How to Get a Business Loan in 5 Steps
Understanding the ins and outs of how to get a business loan could boost your application and chances of approval. From figuring out why you need financing to comparing lenders, there’s a process you can follow on how to take out a business loan.
How to get a business loan: Step by step
- Determine why you need financing
- Check your credit history
- Decide what type of loan is best for you
- Gather financial documents
- Compare lenders and apply
1. Determine why you need financing
Taking on debt could help you achieve business goals, such as expanding your operation or broadening your advertising reach. However, irresponsibly borrowing money may hinder your business and prevent you from meeting daily responsibilities. Before applying for a loan, decide what you want to accomplish, and whether you’d need financing to get there.
Business owners borrow loans for a variety of reasons, including:
- Compensating for a dip in cash flow
- Purchasing inventory
- Expanding the business
- Hiring employees
- Purchasing equipment
- Covering emergency business expenses
Financial institutions will ask how you plan to use the funds before lending money, said Dick Fleischman, a SCORE mentor in Denver. (SCORE offers business education and resources, in partnership with the U.S. Small Business Administration.)
“Look at whether what you’re suggesting is feasible,” Fleischman said. “Do you have a good understanding of what you’re trying to do?”
Once you understand your purpose for seeking financing, you can move forward.
2. Check your credit history
A company will begin to build business credit after it’s been operating for a period, but owners of newer businesses have to rely on their personal credit history when applying for financing. Make sure your personal credit and business credit, if applicable, are in good shape before approaching a lender. (You can check your personal credit score through LendingTree.)
Many traditional lenders prefer borrowers with a personal credit score of at least 700, Fleischman said. However, some alternative lenders could approve borrowers with scores as low as 550 if the business is performing well.
Lenders view low-credit applicants as risky borrowers, so they may only offer short-term loans with high interest rates, if anything at all. If you’re looking for more favorable financing, you may want to improve your credit before applying for a business loan.
Here are some ways to get a boost:
- Dispute any errors. Contact the relevant credit bureau to dispute errors on your report. Your score should improve if the agency agrees to remove the errors. You could also contact the creditors that reported negative information and work out an arrangement to have it removed, Fleischman said.
- Pay down existing debt. Keeping balances low on revolving credit accounts can raise your score. It’s best to pay off your credit card balance each month and avoid using more than 30% of your credit limit.
- Make on-time bill payments. Establishing a history of paying bills on time or early would improve your credit profile.
3. Decide what type of loan is best for you
When applying for financing, you have several types of business loans available to you, depending on what you need.
Short- and long-term loans
Short-term loans often have a fast approval process and quick repayment terms, from a few months to a couple of years. Short-term loans usually require minimal paperwork and are more accessible than longer-term financing to applicants with less-than-perfect credit.
Long-term loans are best suited for large business purchases or investments, since repayment terms can span 10 to 20 years. Because of the longer terms, these loans often have lower interest rates than short-term loans.
These are long-term loans backed by the SBA. The SBA would guarantee a portion of the loan, reducing the risk for the lender. Rates and terms are favorable compared to what many online lenders offer, but it may be difficult to qualify for an SBA loan. The application process is lengthy, and the SBA requires borrowers to have strong credit and solid business revenue.
Microloans are issued in small amounts, and may be reserved for business owners who have difficulty obtaining funding elsewhere or who contribute to their communities. The SBA microloan program offers loans up to $50,000 with maximum repayment terms of six years. SBA microloans are reserved for women, minority, veteran and low-income business owners.
Equipment loans can be used to finance large assets, such as commercial equipment or machinery. The equipment itself would act as collateral on the loan, which could earn you a lower interest rate.
4. Gather financial documents
Lenders often want to see financial records to get a clear picture of the business’s standing and your history handling money as a business owner.
“What the lending institution is going to be looking for is some type of track record that will show your ability to repay the loan,” Fleischman said.
Typically, you must submit two to three years’ worth of financial statements and your past two or three tax returns, according to Fleischman. Be prepared to provide the following:
- Business plan
- Balance sheet
- Cash flow history and projections
- Accounts payable
You could prepare these documents on your own if you’re comfortable with bookkeeping and accounting practices. If not, a certified public accountant, tax preparer or financial advisor could provide assistance.
5. Compare lenders and apply
Business loans are available from traditional financial institutions, such as banks and credit unions, and alternative business lenders, many of which operate online. Banks typically offer more favorable APRs than alternative lenders, but the application process can be more formal and time consuming.
Online lenders require less paperwork and often have less stringent requirements, but they sometimes offer higher rates and smaller funding amounts. You could compare online business lenders through LendingTree to see what you’d be eligible to borrow.
Peer-to-peer (P2P) business lenders may be another option. Individual and institutional investors fund P2P business loans through a lending platform. These lenders may have less strict eligibility requirements than a bank, making P2P loans a good fit for businesses that have trouble qualifying for traditional financing.
When applying for a loan, provide necessary evidence to show why you need a loan, how it would benefit your business and how you plan to repay your debt. Fleischman advised including architectural sketches to illustrate a proposed business expansion or a building contract to show the cost of the project.
“Let’s reverse the chairs and pretend you’re the banker,” Fleischman said. “What would you want to see from a customer to convince you to make the loan?”
What affects your chances of getting a loan?
In addition to the requirements mentioned above, lenders would consider a few other aspects of your business.
Time in business
The longer you’ve been in business, the more willing a lender may be to approve you for a loan. Most lenders require a few years in business — the SBA usually requires two to three years of industry experience, for example. Funding Circle, an online lender, requires applicants to have two years in business.
If you haven’t been operating for long, you may need to bootstrap until you’re in a better position to apply for financing. Bootstrapping would require you to rely on your own savings, money from family and friends or crowdfunding from the general public.
Revenue criteria varies by lender, but most financial institutions will look at your gross revenue when reviewing your application. Gross revenue is your total business income, including gross sales and any other income sources. The minimum annual gross revenue requirement would depend on loan size and the type of loan for which you are applying. Online lender Credibility Capital, for example, requires $150,000 in annual revenue.
If a business loan is secured, you would need to provide collateral that the lender could seize in the event of default; unsecured loans, however, do not require collateral. When you provide assets to secure a loan, you could receive more favorable rates and terms since the risk for the lender would be lessened.
Existing lender relationship
Having a prior relationship with a financial institution could give you a better chance of getting a loan. Whether you’ve previously opened a line of credit or established a bank account with the institution, the lender would already have a sense of your money management skills. A well-established relationship could prove beneficial when you’re seeking funding.
Don’t rush into getting a business loan if you’re not ready, Fleischman said. If you’re unprepared to answer questions about your business or haven’t organized the required documents, you’re not likely to be approved.
“Make sure you have everything lined up properly so that you avoid any land mines that might be out there,” Fleischman said.
Business loan FAQ
When should I pass on a business loan? If you’re uncomfortable with any aspect of your loan offer, you may want to search elsewhere. Consider the interest rate and repayment term that a lender offers, as well as the amount that you could borrow.
Can anyone get a business loan? Your eligibility for a business loan would depend on several factors, including your personal credit history, time in business and business revenue. Online alternative lenders often have more lenient eligibility requirements than traditional bank lenders. Check each lender’s specific requirements to make sure you would qualify.
What are some alternatives to business loans? Business loan alternatives include business lines of credit, merchant cash advances and invoice factoring, among others. These products have various borrowing and repayment processes, and one may be more favorable to your revenue structure than another. You could also rely on bootstrapping to fund your business.
How do I apply for a business loan online? Online business loan applications typically require basic information about your business, including revenue and time in business. You may also need to provide your personal credit score. The online application process is usually faster than applying at a bank, and you could be approved for funding in a matter of days.