How to Compare and Choose the Best Small Business Loans
There are more small business loan sources than ever, thanks in large part to the Internet.
Historically, banks have been reluctant to make loans to small businesses, especially to upstarts.
But there are many different lenders and many different types of business loans.
There’s almost a business loan for every type of business.
By doing your homework, and “getting your ducks in a row”, you’ll have a good chance of getting the financing you need.
What Are Small Business Loans?
The term “small business loans” is a catchall to describe several different types of business financing.
Examples include the following:
As the name implies, these are loans for a specific amount of money over a designated term.
For example, you might borrow $20,000 with a repayment term of 36 months.
Lines of credit
These are revolving lines of credit specifically for business purposes. They work similar to home equity lines of credit, but usually charge higher interest rates.
These are loans used specifically for the acquisition of equipment.
They can be either outright loans to purchase the equipment, or leases.
In either case, the equipment itself serves as collateral for the loan.
These are mortgages used to purchase real estate for business operations.
They can be used to purchase an office building, retail space, a warehouse, or even production facilities.
Merchant cash advances (MCAs)
Designed mainly for businesses with a substantial volume of credit card sales, you’ll get an advance on those sales from the lender.
In exchange, you’ll agree to a monthly payment based on your recent pattern of credit card receipts. These are generally short-term advances, auto-drafted to the lender, and often at very high rates of interest.
Similar to merchant cash advances, they’re short-term loans made based on your receivables from clients.
Business credit cards
This is a dedicated credit card for your business. It will likely be in the name of your business, but you may be personally responsible as well.
Under ideal circumstances, a small business loan will be the obligation of your business only, and not you personally.
But if your business is not well-established, and not particularly large, the lender will usually require some type of personal guarantee from you.
Where Do You Find Small Business Loans?
Most typically, small business loans are available through banks.
However, not all banks offer small business loans, so you’ll need to do a thorough search to find out which ones in your area do.
It’s a great approach to submit an application with the bank you already have a relationship with, preferably one you’ve been banking with for several years, and do your business banking with.
That can include maintaining a business checking account and using certain business banking services, like merchant credit card processing.
There are also web-based sources that specialize in small business lending, particularly term loans, lines of credit, equipment financing, and merchant cash advances.
Online business loan marketplaces
You can also attempt to find financing through an online business loan marketplace.
These are websites where you can apply with several or many different lenders by completing a single application.
Any lenders interested in your credit profile or business type will then make loan offers. It’s a good way to shop and to have the lenders come to you.
Examples of online business loan marketplaces include:
- Funding Circle
- One Park Financial.
With both online lenders and online small business loan marketplaces, you’ll need to look closely at the fees and interest rates charged.
They can be high for new businesses, and applicants with poor credit. Rates over 100% are not unusual.
What are SBA Loans?
SBA loans, or Small Business Administration loans, are loans guaranteed by the Small Business Administration, which is an agency of the US government.
The loans are made by private lenders, like banks, but guaranteed by the SBA.
That makes lenders more willing to make loans to small businesses.
Eligible businesses and purposes
SBA loans are generally available for business startups, and can provide financing for existing businesses, including working capital, purchase of inventory, equipment purchase, or leasehold improvements.
If your business qualifies, SBA loans carry some of the lowest interest rates available on small business loans. Interest rates are based on the prime rate, plus a margin.
With loan terms greater than seven years, the margin is 2.75%. On short-term loans, it’s 2.25%.
If you take a five-year loan, and the prime rate is at 5.50%, your interest rate will be 7.75%.
The application process for SBA loan is lengthy and fairly complicated. But it may be the best option if you’re looking to get a low rate loan, or any type of financing at all.
Unfortunately, banks are notoriously reluctant to make loans to small businesses, particularly startups.
But you may be able to get financing through a bank that offers SBA loans.
Other Small Business Funding Options
Home equity loans and home equity lines of credit (HELOCs) are offered by most banks and credit unions.
They’re some of the lowest interest rates you’ll get on any type of financing, since they’re secured by your home.
- A home equity loan will be for a fixed amount, term, and interest rate.
- A HELOC will provide a line of credit on your home, which you can access and repay on your own terms.
If you have one or more credit cards with a generous credit limit, this can be another potential source of financing for your business.
However, it’s an expensive way to borrow, since interest rates are high. And should your business fail, you’ll still be personally liable for the debts incurred.
Once again, it may be difficult to get formal business financing from a bank if your business is small or new.
And online sources often charge very high fees and interest rates. If you’re unable to get any type of business financing, you can also consider personal loans.
These are unsecured loans for a fixed amount – and usually with a fixed interest rate and term – where the proceeds can be used for just about any purpose. You may be able to take out a personal loan and use the proceeds to finance your business.
Personal loans have become a common offering from online sources, so much so that many banks have taken to offering them as well.
You should check with your bank, or another bank known to offer personal loans, to see if you qualify.
What is Typically Needed to Qualify for a Business Loan?
The answer to this question needs to be broken down into two categories, lender requirements for your business, and documentation needed.
Typical lender requirements for your business include:
- A minimum of one or two years in business.
- Meeting a minimum annual gross revenue requirement, which may be anywhere from $75,000 and up.
- A positive net income. Some lenders will require your net income to be higher than your expenses by some multiple.
- Collateral. This can be business equipment, inventory, or real estate. However, some lenders will impose a blanket business lien on all the assets in your company.
- The business owners must meet minimum credit score requirements.
- A personal guarantee. This is usually required on at least one owner of the business.
- The industry your business operates in will usually be a factor, as most lenders will provide financing in certain industries only.
Typical documentation requirements include:
- Completion of a loan application including business information, and more typically personal information as well.
- Evidence of business licensing and incorporation (if you’re incorporated).
- Business and personal income tax returns for the past two years.
- Financial statements for the current year.
- Personal and business credit reports.
- Personal and business bank account statements.
- A satisfactory business plan.
- Documentation of assets being pledged as collateral for the financing.
Both lists are just samples of potential lender requirements. A lender may ask for more or less information.
Does Your Personal Credit Score Matter?
Even though you’re applying for financing for your business, the lender will generally be interested in obtaining your personal credit score.
The lender recognizes that the financial viability of both you and your business are closely connected.
Most lenders impose a minimum credit score, which may be 600, 650, or some other score.
There are exceptions to the personal credit score requirements.
One is where your business is well-established and has already developed its own credit profile.
This is more typical of businesses that are incorporated, have been in existence for several years, and have substantial revenues.
Another is where a lender is providing financing tied to a specific business source of revenue.
An example is a merchant cash advance, where the loan will be paid out of revenue generated from credit card sales.
The lender will take either a flat amount each month or a percentage of monthly revenue, as an automatic draft from your account. With many such advances, your personal credit score isn’t required.
Tips to Increase Chances of Approval
As is the case with every type of loan, there are ways you can increase your chances of being approved for business financing:
1. Borrow after two years of business operation
Longevity indicates staying power, which is always a desirable quality to a lender.
So, if your business has some proven sustainability, there are greater chances that lenders will approve a loan.
2. Show profits
Many businesses intentionally create losses for tax purposes, but it comes back to haunt them when applying for financing.
3. Improve your credit score
The better your personal credit, the more likely you are to be approved.
4. Have a substantial investment in your business
Lenders prefer to make loans when owners have “skin in the game”.
If you have little or no personal investment in your business, the lender may perceive you’ll be more willing to walk away from a business loan.
5. Create a credible business plan
This will help the lender to know the direction of your business, as well as your plan to get there.
You should also be prepared to shop between various lenders.
Business lending is not a standardized practice, and you’ll find some lenders more receptive than others.
Also, be prepared to provide any and all documentation requested by the lender.
If you fail to provide certain documentation, or even hesitate, the lender may lose confidence in you and deny your application.