As a business owner, there’s a fair chance that at some point in your career, you’ll find yourself strapped for cash. Whether the refrigerator in your restaurant just broke down, you’re facing a cash flow shortfall, or you need to purchase more office space, chances are you will need more money than you currently have access to. Conversely, you may just be starting on your small business venture and need some help getting it off the ground. Either way, you can rest assured that there are numerous ways for small businesses to get funding. Options include investors, crowdfunding, private funding, and even PayPal loans. This article is going to examine some of the most common and popular options for funding a small business.
What is a small business loan?
One of the most popular ways to bankroll your business is to take out a loan, and the two most common types of loans applied for by small businesses are commercial loans and government-backed or SBA loans. While business lines of credit and merchant cash advances are not loans in the strictest sense of the word, they are also valid funding options to consider
Commercial loans
A commercial loan is a capital provided by a lender, often a bank, which is to be repaid with interest over a set period. These loans are typically not guaranteed and so carry greater risk for the lender. Because of this, commercial loans may have high-interest rates.
Merchant cash advances
This type of loan is geared towards businesses that use a card terminal and ones that have an urgent need for a small loan. A merchant cash advance is an advance against the future sales of a business. The lender usually takes a percentage of the daily sales as repayment. As such, this loan is best suited to companies with a substantial volume of credit card sales, such as shops and restaurants. Be aware, though, that they tend to have some of the highest interest rates. The amount you can borrow depends on your turnover and is based on credit or debit card sales rather than cash sales. Advances can vary from a few thousand dollars up to $500,000.
Business Line of Credit
A business line of credit is not dissimilar to the concept of a credit card. You are given a credit limit and allowed to draw and repay funds as you like, provided you don’t exceed that limit, and payments are made on time. You’ll also only pay interest on the portion of the credit that you’ve borrowed. Amounts can vary from $1000 to $250,000.
SBA loans
SBA loans are much sought after as they offer benefits such as low-interest rates, longer repayment terms, and more substantial funding amounts than other lenders. These loans are government-backed, meaning the US government guarantees up to 75% of the loan amount. The Small Business Administration does not provide the money but rather guarantees the loan. Although there are twelve different types of SBA funding, the three most common loan programs for small businesses are:
- 7(a) loans- Similar to a commercial loan. There are eight different types of this loan, with the most common being the standard 7(a) loan. Businesses can borrow up to $5 million, and it can be used for working capital, real estate, and equipment. Repayment terms can be up to 25 years.
- CDC 504 loans- Much more complicated than the loan above, the CDC 504 loan is for buying or building commercial real estate. Two lenders, a bank, and a community development corporation work together to fund the program. This loan consists of a 10% down payment and two separate loans. Loan amounts are usually between $14 and $20 million. It cannot be used as working capital.
- SBA Microloans- This program is well-suited to those who have a home-based business or are self-employed. The SBA loans money to non-profit intermediary lenders that, in turn, lend amounts under $50,000 to for-profit small businesses. However, the SBA doesn’t guarantee any portion of the loan made under the SBA Microloan program. The average loan amount is around $13,000, and the repayment terms are up to six years.
If you’re still not sure whether a commercial or SBA loan is right for you, check out SBA loans:
How do you apply for a small business loan?
First things first, you’ll need to decide what type of loan you want and then choose a lender. If you’ve chosen to apply for an SBA loan, you’ll need to ensure the lender is SBA approved. Then it would help if you gave careful consideration to how much you need to borrow. As you’re working this out, take into account payroll costs, salaries, health benefits, applicable taxes, etc. It would help if you also considered your utility expenses like gas, water, electricity, and telephone/internet. Make sure you’ve got all the necessary paperwork to accompany this.
During the loan interview, you may be asked questions like:
- Why are you applying for this loan?
- Who are your business creditors?
- What business debt do you have?
- How will this loan be used?
It’s a good idea to discuss these questions beforehand so that you have well-thought-out answers prepared. Applications can be made in person or online, depending on the lender.
Merchant cash advance
The process of applying for a merchant cash advance is relatively straightforward and often consists of a one-page application that can be completed online. To qualify for a merchant cash advance, you should have been in business for six months to a year and have annual revenue of $50,000 or more.
To apply for a merchant cash advance, you’ll need the following documents.
- Business bank and credit card statements
- Loan amount
- Company name, address, email, and contact number
- Annual gross revenue of your business
- Number of years in business
- Business owner’s full name, SSN, and home address
- Business ID
- Credit report
- Financial statements
- Recent business tax returns
A business line of credit
When applying for a business line of credit, lenders ideally like to see evidence of strong income flow and a few years of business history. As a bare minimum, you should have been in business six months or have at least $25,000 in yearly revenue.
Documents to prepare are:
- Personal and business tax returns
- Bank account information
- Profit-and-loss statements
- Balance sheet
SBA loan programs
An SBA loan is more complicated to get approval for, and collecting the necessary documentation is more of a mission. You will need most, if not all, of the following to apply:
- SBA loan application
- Valid ID
- Personal background and résumé
- Business and personal financial statements, credit reports, and tax returns
- Ownership and affiliations
- Business license
- Loan application history
- Income tax returns
- Résumés for each principal of the business
- Business overview and history
- Purchase information (if applicable)
- Proof of collateral
A note of caution, however. Many lenders will try to loan you more than you need to make money off your interest. Therefore, it’s essential to go into a loan meeting, knowing exactly how much you need for a small business loan and how much you can afford.
Click here to learn more about merchant cash advances.
Are small business loans hard to get?
The answer to the above depends on various factors such as who your lender is, how much you want to borrow, and which loan type you choose. In many cases, a great deal of time and paperwork (as well as patience) is required.
Commercial loans
Although commercial loans tend to be quicker, simpler, and have a less complicated application process than SBA loans, they are not necessarily straightforward to apply for. Because they are not guaranteed by the government and carry a greater risk to the lender, commercial lenders need to be careful when looking at the qualifications of borrowers. They may have strict eligibility criteria and require personal guarantees and collateral.
Merchant cash advances
Merchant cash advances have a relatively simple application process and are one of the fastest ways to access money. Application forms can be as short as a single page, and most lenders allow you to apply online. They require minimum documentation, and funding can be available in as little as 24 hours.
A business line of credit
It can be easier to apply for a business line of credit through an online lender as they generally have looser requirements than a traditional bank. More massive lines of credit may require collateral; these are called secured lines of credit. An unsecured line of credit, where there is no collateral involved, is often harder to obtain.
SBA loans
In comparison, SBA loans can be among the most challenging to qualify for and have a strict application process. It also takes a lot longer to receive funding, sometimes even several months. Each SBA program specifies what it can and can’t be used for and the amount it provides. In some cases, it may be necessary to demonstrate that you have been in business for two or more years and that your business makes $100,000 in revenue annually. If you’re planning to apply for an SBA microloan, you’ll have to work with an SBA-approved intermediary in your area. You may also be required to undergo business training before you’re considered for a loan.
For a comparison of the best business lines of credit, go to:
https://www.valuepenguin.com/small-business/best-business-lines-of-credit
Who qualifies for an SBA loan?
Each lender and SBA program will have its unique qualifications based on the type of business ownership, where it operates, and how it makes money. However, all the loan programs have the following eligibility criteria in common:
- Must be a for-profit business that is officially registered and operating legally.
- Must be doing business in the US. It should be physically located and operating in the US or its territories.
- Must have invested equity. The owner should have invested their time and money into the business.
- Must have exhausted all other financing options and be unable to get funds from any other source.
A credit score of around 660 is needed to qualify for an SBA loan. You’ll have to prove you need the funds and that they will be used for a sound business purpose. Once you’ve decided on a loan program, thorough research will be required to ensure all qualifying criteria are met.
Top tip: If you’re applying for an SBA loan, ask your lender how many SBA loans they have approved in the last year and how many of them were for businesses in your industry.
Make sure your lender has an SBA experience!
For everything you want to know about SBA loans, check out:
https://fitsmallbusiness.com/types-of-sba-loans/
What credit score is needed for a small business loan?
A credit score allows lenders to assess how able the business is to repay the funds borrowed. There are a few things you can do to keep your credit score looking good such as paying all bills and debts and keeping revolving debt low. High revolving debt is a red flag to potential lenders. It’s also essential that you have no history of bankruptcies, foreclosures, or tax liens on your record.
Merchant cash advances are probably the most flexible when it comes to credit scores. Some lenders will even accept those with credit scores as low as 500. In that case, a score of 500 or above should see you through.
For business lines of credit, a score of 500 is typically the minimum. Although some online lenders like Fundbox don’t have a minimum credit score requirement, you’ll have tremendous success with your application if your score is at least 560 to 620.
For the best chance of success with your SBA loan application, the following credit scores are preferred:
- 7(a) loans ~ credit score of 680 (minimum 640)
- CDC 504 ~ credit score of 680
- Microloan ~ credit score of 640 (minimum 620)
On top of your personal credit score, lenders are starting to look at FICO SBSS scores, which should preferably be at least 160.
To learn more about FICO SBSS scores, visit:
https://www.valuepenguin.com/small-business/fico-small-business-scoring-service-sbss
How do I get a loan for a start-up business?
What about start-up companies? Considering the already stringent loan application process, it’s usually even harder for start-up companies to get approved for loans, let alone SBA loans. Lenders for merchant cash advances and business lines of credit may not even consider start-up businesses.
If you’re aiming for an SBA loan, you’ll have to impress lenders by demonstrating sufficient industry knowledge and experience as well as having an excellent business plan. You’ll need to meet the previously stated application criteria to the extent possible and will probably be expected to provide collateral too. Any down payments required will be around 20%-30% as opposed to the average 10%. Your chances of passing the pre-screen improve if you have a credit score of 700 as well as a high net worth.
What is the average duration of a small business loan?
Bank loans – The answer to this will depend on the type of loan you take out and what terms were agreed with the lender. Terms can range from one to 10 years. They rarely exceed seven years and are often closed after 24 months.
Merchant cash advances – Terms are often relatively short and can be from three to 24 months, but are usually around 18 months in most cases.
A business line of credit – One of the benefits of a credit line is its flexibility. Terms can last anywhere from a few months to five years.
The following terms apply to the three popular SBA programs:
- SBA 7 (a) – For working capital, terms last up to 10 years. For commercial real estate loans, it can be up to 25 years.
- CDC 504 – Typically 10 or 20 years. Keep in mind the CDC loan is made up of two loans, one from the SBA and one from a traditional lender, and each will have different rates and terms.
- SBA microloans – Rates are set by the individual partner institutions based on the creditworthiness of the borrower. The maximum repayment term is six years, but the average loan term is 40 months.
And there you have it, a brief overview of small business loan options. Hopefully, this article has helped you better understand the different types of loans and their various requirements. There is no one-size-fits-all loan, and there are still plenty of options out there, depending on your business and its needs. However, if you’ve put in the effort and have a reliable cash flow and healthy credit score, you could be applying for your first loan in no time.