How to Get a Small Business Loan: Your Funding Handbook

woman from 'Business Loan' center

A business loan offers the financial support necessary for operational growth, routine expenses, and acquisition of equipment or stock. If venturing into the realm of business financing is new for you, you might wonder about the starting point or the paperwork involved.

This guide delineates the procedure, helping you assess your choices and compile your business loan request.

Determine Your Financing Objectives

Understanding the objective behind your need for funds is pivotal in selecting the most appropriate financial product for your business. Below are several typical funding requirements:

  • Acquisition of Equipment: Some financial institutions specialize in equipment financing. These loans cater to businesses looking to acquire essential machinery or office apparatus. The security for this loan is usually the equipment itself, meaning the lender has the right to repossess the equipment if the borrower defaults;
  • Seeking Minimal Capital: If your financial requirements are modest, you might want to look into microloans;
  • Initiating a New Business: Many lenders require businesses to have operated for a certain duration before offering them a loan. For nascent enterprises, this can pose a challenge. However, options like microloans or business credit cards could be explored. Acquiring a business credit card is often more straightforward as the evaluation is largely based on one’s personal credit history;
  • Managing Operational Expenditures: Working capital loans are designed for businesses looking to bridge short-term financial gaps, assisting in regular operational costs like rent and employee salaries;
  • Flexible Borrowing Options: For those uncertain about the exact financial requirement, a business line of credit might be the ideal solution. Once approved, businesses can access funds up to an approved limit, incurring interest only on the withdrawn amount.

Assess Your Qualification Criteria

Securing a business loan entails adhering to certain criteria. While specifics may differ among lenders, the following are four primary components they evaluate during the loan application process:

  • Creditworthiness: A lender will scrutinize both your personal and business credit histories when you submit a loan application. These scores provide insights into your reliability and capability to repay the borrowed amount. A robust credit score generally correlates with better loan terms and reduced interest rates;
  • Assets for Collateral or Personal Assurance: Lenders often require an asset to be designated as collateral. This asset, whether it’s equipment or inventory, serves as security that the lender can claim in case of loan default. Additionally, certain lenders mandate a personal guarantee, which implies that the borrower needs to back the loan using personal assets. This can encompass savings, real estate, or other valuable assets;
  • Duration of Business Operations: Conventional banks commonly necessitate a business to have been active for a minimum of two years. In contrast, digital lenders might only ask for a one-year operational history. However, for businesses with an operational history shorter than one year, some online platforms might consider applicants that have been in business for just half a year, provided they meet other criteria;
  • Annual Turnover: Your yearly sales volume is a significant criterion. Prior to filing an application, it’s advisable to enquire about the lender’s financial benchmarks and cross-check them against your business’s financial status to determine compatibility.
woman with laptop in 'Business Loan' office

Evaluate Various Business Financing Alternatives

There are multiple avenues for securing small business loans. Here’s an examination of three prevalent lending institutions.

Digital Lenders:

Digital lenders present an array of loan options tailored for small businesses, ranging from term loans, merchant cash advances, credit lines, to microloans. The 2019 Federal Reserve’s Small Business Credit Survey highlighted that online lenders had an 80% loan approval rate, surpassing traditional banks’ 74%.

One of the primary reasons for the increased acceptance rate of online lenders is their relatively relaxed eligibility prerequisites compared to their traditional counterparts.

This can be particularly beneficial if your credit rating is subpar. Additionally, their loan processing is notably rapid, with some disbursing funds on the same day of application.

A significant drawback is the potential for higher interest rates compared to traditional banks.

Conventional Banking Institutions:

These banks cater to diverse business loan needs, similar to their online competitors.

The primary merit of seeking a loan from a conventional bank is the probability of acquiring more favorable interest rates, especially for creditworthy applicants.

These banks frequently uphold stringent eligibility conditions. A less-than-desirable credit score (e.g., a FICO rating below 580) could hinder loan approval unless there’s a co-signer involved. Additionally, the processing time can be prolonged. 

Microlending Organizations:

Predominantly not-for-profit entities, microlenders offer loans, typically capped at $50,000, targeting businesses that may not be eligible for standard business loans.

Generally, they are more flexible in their eligibility requirements. Take, for instance, the microlender Kiva. They don’t stipulate a minimum credit score. Instead, their system operates on the principle of “social backing”.

To be eligible, applicants must initially secure a predetermined number of individual lenders through Kiva’s platform prior to their loan request being publicly listed on their site.

Compile Necessary Documentation

After familiarizing yourself with available financing options, it’s crucial to assemble all pertinent documentation. Typically, a lender will request the following:

  • Personal and corporate tax filings;
  • Business permits and certifications;
  • Corporate charter documents;
  • Bank records for both personal and business accounts;
  • Statements reflecting profit and losses;
  • Financial reports;
  • Comprehensive business strategy;
  • Premises leasing agreement.

Ensuring you have these documents readily available can streamline the loan application process and improve your chances of approval.

Establish Your Financing Requirements

woman consulting a client about loan requirements

Each business possesses distinct financial prerequisites; hence, there isn’t a universal financial blueprint. Your individual economic standing, combined with your business aspirations, will mold your enterprise’s financial direction.

Upon determining the initial capital requirement, the subsequent step is to explore sources of this funding.

Self-funding

Commonly referred to as bootstrapping, this method involves utilizing personal finances to bolster your business. This might encompass contributions from relatives or friends, depleting personal savings, or drawing from retirement funds like a 401(k).

Bootstrapping allows you to maintain full business authority. However, it places the financial burden squarely on your shoulders. It’s crucial to operate within your means, particularly if considering early retirement fund withdrawals.

Early access could incur substantial charges or penalties, potentially jeopardizing future retirement plans. Thus, consulting with a financial advisor and your fund administrator is advised.

Investors

Investors can infuse your business with capital through venture capital commitments. This usually entails exchanging capital for a stake in the company and often a hands-on role in its operation.

Distinct features:

  • Targets businesses with significant growth potential;
  • Offers equity instead of a traditional debt model;
  • Embraces higher risks with the prospect of more substantial returns;
  • Operates on an extended investment timeframe compared to standard loans;
  • Control Implications: Securing venture capital often implies relinquishing a degree of control and ownership. It’s not uncommon for venture capitalists to seek representation on the company’s board of directors.

Securing venture capital:

  • Research: Identify potential investors, including venture capital entities or individual “angel investors.” Ensure they have a credible reputation and experience with startups;
  • Present Your Vision: Share your comprehensive business plan, ensuring it aligns with the investor’s criteria, which could be industry-specific, region-centric, or based on business maturity;
  • Undergo Thorough Evaluation: Investors will meticulously evaluate various facets of your enterprise, from the management cadre and market dynamics to governance structures and fiscal health;
  • Finalize Terms: If the investor is inclined to invest, the subsequent phase involves ratifying a term sheet outlining the investment’s terms and conditions;
  • Receive Investment: Upon term sheet consensus, the capital is disbursed. The investment generally follows a phased approach, contingent on the achievement of set business milestones.

Crowdfunding initiatives:

Crowdfunding amalgamates capital from a diverse group of contributors, termed crowdfunders. Unlike conventional investors, crowdfunders don’t seek equity or anticipate financial ROI.

In gratitude for their contributions, crowdfunders anticipate non-financial rewards. This could be the product itself or other unique benefits, making crowdfunding a favored approach for creative endeavors or innovative product launches.

Crowdfunding provides entrepreneurs with the advantage of retaining full business control. If a venture fails, there’s typically no obligation to reimburse contributors. However, it’s paramount to understand each crowdfunding platform’s terms and legal stipulations.

Securing a Business Loan

If autonomy over your business is paramount but you lack adequate capital, contemplating a business loan might be the route to take.

Enhance your loan approval odds by having a coherent business strategy, a detailed expense breakdown, and projected financials for the subsequent five years. These instruments not only aid in quantifying your loan amount but also reassure lenders of your venture’s viability.

Once primed, reach out to banking institutions or credit unions to solicit a loan. Ensure you compare diverse loan offers to secure the most advantageous terms.

Conclusion

Understanding the intricacies of small business financing is paramount for business growth and stability. By meticulously assessing financing needs, exploring diverse lending options, and preparing essential documentation, businesses can effectively position themselves to secure the appropriate financial support.

This knowledge not only empowers businesses in their initial stages but also fosters informed decision-making for long-term financial sustainability.