How to Get a Small Business Loan
Need a cash infusion for your business? Here’s everything you need to know about applying for — and improving your chances of getting — a small business loan.
It takes money to start a business. And unless you’re carrying around a whole lot of cash, that can mean taking out a loan. If you’re just getting a new business off the ground, that can be a little overwhelming, and lender requirements can be intimidating. The good news is that you can absolutely handle it.
So how do you actually get a loan?
1. Determine how much you need
Choosing the right loan amount will ultimately depend on what you plan to use the funds for. If you need working capital for day-to-day expenses, you might only need a few thousand dollars. If you’re buying machinery or equipment, though, you may need a much larger loan.
For example, Accion Opportunity Fund, an online lender that caters to small businesses from underserved communities, offers equipment financing loans up to $250,000 for new borrowers and $350,000 for returning borrowers. That might sound like a lot, but it’s not outside the realm of possibility if your business requires heavy machinery. Be sure to research any prospective purchase costs before applying for a loan.
Your ideal funding amount will also depend on the financial health of your company. If the business is in a good place, you may just need a small cash injection to put toward expansion and growth. A struggling business, on the other hand, may need a larger amount to cover payroll, get on top of debt payments, and achieve steady cash flow.
2. Write a business plan
Most experts advise that all new businesses start out with a clear business plan. Turning ideas into a written business plan forces you to crystallize your company goals, financial projections, and plans for growth. If you’ve never written a business plan before, you may not know where to start or what to include.
It helps to think of your business plan as the answer booklet to all your lender’s potential questions. The plan should help the lender understand your business, relevant market dynamics, and your company’s future potential. A successful business plan demonstrates that a company is already generating income and has a plan to continue that growth.
When assessing your business plan, lenders will want to see:
- A summary of your business and industry
- Your current balance sheet
- Future financial projections
- Marketing plans
- Growth opportunities you plan to explore
- An analysis of your competitors and your market, as well as details on how your business fits into that marketplace
- Projected timelines for profitability and further growth
- Potential obstacles — and your plans for dealing with them
Your business plan shows lenders that you’ve put in the work and that your business makes financial sense. They’ll be able to see where you want to use the money and how you’re going to make the money you need to repay it.
3. Determine which small business loan you may qualify for
Before you start applying for loans, take a look at all your loan options and make sure you meet the basic eligibility requirements. It’s also important to understand what each lender is looking for so you can craft your application to meet those criteria. Here are a few of the most common questions a lender will ask.
What’s your credit score?
Lenders want to know that you’ll be able to pay back the money you’ve borrowed — and that you’ll do so on time. To determine whether or not a business has the means to repay its debts, lenders look at a few financial metrics, including your credit score. Your credit score is basically a grade of your borrowing history and creditworthiness. The higher the score, the more confidence a lender has that you’ll be able to repay your loan.
Each lender has a different minimum credit score; there is no universal standard. That said, you can be certain that the higher your credit score, the more loan options will be available to you. Here’s what each score means.
- 700 or above: A credit score around 700 is considered “good.” If your score is in this range, you’ll typically qualify for a wide variety of loan options, including AOF loans, traditional bank loans, business lines of credit, and U.S. Small Business Administration (SBA) loans. An “excellent” score (750 or above) will typically unlock low interest rates and more flexible payment terms.
- 600 to 700: This is considered a good to average score, and will unlock pretty much all of AOF’s loans. While you may or may not qualify for traditional bank loans with a credit score of 600, you can look at alternative lenders, including AOF and other Community Development Financial Institutions (CDFIs), for funding.
- 550 to 600: This credit score will take you out of the running for most SBA loans, as well as loan products from many affordable alternative lenders. That said, AOF looks at more than just your credit score when evaluating your loan application. if you can prove consistent cash flow and have several years in business, that may be enough to offset the low credit score.
- Below 550: A credit score of 550 is often the minimum credit requirement for even the most lenient lenders. If your score is below this, you’ll likely have a hard time getting a loan. You may still qualify for merchant cash advances, but they usually offer dangerously high interest rates and unclear terms. Fortunately, you can improve your credit over time. Resources like Credit Karma can help you rebuild your credit score so you can qualify for better financing options.
How long have you been in business?
While there are some loans available for early-stage startups, most lenders will only approve loans to businesses that have been operational for at least six months to a year. Others require at least two years of business history.
In general, the longer you’ve been in business, the higher your chance of getting approved for a loan. Years in business show the lender that you have a solid track record and can sustain your momentum. Besides, the first couple of years can be a make-or-break time for a new business venture. If you’re past that phase of your business, lenders will feel confident that you’re on stable footing and that it’s all uphill from here.
If you’re unable to qualify for a term loan because you’re newly in business, you may want to look at credit cards, business lines of credit, and microloans, which often offer more flexibility.
Is your revenue high enough?
Each lender defines “sufficient revenue” a little differently. While some small business lenders want to support entrepreneurs who have small profits but big impacts on their communities, other lenders are more focused on building million-dollar companies.
Generally speaking, however, your annual revenue will dictate what size loan you’re able to get. (After all, if you only make $50,000 a year, you’ll be hard-pressed to pay back a $1 million loan with any expediency.) If your annual revenue is below $50,000, you may want to look at microloans or business lines of credit instead of traditional term loans.
4. Consider repayment terms
Before you get carried away with filling out your business loan application, take some time to consider the terms. What’s the interest rate? Can you afford the repayment plan? If your loan has a 5-year term but expensive monthly payments, does it make sense to secure a 10-year term with smaller payments instead?
You’ll need to take an honest look at your finances to be able to determine how much of a monthly payment you can afford. Once you know what you can afford in monthly outgoings, you can look at loans that will meet those criteria.
5. Prepare the Documents You’ll Need to Apply
Once you’ve selected a loan that suits your needs, you’ll need to prepare the proper documentation to apply. Check with your prospective lender on what they require for a loan application. Be honest and forthright when applying; not only is it illegal to lie on a loan applicaiton, but overestimating potential profits or underestimating expenses can get you in over your head with debt, as well.
Documents you’ll likely need to submit during the application process include:
- Business registration documents and licenses
- An updated business plan
- Tax returns, balance sheet, and other financial statements
- Accounts receivables
- Bank statements
- An Employer Identification Number (EIN)
- Details of previous loans, including working capital loans and lines of credit
- A business and/or personal credit report
- Details of your business assets, such as commercial real estate holdings
6. Find the Best Lender for You
Bank loans aren’t the only way new businesses can qualify for startup funding. Other lending options exist for new businesses to get the funding they need. Check out these funding options, and look into these lenders as possible backers of your first business loan:
Community Development Financial Institutions (CDFIs)
CDFIs provide low-interest financing of amounts less than $250,000. These loan amounts can be used for new business startup costs. CDFIs focus on providing accessible lending to underrepresented entrepreneur groups and lower-income areas.
CDFIs may be a good option for first business loans, since they also offer hands-on business resources, mentoring, and technical assistance. To learn more about CDFIs, visit the Opportunity Finance Network.
Community banks are smaller local businesses that seek to work with other smaller local businesses. Because of their regional client base, smaller banks may offer more financial products and financing to local businesses than their national counterparts do.
Community banks have connections within the local community, so personal connections are important to these banking institutions. The community focus may make a community bank a good choice for a brand-new business seeking a loan.
For more information on community banks, visit the Independent Community Bankers of America.
Credit unions are nonprofit institutions that offer small business loans to their members. Joining a credit union can give new small businesses access to a variety of loan options. Credit unions usually offer lower interest rates than traditional banks.
To find credit unions in your area, visit the National Credit Union Association.
Alternative Online Lenders
Online lenders are another option for small businesses seeking their first business loan. Online lenders offer rapid approval of applications and quick fund disbursement. The disadvantage of online lenders is that the online lending world is broadly unregulated.
With that in mind, new business owners should be careful of those who are acting unethically. Before committing to an online lender, you should conduct proper due diligence on the business to see if they are ethical and have had any BBB complaints.
7. Find the Right Loan for You
There are multiple loan options and loan products available to small businesses, so make sure you do your homework. SBA loans, microloans, online loans, term loans, and business lines of credit are potential loan options to consider. Let’s look at the most common types of business loans.
Loans offered by the SBA have some of the most favorable terms for small business owners. SBA loans often start at $10,000 and go up to $350,000, but what makes them easier for small businesses to afford is their longer repayment periods. SBA loans often come with terms of up to 25 years, and require a minimum credit score of 650.
If you’re looking for a small, short-term loan, microloans (also called “small-dollar loans”) can be a good option. Microloans are frequently offered by alternative lenders. They’re almost always open to businesses in underserved communities that don’t meet the eligibility criteria of traditional lenders.
Online loans are typically unsecured loans, i.e., they don’t usually require collateral such as personal assets or personal guarantees. Online loans are a good option for businesses with bad credit, though the tradeoff here is that you may end up paying much higher interest rates than you would otherwise. Because the application process is so fast (some applicants are approved in a matter of hours) online loans can be helpful if you’re in urgent need of cash. That said, not all online lenders are reputable. Be sure to keep an eye out for predatory lending schemes when you begin your search.
These are your traditional bank loans, offered for a fixed interest rate over a certain period of time — usually two to ten years. The downside to term loans is that you must have good credit to apply. That can make them difficult to get, especially for new businesses with limited financial history.
Business lines of credit
If you’re looking for more flexible financing options, a business line of credit can work in place of a small business loan. A business line of credit is similar to a bank overdraft or a business credit card where, instead of a lump sum, you can take out money as you need it and only pay interest on the amount borrowed. A business line of credit is especially useful if you’re looking for a short-term cash infusion or working capital, but be aware that interest rates can be high and you typically need good credit to qualify.
Which type of loan is right for my business?
With each type, consider what you need in terms of the amount, the length (term) of the loan, the interest rate, ability to borrow more, ability to pay the loan back early if you want to.
Some of the questions you’ll want to think about are:
- How much you need: First make a spreadsheet of estimated future purchases and outgoings over the time period you expect to need the loan for. Make sure you understand exactly what expenses your business will incur. If you underestimate how much loan you’ll need, you can always take out another. If you overestimate, though, you’ll end up paying more in interest.
- Length of loan: Longer loan terms come with smaller monthly payments — ideal for borrowers with limited cash flow. That said, you’ll end up paying more in interest over the life of the loan than you would with a shorter term.
- Interest rates: Interest rates vary widely among lenders. Usually they’re between 5% to 20%, but they can be even higher if you have a low credit score. Shop around to get a feel for other interest rate options before you commit to an offer.
- Flexibility: Do you want the flexibility to repay the loan early if you have the means? Not all loans will allow for that, and some will charge a penalty for repayment.
It’s important to remember that not all loan programs are created equal, and some options may work better for your business needs than others. With term loans, for instance, you’ll need good to excellent credit to apply, and you won’t have the flexibility to repay early without paying a penalty. If your cash flow is erratic, if you have poor credit, or if you want maximum flexibility to pay off your loan early, you may want to consider a business line of credit or a microloan instead.
8. Review all your options and make a decision
Before you sign on the dotted line, carefully review these aspects of your selected loan:
- Loan amount: Is the amount sufficient for your business needs? If you anticipate having to make some high-dollar purchases in the next year or so, will this loan amount be enough? Conversely, if you don’t have any big purchases ahead — and already have debts or limited short-term revenue growth — might it be prudent to take on a smaller loan instead?
- Loan term: Over what period will you be repaying the loan? If your business doesn’t yet have strong revenue, might you benefit from having a longer term — and therefore a lower monthly payment? Conversely, if you expect serious growth in the next couple of years, can you save money in interest by taking on a shorter loan term?
- Flexibility: Do you want the option of paying the loan back early if you’re able to? Or is there a penalty for doing so?
- Interest rate, costs, and fees: Read your loan contract carefully to understand how much you’ll be paying over the loan term and when. Make sure you’ve accounted for any hidden fees in your budget calculations. (To learn more about interest rates and how to calculate APR when given loan terms, take Accion’s micro-course on APR vs. Interest Rate.)
Most importantly, make sure you read all the fine print before you sign any documents. Double-check that you understand all the terms, the fees, and the payment schedule so you don’t encounter any surprises down the road.
To ensure you’re working with an ethical lender, check out the Borrower’s Bill of Rights so you’re aware of your rights. If you have any questions about any terms, ask the lender – they want you to understand what you’re signing, too. And consider taking those terms and asking a third party, like a lawyer or financial advisor, to make sure that you’re clear on the terms.
Explore funding options with AOF
There are a variety of small business financing options available to both up-and-coming and established entrepreneurs. However, if you’re a minority or woman business owner or live in an underserved community or region, accessing those loans isn’t always easy.
Accion Opportunity Fund is here to help. We provide small business loans to entrepreneurs from all walks of life — and with all kinds of credit histories. Our loans and repayment terms are customized so you can get the capital you need at the terms that work for you. Take a look at our small business loan options today to learn how AOF can help you grow your business.