Everything You Need to Know to Get Your First Business Loan
Last Updated: April 9, 2019
Table of Contents
- What to Do Before Applying for a Business Loan
- Starting Your Loan Search
- Applying for the Loan
- Applying for An Online Business Loan vs. Bank Loan
- Start Building Credit Today
Applying for a business loan as a newbie, as daunting as it may sound, is actually a straightforward process that can be perfected with a little preparation. To help ease any concerns you may have regarding the application process and your eligibility for small business loans, we put together this guide to getting approved without the stress or hassle.
There are very few aspects of running a small business more important than securing that first business loan. If you want a painless loan application process, read on and find out how to obtain a business loan that suits your company’s unique needs and challenges.
What to Do Before Applying for a Business Loan
You should never jump into a business loan without exercising due diligence first. Before you apply (or even narrow down a lender or loan type to apply for), you’ve got to take a look in the mirror and ask yourself why it is you need a loan.
Sometimes, taking out a business loan isn’t even necessary to satisfy your goals.
Unless a business loan is imperative for you (i.e., your best or only option for getting to where you need to be), then you may be better off holding out to find another source of capital. If you’ve found that a term loan or SBA loan offers the most accessible route to the working capital you need, then you should commit to applying for the best loan possible.
Discovering Your “Why”
Veteran business owners know that one of the first things that loan officers ask new applicants is “why?” In other words, why you think you need the loan you’re applying for. Far too often, a loan application is considered dead on arrival if the applicant is at a loss for why they need it.
If, at this moment, you’re struggling to pinpoint a specific reason as to why you need a loan—don’t be afraid to generalize. Most loan officers don’t expect you to provide an itemized, line-by-line breakdown of your forecasted expenses. Instead, you can simply state that you need the cash to cover day-to-day working capital over a span of several months.
There is a wide range of reasons why entrepreneurs need to apply for business loans. Below, we’ve broken down some of the most common reasons for applying for a business loan or other forms of business financing.
- Scaling Your Business: Businesses need cash if they want to grow. Scaling a business requires capital to cover new hires and other expenses.
- Solve Cash Flow Delays: When clients are slow to pay their invoices, cash shortages can occur which can cause serious business delays. Cash flow loans can provide a quick and easy solution to a cash crunch.
- Basic Working Capital: You need money to make money. A working capital loan is a cash infusion that can help cover the startup costs of a thriving enterprise.
- Acquiring a Business: Business acquisition loans are some of the most frequently applied-for loans on the market. These are used to buy an existing business and their assets.
- Starting a Business: Registering a business and getting off the ground can be expensive. Fortunately, startup loans can provide the cash needed to set your business on the path to profitability.
- Debt Refinancing: These loans are used to repay existing loans that are more costly due to higher interest rates.
- Equipment Financing: Cash infusions used to cover equipment acquisition costs, including computers, vehicles and other business tools.
What Can You Afford?
Another critical step every business owner needs to take before applying for a loan is to discern how much capital they need, and how much they can afford. Even though your business might be able to use an additional $50,000 in working capital or reserve cash, this doesn’t necessarily mean that you can afford it.
The last thing your business needs during its early days is to be straddled with debt. However, the reverse also presents a difficulty for your business’s long-term success: not taking on enough working capital to cover your expenses.
It’s crucial for business owners to pinpoint exactly how much they need and to be careful not to underestimate their expenses.
Online business loan calculators are some of the best tools available for entrepreneurs to use find out how much they need from a loan and whether they can afford it. Make sure you have an idea of the interest rate and term length of the loan you’re interested in before using an online calculator since you’ll need to plug this data into their formula to get an accurate assessment.
Find Your Debt Service Coverage Ratio (DSCR)
Creditors assess your business using several metrics and key performance indicators when determining whether you have the capacity to repay the loan. Although the classic debt-to-income (DTI) ratio is well-known as being one of the top indicators of a business’s ability to take on more debt, the debt service coverage ratio (DSCR) adds more to the picture.
To discover your DSCR, plug your company’s financial data into the simple DSCR formula below:
DSCR = Net Operating Income / Total Debt Service
For those unfamiliar with the term “total debt service,” this merely refers to your total monthly loan payments. If your DSCR is positive (i.e., equal or greater than 1), this means your company has enough cash to cover all existing loan payments.
Unsurprisingly, a negative DSCR is a major red flag to lenders, since it implies that your business cannot possibly repay its debts without somehow generating additional revenues.
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Starting Your Loan Search
Once you’ve decided that a loan is truly the best option for your business and you have a good estimate as to how much you will need and what you can afford, you can start shopping around. Fortunately, a lot has changed in the world of commercial lending over the past decade or two, leaving entrepreneurs with plenty of options for financing their company.
A cursory glance at the Google search results for “small business loans” will prove that there is a seemingly endless supply of lending options on the market. Taking out a loan, it would seem, involves hours of research to find the loan type that best fits your company’s budget and needs.
Luckily for you, we’ve done all the heavy lifting for you. Below, we’ll give you a quick overview of all the most popular small business lending options and we’ll touch on what kind of business is well-suited for each.
Backed by the U.S. Small Business Administration (SBA), SBA loans are among the top choices of loan types for entrepreneurs. Plus, SBA loans can be applied for from just about any online or brick-and-mortar lending institution.
It’s worth noting that, despite their name, SBA loans aren’t issued by the government. Instead, they’re offered by regular private banks and lenders. The only substantive difference between an SBA loan and a standard term loan is that the Small Business Administration partially guarantees an SBA loan. In other words, the SBA provides some collateral to offset the risk inherent in lending to a small business.
One of the best aspects of SBA loans is that they’re suitable for virtually every small business need. For instance, borrowers can select between the following SBA-secured loans:
- 7(a) SBA Loans: Conventional term loans commonly used to finance business expansions, day-to-day working capital and capital expenses.
- Microfinance SBA Loans: Short-term loans worth $50,000 or less that are typically issued to non-profit and mission-based businesses.
- CDC/504 SBA Loans: Larger loans that are commonly used to purchase real estate and other significant capital expenses.
- SBA CAPLine: A line of credit program. CAPLines are used for specific purposes, such as working capital or seasonal needs.
The downside to applying for an SBA loan is that they tend to be highly competitive. Since the SBA has a fixed budget, they can only secure so many loans before their coffers run dry.
This is why the SBA and, by extension, the loan-issuing institutions, are hesitant to lend to any entrepreneur with a business plan and a dream. Owners need strong credit scores if they want a chance at getting approved.
Business Lines of Credit
In the commercial lending world, business lines of credit are one of the most in-demand loan types on the market. Made popular by their “take-what-you-need” approach to lending, business lines of credit provide a safe and effective route to capital that traditional term loans simply do not.
Business lines of credit operate much the same way as a regular line of credit in that it involves the lender approving a borrower’s access to a pool of funds that can be drawn from at any time. Since you only pay interest on the money you withdrawal, you don’t get stuck footing a bill every month simply for receiving a lump sum loan deposit that sits dormant in your bank.
Lines of credit are revolving in the sense that once they have been used and replenished, they can be used again. And although they can be a challenge to qualify for, especially for market newcomers, they can provide the most flexibility out of any other loan or debt financing option.
Those in need of a financial safety net or on-demand access to more cash should consider applying for a business line of credit.
Equipment for your business should never be cheap. However, some industries more than others charge exorbitant fees for industry-related equipment simply for the fact that they have a monopoly on their production, or because the technologies involved are on the bleeding edge.
Those working in fields with expensive equipment, such as the medical or dental professions, are well-positioned for an equipment financing loan.
Under these arrangements, lenders will purchase the equipment up front with cash and will receive regular repayments from the borrower until the value of the items, plus interest, has been met.
Equipment financing loans are among the easiest to get approved for since the equipment acts as collateral. Therefore, all equipment loans are technically secured by the equipment itself. For this reason, borrowers can often get away with applying with a lower credit score.
Companies that issue invoices to their customers know all too well that sometimes customers can drag their feet when it comes to making a repayment. Instead of letting unpaid invoices pile up and cause a severe backlog in your accounts receivable, invoice financing can convert outstanding invoices into cash, so you don’t have to wait around or dig into your cash reserves.
Typically, invoice financing involves a cash infusion worth a fraction of the total sum of the invoices. For instance, you may receive an advance of $80,000 for invoices totaling $100,000 in receivables. The remaining balance is remitted to borrowers (minus fees) after the invoice is paid in full by your customers.
Your credit score, as well as your customers’, factor into the percentage you receive in return for your invoices.
Business owners that choose invoice financing need to be mindful of “factor fees,” which are charges owed to the buyer for every week that the invoices go unpaid. These fees are taken out of a reserve amount of cash (typically around one percent of the invoice value), which you receive once all the invoices are paid.
Since invoice financing is a secure form of lending—because, in this case, the invoices serve as collateral—it is generally easier to qualify for invoice financing than, say, a regular term loan. We recommend invoice financing for business-to-business (B2B) companies that regularly issue high-value invoices to clients.
Companies that need cash to cover immediate expenses might be better-suited for a short-term loan. Usually, these loans have a repayment period of 18 months or fewer, which makes them ideal for businesses that want to avoid locking into long-term debt.
The drawback to short-term loans is that they tend to be costlier than your standard term loan. For some, this is a pittance for the price of convenience and peace of mind.
With higher fees come more lenient eligibility terms. Whereas long-term loans require high personal or business credit scores and higher annual revenues, short-term loans can be secured with FICO® scores as low as 540 and a total time in business of only one year. New businesses that have a short roadmap to profitability are well-suited for short-term loans.
With repayment terms ranging between one- and five-years, medium-term loans offer flexibility and convenience for business owners that want to avoid the APRs of short-term loans. A standard interest rate on a medium-term loan ranges between 7-12%, depending on your time in business and credit rating.
Another great feature of medium-term loans is that they can come in a variety of sizes. Medium-term loans start as low as $10,000 and can reach as high as $2 million depending on the lender. This makes medium-term loans ideal for both small business owners and burgeoning mid-sized enterprises looking to expand into new markets.
Those with personal credit scores north of 600 should consider applying for a medium-term bank loan. Due to their higher value and longer term (and in turn higher risk) borrowers need a more impressive FICO® score than what’s considered acceptable for a short-term loan.
Merchant Cash Advance
Business owners interested in a flexible business financing solution should consider applying for a merchant cash advance (MCA).
MCAs work by selling a predetermined portion of your company’s future sales. In exchange for a cash payment, the borrower will forfeit a fixed amount on a daily or weekly basis until the principal is paid with interest. The main benefit of an MCA is that they are a viable funding option for many business owners, including those with credit and business revenue challenges.
Although merchant cash advances boast a speedy and straightforward application process, they come at a high cost and can send businesses into a debt spiral if not used responsibly. For this reason, we suggest using an MCA calculator first to get a sense of its effective cost.
Online business loans are one of the fastest-growing alternatives to the standard bank loan. Business owners that need reliable and affordable access to cash in a hurry can apply for a medium-term online loan and expect to have their application processed in a fraction of the time that a bank would take.
In most cases, the total time required to apply for an online loan, get approved and receive the cash in your bank account amounts to less than two weeks. This makes applying for an online loan one of the best options for borrowers that can’t wait around for a bank to process their application over a period of a month or longer.
Find the loan that’s right for you.
Applying for the Loan
Once you’ve decided which loan type is appropriate for your business, you can start collecting all the necessary documents for the application. To be on the safe side, you should gather all of the following documents regardless of the loan or financing option you choose:
- Bank statements covering the previous year
- Business licenses, permits and other necessary certificates
- Business tax returns covering the previous one to three years
- Business plan
- Incorporating documents (e.g., Articles of Incorporation)
- Copies of office and/or equipment leases
- Personal financial statements covering up to three years
If you decide to apply for an SBA loan, some documents must be gathered that are specific to this loan type. These documents include:
- SBA Form 912
- SBA Form 4
- SBA Form 4(i)
- SBA Form 4 section 12
- Papers detailing ownership structure
Since lending institutions will heavily vet all the forms and signed information, it is important that all statements are accurate and truthful. Providing misleading or false information, knowingly or not, will cause your loan to be denied on the spot and will penalize your company when you apply for a loan in the future.
Fortunately, applying for a loan online involves a more streamlined process than traditional brick-and-mortar lending. Online loan applications sometimes only require your business and personal FICO® scores, tax returns, balance sheet, profit and loss statement, annual revenues and incorporating documents.
Find out what you qualify for in minutes.
Closing the Deal
If you apply for a business loan through a bank or credit union, you will likely have to schedule a meeting with their in-house loan officer to go over your application in person.
During this meeting, it’s a good idea to put together a brief business loan presentation that explains what you need the loan for and how it will fit in with your business’s long-term financial forecast.
At the meeting, you will be presented with a business loan agreement that will need to be signed by you or a joint-owner of the company if they have signing authority.
Make sure you read this contract carefully from cover to cover to spot out any hidden fees or conditions that can increase the cost of the loan.
Look out for ancillary fees and surcharges that the lender might tack on in the fine print. Before you sign on the dotted line, make sure you check if there are:
- Application fees
- Origination fees
- Credit check fees
- Prepayment fees
- Late payment fees
- Guarantee fees
Although some of the above fees are standard for business loans (such as guarantee fees for SBA loans), it’s important that you’re aware of these fees to estimate the true cost of the loan.
Applying for An Online Business Loan vs. Bank Loan
These days, more and more small businesses are turning to online business loans for the unmatched convenience, speed and flexible eligibility requirements they offer. It should come as no surprise, then, that most short-term business loans are now applied for online.
After all, the last thing a business owner needs is more paperwork. As anybody who’s ever applied for a traditional bank loan knows all too well, countless forms need to be filled out and documents need to be handed over to get approved. With online lenders, business loans can be approved as fast as 24 hours and without any hassles or hiccups.
The Benefits of Online Business Loans for First-Time Borrowers
There are plenty of reasons why your business can benefit from applying for a business loan online, especially if you’re a first-time applicant. First among them is the ease with which they can be applied for.
While banks aren’t exactly known for their convenient hours of operation, online lenders are available 24/7 to help you get the capital you need.
Second, applying for a business loan online is significantly faster than applying through your local bank branch. Although regional banks are speedier than large multinationals, nothing beats the same-day processing that online lenders are known for.
Since proprietary algorithms primarily determine eligibility, whether you get approved is a function of computerized systems that evaluate your application objectively based on your financials.
Last, when you apply for your first business loan through an online lending marketplace, you’re given a wider variety of choices than your standard brick-and-mortar fare. Since countless online lenders can be applied to, you can hunt for the most attractive rate among a pool of lenders.
By contrast, with traditional lending, you are limited to whichever banks are operating near your physical location.
Things to Know Before You Apply for the First Time
Regardless of whether you decide to apply online or through traditional lenders, it’s always a good idea to speak with an accountant first. With their input, you can make a level-headed judgment regarding how much financial support your business needs in the short and long-term.
It’s also a good idea to set aside assets to be used as collateral to secure the loan if you have a poor credit history. Often, lenders consider unsecured loans from small businesses to be too risky to touch. This is why it is important that entrepreneurs consider other assets in their possession to put up as collateral, which the lender can recoup if you default on the loan.
If you don’t have cash laying around, several other assets can be used to secure a business loan, including:
- Personal real estate
- Home equity
- Blanket lien
- Personal vehicles
- Investment accounts
- Accounts receivable
Seize the funds you need as soon as same day.
Start Building Credit Today
Now more than ever it’s easier to apply for your first business loan. With a variety of low-interest options to choose from, building credit through business loans doesn’t have to put you in a debt spiral or cause any unnecessary hassles or headaches.
Once you’ve established that you need a loan to get your business off the ground, consider applying for fast and affordable online business loans to accelerate your business’s growth.
After getting approved within minutes, you’ll be well on your way to building a rock-solid business credit score. With an excellent credit history behind you, accessing working capital will be easier throughout the lifetime of your business.