This article is part of a larger series on Business Financing.
Getting a small business loan is a necessity for business growth or sustaining operations. However, it can sometimes be challenging to find a loan that you qualify for. Here are the six steps to getting the small business loan that you need:
- Determine what you need the funds for: Knowing the specific purpose of the funds will help you figure out the right loan.
- Determine your eligibility: Learn what lenders look at to determine if you can qualify for financing.
- Determine your capacity to repay: Knowing whether you can afford the estimated loan payment is critical before you apply for financing.
- Gather your information: Obtaining all of the necessary paperwork before you apply will save you time.
- Find the right lender: Ask questions and make an informed decision on where to apply.
- Submit your application: Apply for funding from the right lender and get the loan you need.
Step 1: Determine What You Need Funds For
An important part of getting a small business loan is knowing what the funds will be used for. There are many different loan options for a business. Some types of loans can be used for multiple purposes and others only in specific situations. The qualifications, interest rates, and terms will vary based on the type of loan you apply for and which lender you apply with. It’s important to evaluate your options and do your homework so you don’t end up applying for a loan that you may not qualify for or isn’t best suited to your business.
Businesses that need vehicles, pieces of machinery, or other larger items will obtain equipment loans secured by liens placed on the equipment they’re purchasing. In some cases, equipment leases may make sense for a business owner, although the overall cost for equipment financing may be higher with an equipment lease than with a loan.
Loans for business expansion, such as moving into a new and larger location, often require getting a commercial real estate mortgage or a loan guaranteed by the Small Business Administration (SBA) to help finance your needs.
Starting a Business
If you’re starting a business, a startup loan is often needed. These loans can fund initial operations and incurred expenses as part of the launch of your business.
Buying a Business
Business acquisition loans typically come from banks and credit unions. Collateral is often in the form of business assets. A certified business evaluation is traditionally needed as part of the loan process.
A business line of credit or invoice factoring loan makes sense to finance working capital needs. If your credit score is high enough and business performance is sufficient, the line of credit is preferred, given that interest rates and fees are much lower.
Multiple needs can be bundled together: In some cases, multiple loan needs can combine into a larger package that is secured by real estate, business assets, and/or equipment. For example, an SBA 7(a) loan can be teamed up with a business line of credit and be backed by real estate.
Step 2: Determine Your Eligibility
Eligibility requirements will vary by lender for the loan products they offer. It’s important to understand the most important factors that lenders will consider:
Individuals with at least a 20% ownership stake in a business will have their personal credit score checked as part of the application process by the vast majority of lenders. Having a lower than optimal credit score doesn’t make it impossible to get a business loan, but it is something that banks consider to be very important. In a recent FDIC survey, 91.6% of banks consider a business owner’s credit score as an important factor in lending.
If your FICO score is 680 or higher, it’s relatively easy to qualify for most loans. Non-bank lenders may approve you with a score as low as 500 to 600 but will charge you significantly higher interest rates.
For traditional lenders, collateral is important for obtaining financing. Equipment or commercial real estate will often serve as collateral for those specific types of loans. Additionally, other business or personal assets can sometimes be used.
Nonbank lenders may not require collateral, but they’ll often place a Uniform Commercial Code (UCC) lien on your business assets. The vast majority of lenders will require a personal guarantee.
Length of Time Business Has Operated
Unless a business owner has a track record in the industry they’re starting a new business in, it is tough to get an initial loan without paying higher interest rates or utilizing a rollover for business startups (ROBS) plan. Nonbank lenders may require a few months to a year in operation before getting funding, while traditional lenders may want as much as two years of experience.
Step 3: Determine Your Capacity To Repay
To obtain financing, you’ll need to be able to show that your business is either profitable or on a path to profitability, as well as show that you can afford your loan payments. Banks will determine profitability and repayment ability by calculating your debt service coverage ratio (DSCR). Your DSCR is the amount of debt relative to income, calculated by dividing net operating income by the total of your debt and interest payments. Lenders prefer a DSCR of 1.25 or higher.
Use our calculator if applying for SBA 7(a) financing: If you feel that an SBA loan for equipment or working capital is your best option, use our calculator to estimate your monthly payment.
Step 4: Gather Your Information
Bank lenders will require you to obtain and submit several pieces of information to obtain financing. Nonbank lenders may require less information, but business owners should have access to this information in case you’re asked for it as it will save time.
Many lenders will require the three most recently completed full tax returns for the business and for any owners with a 20% or larger stake in the business.
Business and Personal Financials
Business financials that banks and nonbank lenders may require include a balance sheet and an income statement for the current year. If you have business accounting software, these reports should be easy to generate. Personal financial statements are also used to gauge an owner’s net worth. The SBA has a comprehensive form that can be used.
Business Plan, If Necessary
If you’re starting a business, have experienced a year with a loss in income, or are a business that needs SBA financing, a business plan will likely be required, especially in cases of SBA financing. The plan should detail what the loan will be used for and have financial projections to show how your business will do over the coming three years.
Business plans serve as an educational tool to lay out a case for why the lender should give you money. Additional information may be required―depending on whether you’re a startup or an existing business in an industry a lender isn’t familiar with―as well as the amount of the loan you’re requesting.
The SBA partners with several organizations, including SCORE, Small Business Development Centers (SBDC), and Women’s Business Centers, to help small businesses develop business plans.
Step 5: Find the Right Lender
A lender that has experience in lending to businesses in your industry will better understand what your business needs. Some larger lenders have specific lending teams that deal with specific types of loans, such as commercial real estate, equipment financing, or lines of credit. An experienced lender can help determine the right type of loan to apply for and may structure a loan package based on your specific needs.
Some questions you should ask potential lenders before you apply for a small business loan are:
- What fees are involved with originating and closing on a small business loan?
- What does the application process entail?
- How long does it take to get a decision?
- What documentation do I need to provide with the application?
- Will I need to submit a business plan with the application?
- Do you require a personal guarantee?
If you’re applying for a line of credit, some additional questions to ask include:
- What’s the annual fee?
- Can I draw on the line of credit online or on a mobile app?
If you’re applying for a term loan, some additional questions to ask include:
- Is there a prepayment penalty?
- What’s the required repayment schedule?
If you aren’t sure where to apply, Lendio is one option worth considering. Lendio partners with over 75 financial institutions and offers multiple options for financing, including commercial mortgages and lines of credit. Lendio offers SBA financing as well.
Step 6: Submit Your Application
The last step to getting a business loan is the application, often made online through the lender’s website. If you use a traditional lender, the application may also be made in person. The application process can take minutes for short-term financing or much longer for a commercial mortgage or a larger loan deal. Approval time on loans varies based on where you apply, how much you apply for, and if an appraisal is needed on real estate.
There are many options for financing available for businesses. While the process for getting a small business loan can appear daunting at first, understanding the different types of financing available, getting your relevant information together, and asking questions of lenders will help you in your search for financing.