Money is often the greatest barrier entrepreneurs face to achieving their dreams. You might have an amazing idea for a product or service and know there’s market demand to meet it — but it takes cash to realize that idea and get your business into the marketplace.
Very few small business owners have the capital to finance their new ventures themselves. That’s where small business loans come in. If you’re approved for a small business loan, you can borrow the funds you need to get your business started, keep it going, or help it grow. Then you can start making real money and pay it back — not to mention, pay yourself!
But the world of small business loans is complex, and even figuring out if you qualify for this kind of financing can be overwhelming. That’s why we’ve compiled this handy guide to the different types of loans for small businesses, including the most popular ones like SBA loans and what you need to qualify for them.
What Type of Small Business Loan Do I Need?
The right type of loan for your small business will depend on your business model, industry, needs, and where you’re at in your entrepreneurship journey. Each type of loan has different qualifying standards that lenders use to approve candidates, so you’ll want to look into all the available options and assess which one is the best fit.
Looking To Get Your Small Business off the Ground?
That means you need startup capital, a whole other arena than what we typically think of as business loans. Usually, lenders want to see that your business has cash flow so they know you can pay them back — and since you don’t have any yet, you’ll need to get creative.
You need money to launch your brilliant business idea. To get it, try looking at lending options that aren’t specifically targeted to small businesses. You could try a personal loan, personal line of credit, or a business credit card, as long as your credit score allows it. These are all unsecured options (as in, you don’t need to provide any form of collateral), so you might not get quite as much money as you would through another type of loan.
Private investors, like angel investors, are another way for promising startups to get financing, especially in the tech industry, but that’s a huge topic deserving of its own article. But whatever startup funding option you choose, it will give you the boost you need to get your business up and running.
Do You Need Ongoing Funding for Small Business Expenses?
If your business is operational and has some cash flow, but you still need help with the daily costs of doing business, you should look outside personal lending options. A business line of credit is a great option here — and if you can demonstrate that your business is financially healthy and bringing in money, you may be able to get more capital than you would have through a personal loan.
Even if you don’t have an immediate need for this kind of financing, getting approved for it might be a smart idea. Entrepreneurship is full of unexpected costs. Having emergency funding available could be the difference between your business screeching to a halt when equipment fails or your premises flood and having the resources to get up and running again.
Are You Taking Your Small Business To the Next Level?
If you’re planning for business growth and expansion, you’ll want what most people tend to think of when they hear ‘small business loan.’ This is usually either an SBA loan backed by the government or a bank-backed small business loan.
If you qualify, you can borrow much more with these types of loans than the categories above — potentially in the millions of dollars. But it comes at a price. Nobody lends out that amount of money without assurance that you’ll pay it back, so you’ll have to prove that your business is legit and that your ambitious growth plans are well-thought-out.
These are broad categories, and there are many types of loans that can work well for small business owners. However, a few are tailored to small businesses’ unique needs. Let’s run through a few of them below.
What Kind of Loans Are Available for Small Businesses?
SBA (Small Business Administration) Loans
These loans help small businesses grow. Just like any other loan, they’ll usually come from a bank, but in this case, the United States Small Business Administration steps in to guarantee the money. The government helps SBA lenders give out these loans because it boosts the economy when people pursue their small business dreams — it’s a win-win situation.
If the borrower defaults on paying back their SBA loan, the government will repay the SBA lender 85%, making these loans much lower risk for banks, and therefore more accessible for small businesses. You can borrow as much as $5 million in an SBA loan, and they often have better repayment terms, as well.
SBA microloans make the advantages of the SBA small business loan program available to smaller businesses at the earlier stages of their journey. Instead of guaranteeing loans provided through banks, the US Small Business Administration loans money to more minor, nonprofit lenders. These intermediaries then offer businesses getting off-the-ground loans of up to $50,000. Many companies that receive SBA microloans are led by women, people of color, and other minorities!
If you have a good credit score and your business doesn’t need a considerable sum of money, SBA microloans could be a great way to get things going! The average loan amount is under $20,000, so SBA microloans are reasonably accessible.
This is a small business loan intended to help you buy specialized tools and equipment that you need to do business. In this type of loan, the equipment itself acts as collateral — so if something happens and you can’t pay it back, the lender will repossess the equipment. If you’re starting a business that requires a lot of expensive equipment, such as construction or pressure washing, equipment financing could be a critical part of getting things off the ground.
Having trouble getting a client to pay up? This type of loan can help you get around cash flow issues when customers drag their feet on paying agreed-upon fees. You’ll sell your unpaid invoices to a third-party factoring company that will pay you what you’re owed and then collects the money directly from the clients themselves.
Save this type of loan when you need it — it doesn’t come cheap, and you can’t control what kind of tactics they use to get payment from your customer. In other words, maybe don’t try this out unless the client’s very difficult and you don’t expect to do business with them again.
Merchant Cash Advances
This is a quick and easy to get — but expensive — form of loan that’s secured against your future sales. Businesses in the retail or restaurant sectors most often use it due to their high credit card transaction volume. You’ll borrow a moderately large amount of money, usually between $5,000 and $50,000, and it will be repaid automatically as a percentage of your credit card sales. Some credit card companies will offer this loan themselves, as well as lenders who specialize in cash advances.
Short-Term and Long-Term Loans
While not exclusive to small business loans, the choosing between a short-term and a long-term loan is crucial. Here, ‘term’ refers to how much time you’ll have to pay off your loan; and how quickly you’ll receive the financing.
Choosing between short-term loans and long-term is all about tradeoffs. If you apply for a short-term loan, you’ll most likely need to repay it in less than a year. But, you get access to the money much more quickly — as little as two days from some online lenders. You can usually borrow between $5,000 and $250,000 in a short-term loan.
On the flip side, long-term loans take longer to get approved for. However, they have affordable interest rates, and more years to pay them off. They’re best for achieving sustainable business growth rather than a quick infusion of cash. Long-term loans are most often available in sums up to about $100,000.
Qualifying for a Small Business Loan
There are several factors that banks and lenders consider when they’re determining whether to approve your small business loan application. It’s crucial to know the loan application process and be familiar with all eligibility requirements before you apply. Here are some of the essential qualifiers to know.
Personal Credit Score
That’s right — your credit score matters when you’re applying for a business loan. Your lender will check your credit score, and the better it is, the lower your interest rates will be.
As you probably know, if your credit score is less than ideal, you can’t dramatically bump it up overnight. That’s why consistently making smart financial decisions throughout your life is so important. You never know when you’ll need to borrow money, and you want to have that option available.
Business Debt and Cash Flow
How much money is your business making? How much do you owe? Lenders consider these fundamental factors to approve a small business or SBA loan.
A healthy amount of income and a small debt load can help you get approved for a small business loan. To understand your business’s financial standing, your prospective lender might also assess your business expenses compared to your gross income.
Collateral refers to valuable assets that you provide to secure your debt. The idea is that if you aren’t able to make the payments, these assets can be repossessed by the lender. Collateral can take many forms — equipment, commercial real estate, vehicles, or even other businesses. Depending on your business’s size, you may have to provide both business and personal assets as collateral.
From the lender’s point of view, a collateral-backed loan is less risky. Meaning that, you may be able to get approved faster. You might also be able to borrow more money at a lower interest rate.
Your cash flow and debt profile show banks where your business stands today. But that’s not enough — since you’ll be repaying this money in the future, they need to understand where you’re going, and that’s where a business plan comes in. This is how you show that you have solid, realistic, and well-thought-out plans for your business and growth.
While many small business owners don’t have a formal business plan, it’s not optional if you’re trying to get financing. Creating a great business plan is essential to leveling up and getting serious about entrepreneurship. A business plan is a detailed analysis of your product or service and the market opportunity it caters to. It can also help you explain exactly why you need the money. It’s more convincing to say, “I need $15,000 to upgrade my equipment and $10,000 to advertise my services” than “I need $25,000 to grow my company.
Age of Business
Your business’ phase will determine what type of loans you have access to. As we mentioned, if you’re getting off the ground, you should apply for personal loans and startup funding.
Lenders usually require businesses to operate for at least two years to consider them for SBA loans. This may seem strict or unfair, but don’t forget that business loans are risky for the lender. 20% of new businesses fail in their first two years. This restriction mitigates some of that risk, although lenders cannot remove it entirely.
Not all businesses are created equal. There are various levels of risk involved in providing loans to entrepreneurs across industries. This is why your business’s nature is one-factor banks and lenders use to assess you in the application process.
Many lenders avoid some industries, particularly those in legal gray areas such as cannabis, gambling, and the adult industry. Your ability to get small business loan may be affected if your business is subject to heavy seasonal fluctuations.
You won’t change your business model, so lenders perceive you as lower-risk, so it isn’t much you can do. However, you should know how banks assess your application, so you choose the option where you’re most likely to succeed — even if that means looking at alternate forms of financing.
What Documents Will I Need To Qualify for a Small Business Loan?
When you’re asking to borrow tens of thousands of dollars, you must prove that your business is standing financially. Banks will not take your word for it — make sure you have everything organized and ready for your application process.
The specifics vary from lender to lender, but here’s a general list of the documents that you need to provide.
As we mentioned above, a business plan shows that your company will move forward along a clear trajectory. No matter how great your ideas are, banks won’t lend you money if you don’t present a business plan.
Tax returns provide more information about your income. Also, they show that you’re a responsible, reliable person who has stayed on top of their taxes. You’ll likely need to provide both business and personal tax returns.
Be ready to share both business and personal bank statements, so lenders assess your business’s cash flow and expenses.
This includes articles of incorporation, leases for your commercial premises, business licenses, and proof of your ownership of the company. Financial records can prove your business’s cash flow and debt-to-income ratio. However, these documents demonstrate to lenders that you are a legitimate, well-run business that they can trust.
How Can I Improve My Chances of Qualifying for a Small Business Loan?
Even if your cash flow, debt, and business plan might help your qualify, you still need a carefully-thought approach. Here are a few strategies to boost your chances and prepare you for the application process.
Don’t just rush out and apply for dozens of business loans without really looking into whether they’re suitable for you. This might seem like an excellent way to ensure you get approved for one or two of the loans. However, credit bureaus can see how many loan applications you’ve filed, which can impact your credit score. While there’s nothing wrong with applying for more than one, do it because receiving them would align with your business goals.
Choose Your Lender Carefully
On the flip side, just because a lender is willing to work with you doesn’t mean they’re the best option. Carefully research all potential lenders, both before you apply and before you accept their offer. Trying to secure small business financing can feel overwhelming. It’s normal to lean for the first available option, but this decision shouldn’t be taken lightly.
Explore all the available options, including online lenders, traditional banks, government-backed SBA loans, and microloans. Ensure you get terms in writing, especially the annual percentage rate (APR) of the offer.
Make a Good Impression
Looking good on paper and ticking off all the boxes is a prerequisite to getting small business funding. But that isn’t the whole story. It would help if you also made an excellent personal impression during all your interactions with a potential lender, whether that’s face-to-face, on the phone, or even over email.
Remember, these loans are in high demand, and lenders do not have to award them to everyone who meets the requirements. Try to make this process as seriously as you would apply for a job — a positive, professional attitude can set you apart from other applicants and ensure you come across as a trustworthy, competent person.
Moving Your Business Forward
Getting a small business loan can be intimidating, but it’s an essential part of moving forward as an entrepreneur. If you’re prepared with a sound business model, you’ll easily secure the financing you need to chase your dreams.
Whether you choose to pursue an SBA loan, a line of credit, or another option entirely, you can find a way to finance your small business that fits in with your budget, needs, and goals. So don’t be overwhelmed — do your research, rely on your business smarts, and take things one day at a time.
Article by Genevieve Michaels
Genevieve Michaels is a freelance writer based in Vancouver, Canada. She specializes in long-form content with a focus on B2B marketing, tech, and software. She comes from a professional background in contemporary art, and holds a Bachelor of Fine Arts in Creative Writing from the University of British Columbia.