Complete Guide – How to Get a Business Loan

Small Business Owner
Along with all the other challenges that come from being in charge of a small business, obtaining a business loan is no easy feat. However, it is a reality that some business owners require financing to get their business running, grow it or cover their day-to-day costs like inventory and payroll. Although finding the right lender to borrow from and then proceeding to apply and get approved for a small business loan is not the easiest thing in the world, the more you prepare, the better off you will be. Here’s the complete guide on how to get a business loan.


Analyze Why You Need a Loan


Lenders will often begin by asking you why you want to take out a small business loan. In most cases your answer will fall into one of four categories—you wish to start a company, get help on your day-to-day expenses, you want your business to grow, or you want a safety net. If your answer does not fall into one of these four categories than think carefully before you take out a small business loan, as you may not need one.


What Type of Loan to Obtain?


Why you need the small business loan will determine the kind of loan that will be best for your business. If you are looking to start a business, then it is almost impossible to obtain a loan from a traditional bank in your business’s first year. Instead, it is better to look into business lines of credit, a loan from an alternate lender, or from a crowd-funding source.


What Type of Loan to Obtain for Day-to-Day Expenses?


It is best to obtain a short-term cash flow loan, which is a one-time injection of funds that you must repay in a short amount of time to handle your day-to-day expenses. You could also obtain a business line of credit, which lets you borrow and repay the money you need, similar to a credit card. Lastly, you could use accounts receivable financing, which allows you to receive your unpaid invoices in advance and then repay it with a fee once your customers have paid up.


What Type of Loan to Obtain to Grow Your Business?


If you wish to grow your company by expanding to a new venue, buying new equipment, or adding a service or product, then you’ll likely want a term loan. This type of loan will give you a lump sum of funds that requires you to repay it in fixed payments. However, with this, it’s important that your loan repayment term not last longer than the equipment or product that you purchased with it. For instance, if you buy a new fridge for your restaurant that you expect to last five years then take out a loan with about the same term.


What Type of Loan to Obtain for a Safety Net?


If you do not require immediate cash, but would like to have a safety net in the case of an emergency then a term loan or a business line of credit is the best option to secure the lowest interest rate possible. It is ideal to obtain a business line of credit before you need it, as that way you will not go into panic mode in the case that an emergency does occur.


Determine Which Lender to Borrow From


There are several kinds of lenders that you can obtain a small business loan from, including online lenders, banks, and microlenders. All of these offer loan products including lines of credit and term loans. It is recommended that you take your small business loan endeavors like you would when shopping for a car. Once you figure out the kind of lender and loan you want, make sure that you compare several different options by looking at the annual percentage rate and terms.


Getting a Loan from a Traditional Bank


The options you have from a traditional bank include lines of credit, term loans, and commercial mortgages if you would like to refinance or buy a property. The US Small Business Administration provides small business loans through banks through short-term loans, loan programs, and disaster loans. Typically, SBA loans can be taken out for between $5,000 and $5 million. However, be aware that small businesses have a difficult time gaining approval from traditional banks because of factors like low cash reserves or sales volume. Additionally, if you have no collateral or bad credit, you’ll likely find yourself empty-handed when it comes to getting approved for a traditional bank loan.


Know Your Credit Score


Where you fall on the credit score spectrum is only one factor that will aid in determining what type of loan you can qualify for. You can get ahold of your credit report free of charge from all of the major credit bureaus. Banks typically require that you have a credit score of higher than 680. Consider obtaining a small business loan from an online lender or microlender if you do not.


Other Factors to Determine If You Are Creditworthy


Lenders will also look at the length of time you’ve been in business to see if you qualify for a loan. It is usually required that you’ve been in business for one year to be eligible for an online small business loan and two years for the majority of traditional banks. If you have not been in business for this long, then consider a startup loan instead. Lenders will also want to know if you make enough money. Most online lenders have minimum annual revenue marks that you will have to hit. Lastly, lenders will look at your financials to determine if you can afford to make all of your loan payments on time. It is up to the discretion of the lender how many times a month you have to make payments, and so it is important to keep this in mind when figuring out which loan to apply for.


Make Sure You Can Pay Off Your Loan


To ensure that you can repay your loan on time and make timely payments each month, you should make sure that your income is at minimum 1.25 times your expenses, which includes your new loan repayments. For example, if you make $20,000 a month but have $14,000 worth of expenditure like payroll, inventory, and rent, then the most that you should take out is a loan that requires you to make $2,000 a month payments.


Put Your Documents Together


Once you’ve looked at all of your loan options, it is time to apply for the loan that matches your financial requirements and that you can qualify for. Keep in mind that you may apply for more than one small business loan in a short amount of time without it impacting your credit score. Depending on the lender, you may need to submit a personal and business tax return, bank statements, legal business documents, and financial statements.

Not every small business loan is right for every company, and so it is imperative that you take out the loan that is right for you by comparing all of your options and matching your business’s needs with a loan that fits your criteria.

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Written by William Mahnic


William Mahnic is a Finance Professor at Case Western University and has spent more than 20 years in the finance industry before becoming a professor. Mahnic has appeared as a commentator on both TV and radio talk shows including NPR, Crain’s Cleveland Business, WKYC 3 and The Washington Post. He has been interviewed in BusinessWeek, Wall Street Journal and The Los Angeles Times.