation, such as cash flow statements and future income projections
- Business and/or personal bank statements
- A current, valid business lease or proof of ownership of the premises where your business is located
- Current copies of any licenses your business may require to operate
Specialized loans may require additional documents, which the lender will specify at the outset of the application process.
7 Steps to Securing a Business Loan
Small business financing experts and consumer credit bureaus recommend that you follow these straightforward steps to get your business loan:
1. Determine how much money you need. It is not generally considered a good idea to borrow more than you need, as doing so only increases your costs over the lifetime of the loan. It also sends a red flag to the lender, since they vastly prefer working with borrowers who have thought about their needs in detail and show restraint and personal responsibility with money.
2. Figure out which loan type best meets your needs. Shop around among lenders that advertise their rates and terms to get an idea of what you can expect. Then, make sure you match the lender’s stated criteria for those loan types. For instance, many term loans require that you have been in business for at least 12 months. If you haven’t, you may need to pursue a different financing option.
3. Review your credit report. Ensure it is complete and accurate. Challenge any incorrect or misrepresented information. Ideally, have any such issues corrected before you apply for the loan.
4. Shop around among various lenders, collecting firm quotes for your loan. Include traditional lenders like banks and credit unions, but also consider alternatives like online lenders and loan market aggregators. These services can process loans more quickly, offer a wider range of options, and deliver beneficial rates and terms because they operate in a more competitive space.
5. Double-check the lender’s qualification standards if you have any doubts about them. In addition to requiring that your business has been operational for a certain period of time, lenders also commonly impose minimum credit score standards and monthly or annual revenue cutoffs.
6. Collect all documentation the lender will need in order to process your loan application.
7. Complete and submit your loan application and wait for the lender’s decision. If approved, you will likely receive your financing within 24 to 72 business hours.
Tips for Making the Process Safer and Easier
Business loans can help you bring your enterprise to the next level, but they also come with significant risks that you must manage carefully. If you default on your loan or otherwise fail to honor your obligations, you could lose your collateral, cede partial or full ownership of the business to the lender, or suffer long-term damage to your credit score.
Loans also cost money, so you’ll want to steer clear of options that may be easy to get but also carry huge fees and interest rates. To these ends, keep the following advice in mind as you shop around:
- Banks are often the safest bet if you have excellent credit, collateral to offer, and don’t have a pressing need for immediate funding
- Online lenders generally represent a better option for credit-challenged borrowers, those who lack collateral, and those who need money quickly
- Read the fine print: many lenders tack origination fees and other charges onto their loans, so the annual percentage rate (APR) or factor rate might not tell the whole story
- Watch for lenders that guarantee loans to all applicants regardless of their credit history: this is a red flag and almost certainly means that you will pay exorbitant interest rates even if the company is legit
- Do not work with lenders that require you to pay fees or charges up front
- If you have poor credit and do not have a pressing need for the loan, spend some time rebuilding your score before applying for a loan
- Use loan calculators and online research tools to generate a complete and accurate picture of the lifetime cost of the loan before you apply
If you have collateral to offer, this can help you secure better loan terms in the form of reduced interest rates. However, remember that you can lose those assets if you default on your loan. Also, familiarize yourself with the term “personal guarantee.” This means that the lender has the legal right to recoup unpaid loan balances from your personal assets if you default on the business loan. It poses risk but may be required by your lender.
Look for companies with established digital footprints: those with Better Business Bureau (BBB) profiles and/or accreditation are good bets, as are lenders with large numbers of professional coverage and user-generated reviews on trustworthy third-party sites.