How to get a business loan? Getting a business loan is a major hurdle facing small businesses, mainly due to tight lending standards by banks. But obtaining outside financing is often necessary to start or grow a business or cover day-to-day expenses, including payroll and inventory.
Although finding, applying for and getting approved for small-business loans can be difficult, the more prepared you are, the better.
Start before the loan is needed. It is critical to build a relationship with the people at the lender before the business actually needs the loan. Decide what the money is needed for. There are good and bad reasons for business loans. Good reasons include financing a piece of equipment, real estate, long term software development or large seasonal sales variances. Decide how much money the company needs. Most small businesses don’t ask for a large enough loan. Underestimating the amount of money can lead to problems with a lack of working capital sooner than planned. Overestimating can make lenders question the business owner’s assumptions and credibility.
Here’s how to get a business loan in five steps:
How to get a business loan in five steps
1. Ask yourself, why do I need this loan?
Lenders will ask you this question, and your answer will likely fall into one of these four categories:
- To start your business.
- To manage day-to-day expenses.
- To grow your business.
- To have a safety cushion.
What criteria do banks look for in making small business loans?
Different banks or lending institutions may have different standards, but in general, in order to consider your application for a small business loan, banks will require:
- The loan must be for a sound business purpose. For SBA-guaranteed loans, the business must be eligible based on size, use of loan proceeds and the nature of the business (no lending, speculating, passive investment, pyramid sales, gambling, etc.)
- You and your partner(s) are of good character, have experience and good personal and/or business credit history.
- Ability to pay back the loan- reasonable to strong collateral (personal and business assets) is very important. SBA expects the loan to be fully secured, but we will not decline a request to guaranty a loan if the only unfavorable factor is insufficient collateral. And of course, owners must have personal equity investment in the business/skin in the game.
2. Research the best rates
Being eligible for a loan is one thing, but consider how those loan repayments will influence your ongoing cash flow. Research which lenders offer the best rates to small businesses, then target your application according to their lending criteria. Knowing what rates are available on the open market also gives you better bargaining power to further reduce your rate.
3. Get your documentation together
Once you know which lender you want to approach and why you need the funds, build a dossier of relevant documentation as evidence to support your application. Include everything from banking statements and invoices through to your business plan, forward revenue projections, product prototype designs, business insurance policy details and competitor analysis.
4. What is the typical size of a small business loan?
Small businesses come in many sizes, from a start-up of a one-person company to hundreds of employees, and their financial needs vary accordingly, so “typical” also varies. That said, in the banking industry the median small business loan is about $130,000 – $140,000 with highest around $250,000. SBA small business loans range from about $5,000 (microloans) to $5 million (largest guaranteed) with the average loan around $371,000.
Small businesses have a tougher time getting approved due to factors including lower sales volume and cash reserves; add to that bad personal credit or no collateral (such as real estate to secure a loan), and many small-business owners come up empty-handed. Getting funded takes longer than other options — typically two to six months — but banks are usually your lowest-APR option.
5. Know Your Credit Score
A credit score is used to gauge how creditworthy a person is. Although most SBA loan companies look more than the credit score to determine the ability of a borrower to pay back the money borrowed, they still look closely into it. Here are the things that most lenders look for in their clients:
- Credit score. A score of 600-700 is already acceptable but a range of 700-800 will gain you more points in the eyes of the lender.
- Debt to Income ratio. This is your personal debts, and your debt should be 33% or less of your monthly income.
- Age of Business. Most lenders will favor businesses who have been in operation for two years or more and have a consistent income.
- Industry risk. The industry risk is a rate the government gives to industries based on SIC codes. You can check the industry risk of your business before applying for a loan.
- Cash Flow. If you have a high, regular cash flow, your chance of getting approved when asking for a loan is also higher.
6. Find a Lender
The next step, and a very important one, is to find the perfect lender. This might be difficult but not impossible. You could aid your search by reading reviews of SBA loan programs found on review sites on the internet. The type of lender you will pick will depend on the type of loan that you have chosen. Here are some of the types of lenders that you can approach for your loan:
- Commercial banks: This is best for traditional loans that fall into the strict parameters discussed. You could go to a commercial bank to ask for a business loan but if you are planning a startup, you might not get approved here. They have very strict requirements and favors large businesses and corporations.
- Non-Bank Lenders: With the increase in the number of small businesses, non-bank lenders are also increasing. These are increasing in record numbers for lenders looking to get a higher return. Help can be located using sites such as Fundera.
- Region specific lenders: Local community banks and other lenders that have an interest in economic development in a certain geographic or industry area.
- Micro and alternative lenders: Crowdfunding sites like Kickstarter and IndieGoGo can be helpful for capital needs under $10,000. Personal loans can also be sourced from peer to peer sites like Prosper and The Lending Club.
- Alternative Lenders: This is where SBA loan providers come in. Crowdfunding also falls under this category.
7. Prepare the Loan Application
Once you have chosen your preferred lender, they will give you a loan package to fill out to start the application process. Read small business loans reviews to have an idea on what a specific company will ask for in their loan package. This package might differ from lender to lender but, generally, it includes:
- Your business plan. The lender will ask for this to get an idea on what you will do with the money and if you might be able to pay it back in time.
- Your resumes. Lenders will look at your capability to handle a business so they can know if you know what you are doing. If you have a partner for your business endeavor, you also have to provide their resume.
- Financial reports. This includes the projected profit and loss, cash flow statements and the balance sheet.
- Your personal financial information which includes your tax returns.
Before submitting the application package, read the article about how to convince an SBA loan provider to finance your business to have an idea on what you could do to increase your chances of approval.
8. Wait for Approval
Wait. Expect to get an answer within two to four weeks. Check in each week for a status. It is typical that the lending institution will need additional documentation.
Have you been successful in getting a business loan? If so, tell us how and who was the lender.