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Small Business Loans Guide: Before You Start
There are many reasons to get a loan for your business. To start a business, for working capital, for equipment, for emergencies — the list goes on. Find out more with our ultimate guide.
- The Main Types of Lenders for a Small Business Loan
- The Benefits of an Alternative Lender
- Types of Loans
- Bank Loans
- SBA 7(a) Loans
- SBA Express Loans
- SBA 504 Loans
- SBA Loans Comparison
- Lines of Credit
- Invoice Financing
- Merchant Cash Advances
- Secured vs. Unsecured Business Loans
- Documents Needed for a Business Loan
- Loan Eligibility
- Comparing Lenders
- Interest Rate and APR
- Additional Fees
- Fund Amount
- Repayment Terms
- Security of the Loan
- Applying for a Small Business Loan
- Related Questions
- Get Financing
There are many reasons why you may be interested in getting a loan for your business. To start a business, for working capital, for cash flow reasons, for equipment, for emergencies — the list goes on and on. So, let's start by understanding the types of lenders and loans available to you. The age of your business, the revenues of your business, and how fast you need the cash will influence which lender and type of loan will be the best for your business.
The Main Types of Lenders for a Small Business Loan
First, there is the SBA — the Small Business Administration. They offer different types of loans for small businesses. The biggest benefit of an SBA loan is that the SBA partners with lenders to provide loans, and guarantees 75% to 90% of the loan amount. This results in better terms and easier qualifications for small businesses. The downside of an SBA business loan comes in the form of increased paperwork and funding speeds that can be, at times, slower than other lenders. However, if you work with an SBA Preferred Lender, this significantly speeds up the process.
Next you have conventional banks. These are the regular, everyday banks that provide loans to businesses — think Bank of America or Chase Bank. Now, conventional bank loans generally have the best terms regarding interest rates and fees when it comes to small business loans. But the biggest downside of a business loan from a conventional bank is how difficult it is to qualify and get approved — especially for new businesses. As a result, loans from a conventional bank are generally best for established businesses with consistent revenues.
The Benefits of an Alternative Lender
So, what are the benefits of an alternative lender? Well, loan approvals typically take less than a few hours and funds are provided in less than a week for smaller loans. Alternative lenders also often have the easiest eligibility requirements and fewer rules for the use of funds.
This brings us to the downside of using alternative or online lenders: To make up for how quickly you can get approved and funded, they typically offer the highest interest rates and fees compared to other types of lenders. But because it's so easy to get funding, alternative lenders are often best for startups or business owners without high revenues.
Types of Loans
We’ve gone over the lenders. Now, let's talk about the types of loans you can get for your small business.
Bank Loans
First up: bank loans. These are loans provided by conventional banks. Their main benefit is that they typically have relatively low interest rates. The biggest downside to bank loans is lower leverage. Bank loans generally allow up to 65% or 75% leverage, while SBA loans can go up to 90%. Other downsides include strict lending qualifications, which places this type of financing out of the reach of many businesses. You'll need great credit and an established business. Because of this, loans from conventional banks are generally best for established businesses with good credit. And these are going to be your popular lenders once again, like Bank of America, Chase, or Wells Fargo.
SBA 7(a) Loans
Then, we have SBA loans. Let’s look at the SBA’s most popular loan, the 7(a) loan. This loan program is backed by the SBA for up to $5 million dollars with terms of up to 25 years. The biggest benefit is that there are over six different loan categories to fit your needs. The downsides are primarily related to the SBA’s additional paperwork requirements and that personal recourse is required on every loan.
SBA Express Loans
Next, we have SBA Express loans. These are very accessible for businesses without large revenues or good credit and can be approved very quickly — within 36 hours of application. Funding can still take up to 90 days, however. The maximum loan amount for an SBA Express loan is $350,000. These loans require no collateral or SBA guarantee fee.
SBA 504 Loans
The next type of loan from the SBA is a 504 loan. And these are loans up to $20 million dollars for the purchase of commercial real estate, land, and equipment with terms up to 25 years. Now the biggest benefit of these loans is that it is a below-market fixed-rate loan — with a small down payment of only 10%. But here's the downside — it's a lengthy process with involvement from both a bank and an SBA-approved certified development company, also known as a CDC. So this is best for established businesses who need to purchase equipment or buy real estate.
SBA Loans Comparison
Lines of Credit
Then there are lines of credit, which provide a business with access to draw cash up to a limit. The benefit is that interest is paid only on the amount drawn, and once you pay it back the funds are immediately available for use again, similar to a credit card. The downside is that fees can be costly and borrowing amounts can be lower than with a loan.
Invoice Financing
Our next type of loan is called invoice financing. Which is a cash advance — typically 50% to 90% — on unpaid invoices. It's not actually a loan, but the biggest benefit is that it's easier to qualify for than other loan options due to the invoices being collateral. The downside is that fees can be greater than other loan options, and funds are dependent on your sales continuing. As a result, this is likely best only for businesses with consistent sales.
Merchant Cash Advances
Then there's the merchant cash advance, which is a cash advance on unpaid credit card sales. The benefit? Borrowers with bad credit or minimal business history can still qualify. The downside is that this is, broadly speaking, the most expensive form of financing available. It's really only best for businesses who have exhausted all other loan options.
Secured vs. Unsecured Business Loans
No matter what lender or type of loan you decide to go with, the loan will either be a secured loan or an unsecured loan. Secured loans use assets as collateral or recourse in case you default on the loan. Collateral provides some form of protection for the lender and generally results in better loan terms. Common types of collateral include real estate, equipment, cash, cars, outstanding invoices and payments, and even future revenue. The amount and type of collateral needed will vary depending on the lender, the type of loan, and the loan amount.
Unsecured loans do not require collateral and are therefore riskier for the lender. The higher risk typically results in stricter requirements and higher interest rates.
Documents Needed for a Business Loan
You can't just walk into a bank and get a loan. You'll need a few documents first. That’s true no matter what type of loan you apply for or what type of lender you go with. Here are some key documents you should be prepared to provide:
Tax returns: This includes personal income tax returns along with business returns, if applicable. This may also include K-1 statements for partnerships or S corporation shareholders.
Income statements and balance sheets: These are financial documents that provide a snapshot into the business’s performance, its assets, and its liabilities.
Bank statements: You're going to need business and personal bank statements.
Business legal documents: These could include business certificates, licenses, and contracts where applicable.
Business plan: You will need to demonstrate your business has a feasible business plan.
What do I need to apply for a business loan?
- Most lenders will require tax returns, income statements and balance sheets, business and personal bank statements, business legal documents, and a business plan.Learn more →
What is the difference between a secured and unsecured loan?
- A secured loan is a loan that is backed by collateral, such as a piece of equipment, real estate, or cash. An unsecured loan does not require collateral and is therefore more risky for the lender. The higher risk typically results in stricter requirements and/or higher interest rates.Learn more →
What are the different types of small business loans?
There are two main types of small business loans: SBA loans and bank loans. SBA loans are provided by the Small Business Administration and are typically easier to qualify for than bank loans. They also offer higher leverage, up to 90%, and have less paperwork. However, funding speeds can be slower than other lenders. Bank loans, on the other hand, typically have lower interest rates and fees, but are more difficult to qualify for and are best for established businesses with good credit. Sources: Small Business Loans Guide: Before You Start and Small Business Administration.
What are the requirements for a small business loan?
The requirements for a small business loan vary depending on the lender and loan type, but most take into account the four Cs: capital, credit, collateral, and conditions. Capital refers to your ability to repay by looking at your business and personal earnings, savings, and debt. Credit is the credit history of your business and/or you, personally. Collateral includes assets that can be used to secure the loan if it is a secured loan. And lastly, conditions refers to the purpose of the loan, time in business, and industry of the business.
The SBA Express Loan has specific requirements, including that the business must operate for profit, engage in operations within the USA, be in operation for at least 2 years, qualify as a small business according to SBA size standards, be able to prove/show a need for financing, have already financed the business through alternative means, be able to show that funds will be used for sound business purposes, and have no delinquencies on previous debts to the government. Additionally, borrowers must be of good character and demonstrate the ability to repay the SBA Express loan debt.
What are the advantages and disadvantages of small business loans?
The advantages of small business loans include lower interest rates and higher leverage than conventional bank loans. The Small Business Administration (SBA) offers different types of loans for small businesses and guarantees 75% to 90% of the loan amount, making it easier to qualify for a loan. The downside of an SBA loan is increased paperwork and slower funding speeds than other lenders. Conventional bank loans generally have the best terms regarding interest rates and fees, but it is difficult to qualify and get approved, especially for new businesses.
What are the best lenders for small business loans?
The best lenders for small business loans depend on the type of loan you are looking for. The Small Business Administration (SBA) offers different types of loans for small businesses, and they partner with lenders to provide loans with better terms and easier qualifications. However, the process can be slower than other lenders. Conventional banks generally have the best terms regarding interest rates and fees when it comes to small business loans, but they are difficult to qualify for, especially for new businesses. Alternatively, online lenders such as OnDeck, Credibility Capital, Kabbage, QuarterSpot, and LendingClub offer term loans with higher interest rates, but they also feature a simpler application process and approval within a week.
What are the different repayment options for small business loans?
Small business loans typically offer repayment terms of two years or less, with fixed monthly or daily payments. However, term loans may offer longer repayment terms with minimal restrictions on fund use. With higher loan amounts and lower interest rates and fees, your lender will want to make sure you’re good for the money. Non-SBA Financing Options for Small Businesses provides more information on the different repayment options for small business loans.
What are the risks associated with taking out a small business loan?
Taking out a small business loan can be a great way to finance your business, but it is important to understand the risks associated with it. Some of the risks include:
- The possibility of defaulting on the loan if you are unable to make payments.
- The potential for high interest rates, especially with short-term loans.
- The risk of taking on too much debt, which can lead to financial strain.
- The potential for the loan to be more expensive than expected due to hidden fees or other costs.
It is important to do your research and understand the terms of the loan before taking it out. You can find more information about small business loans in the Small Business Loans Guide and the Non-SBA Financing Options for Small Businesses.
Loan Eligibility
Each lender and loan type will have their own specific requirements, but most take into account the four Cs: capital, credit, collateral, and conditions.
Capital refers to your ability to repay by looking at your business and personal earnings, savings, and debt. Credit is the credit history of your business and/or you, personally. Collateral includes assets that can be used to secure the loan if it is a secured loan. And lastly, conditions refers to the purpose of the loan, time in business, and industry of the business.
Comparing Lenders
After you qualify, when comparing two or more loan options against one another, look at the following items to determine which is the best option for you before signing the dotted line:
Interest Rate and APR
An interest rate is the amount a lender charges, given as a percent of the loan’s principal per year. APR is the annual interest rate plus any fees.
Additional Fees
Look for additional fees like application fees, origination fees, servicing or process fees, insufficient fund fees, closing costs, prepayment fees, late payment fees, administrative fees, etc. Not all fees are readily apparent.
Fund Amount
This is, simply, the principal amount — the amount of money the loan will provide you. Ask yourself if this amount is sufficient for your business’s needs.
Repayment Terms
Important repayment terms to examine include the total loan term, how often payments are required, whether or not a balloon payment is involved, and the amount of each payment.
Security of the Loan
Is the loan secured or unsecured? If it's unsecured, what collateral is required?
Applying for a Small Business Loan
At SBA 7(a) Loans, we’re here to make it simple for your business to access the financing it needs. Complete the form below, and we’ll be in touch with a free, no obligation quote.