How to Get a Business Loan in 7 Steps

What is a business loan?

A business loan is nothing more and nothing less than a form of credit that lenders offer businesses. In exchange for their money, lenders require borrowers to repay principal with interest and fees added. Most loans require borrowers to make payments on a set schedule, but interest rates and terms vary a lot depending on the lender and the borrower's qualifications.

Business loans are not the only way that businesses can get money for starting up, buying real estate and equipment, purchasing inventory, meeting payroll, and other business expenses. Many startups raise venture capital by offering equity in the company in the form of different classes of stock, in exchange for cash.

Inventors and entrepreneurs who have a great new idea sometimes get their seed capital through crowdfunding. There are even companies that got their start with a grant from a government program or a charitable foundation. The majority of companies, however, get their funding through business loans.

How to Get a Business Loan

Let's take a closer look at the seven steps for getting a business loan.

1. Choose what kind of loan you want

When you are just starting out, your business credit and your personal credit tend to be the same thing—even if you have formed an LLC or a corporation. Lenders make judgments on business loans on the basis of personal credit reports, at least until the business is up and running. But there are certain kinds of financing that you can get even in your startup period.

It is relatively easy to get a business credit card. You can use your business credit card to make purchases that keep your business going. You will typically have a relatively low credit limit, but there is no set repayment period, as long as you make your minimum payments every month. The disadvantages of business credit cards are that they usually charge high rates of interest and they have limited usefulness for getting cash.

An excellent way to start building your business credit history is with trade credit. Suppliers give you 30 days to pay for inventory and supplies, often with a small discount for paying early. You will have to establish a relationship with your vendors, but trade credit is relatively easy to get.

Even if you have bad credit, you may be able to get merchant cash advances on future debit and credit card receipts. The downside of this kind of loan is that it comes with an astronomical interest rate, sometimes effectively in three figures. It is also relatively easy to get equipment financing on an installment plan, secured by the equipment itself, or even a commercial real estate loan. But serious financing is usually provided by conventional bank lenders or the Small Business Administration (better known as the SBA).

Conventional bank lending vs SBA loans

There are no hard and fast limits on conventional lending, but you will need an established relationship with the lender to be considered for funding. The SBA offers express loans in amounts up to $350,000. SBA 7(a) loans (referring to the section of the law that authorizes the program) can be guaranteed up to $5.5 million.

SBA loans allow long-term repayment, up to:

• 10 years for inventory for a retail business or working capital for any kind of business,
• 10 years for equipment, and
• 25 years for real estate.

The SBA, however, is not the actual lender of the money. The SBA only guarantees repayment of a percentage of the loan, up to 75 percent. SBA loans are also available at favorable interest rates based on the prime rate or LIBOR, or the SBA peg rate. Loans of $25,000 or less, or for seven years or more, come at higher rates of interest. SBA loan rates can range from prime plus 2.25 percent to prime plus 4.75 percent.

Conventional loans and SBA loans differ in a number of very important ways:

• A conventional small business loan usually requires both demonstrating cash flow and putting up property for collateral. Only a percentage of the appraised value of property, usually 80 percent, can be used to collateralize the loan. SBA 7(a) loans do not require any collateral at all.
• Banks want an audited financial statement that shows that you can afford to make your payments. In fact, they usually want proof that you have 125 percent of the cash flow you need to make your payments. SBA loans can use projected cash flow figures.
• Collateral and cash flow are not enough for conventional lenders. They may decline a loan simply because there are certain industries they do not invest in. The SBA funds loans for businesses in almost any industry, even an online business.
• Conventional lenders will look for collateral that will more than cover the amount of their loan. SBA rules state that a loan shall not be denied strictly because of a high loan-to-value ratio. The SBA also does not require borrowers to put their ownership in the company at risk.
• Conventional lenders usually require a 20 to 25 percent down payment to buy real estate. SBA loans usually only require 10 percent.
• Conventional lenders may extend debt financing for real estate for only five to seven years, expecting borrowers to refinance their loans long before the property is paid for. SBA loans usually extend 10 to 25 years.
• Many entrepreneurs want to buy real estate with room for their company and room to rent to other businesses while they are growing. Conventional lenders usually do not finance this kind of arrangement, but the SBA approves loans for up to 100 percent of the cost of real estate as long as the borrower occupies at least 51 percent of the space.
• Refinancing to reduce monthly debt payments is usually impossible with conventional lenders but is often possible with an SBA loan.
• Balloon payments are common with conventional loans, but they are prohibited for SBA loans.
• On-demand loans, which require repayment in full, even if you have been making all of your payments on time, are not allowed by the SBA.
• Loan servicing requires annual submission of tax returns and audited financial statements to meet the terms of the loan. Failure to submit these documents puts the borrower in default of the loan. Conventional lenders usually require annual audited statements that may cost tens of thousands of dollars in CPA fees to prepare. The SBA is usually satisfied with tax returns if the loans are being repaid.
• The SBA may finance intangible assets such as goodwill. Conventional banks may recognize them on your balance sheet if they are allowed by Generally Accepted Accounting Principles (GAAP), for purposes of loan servicing, but they almost never lend money to acquire them.

The SBA offers microloans, disaster loans, and a special real estate financing option known as a 504 loan. Just know that you personally, not your LLC or your corporation, will be on the hook for repayment if your business fails to make the required payments on your loan.

2. Make sure you are qualified for the kind of loan you want

Lenders look at three factors to determine whether you are qualified for a loan.

Credit Score

Banks prefer to lend to businesses and individuals who have excellent credit, a credit score of 720 or higher. Applicants with excellent credit are more likely to be approved than applicants with just good credit, scores between 690 and 719.

The SBA also uses the FICO Small Business Scoring Service to check your SBSS score. You will need 155 or higher on their scale of 0 to 300 to get through prescreening, but there may still be a lender who is willing to work with you if some other aspect of your loan application is sufficiently attractive.

Don't have a good or excellent credit score? You will pay more interest, but there are lenders who specialize in lending to businesses with a poor or limited credit history. Companies like bluevine, ondeck, and Triton Capital can often make loans when the SBA and conventional lenders cannot.

You may also be able to get a loan from a non-profit microlender.

Revenue

Many commercial lenders simply don't do business with companies that are not taking in $250 thousand, $500 thousand, a million, or multiple millions of dollars in revenue every year. Estimates of future revenue are not likely to be considered unless they are already contracted (in which case you can get money through a process called factoring).

Low revenues don't preclude the possibility of getting a business loan at some institutions. SBA microloans and short-term business financing may be available.

How long you have been in business

Online lenders usually work with borrowers who have been in business for at least a year. Banks look for two years of audited financial statements.

3. Calculate the payment you can afford

To be sure you can make your payments on time, your total income should be at least 1.25 times your total expenses, month by month. Include your loan payment in your monthly expenses. For example, if your business takes in $20,000 a month, and you have rent, payroll, and overhead costs of $14,000 a month, you can afford to make loan payments of $2,000 a month. Leave at least a 20 percent margin for unexpectedly low revenue or high expenses.

4. Decide how you want to collateralize your loan

Getting a business loan from a conventional lender is almost impossible without collateral. Lenders want a lien on real property or equipment that they can seize if you cannot or do not repay your loan. They want to be sure that the proceeds from the sale, less the costs of selling the seized collateral, more than covers the amount you owe on your loan. It is usually not a good idea to count on the proceeds of a bank sale leaving any cash to go back to you.

When you put up property as collateral, you risk losing it. But the lender will almost certainly give you a lower interest rate.

Lenders may also require your personal guarantee to give you a loan. That means that they can take your collateral and still sue you for any balance remaining on your loan. They can force you into bankruptcy. In some states, they can come after your house, your cars, and your retirement accounts.

5. Compare lenders

Once you have evaluated your borrowing needs and your borrowing power, it is time to look for a lender. Here are some guidelines for the kind of lender you will need in different situations.

• Banks are a good option if you have good or excellent credit, you have been in business for two years or longer, and you can wait to get your funds. Banks will do a thorough investigation of your creditworthiness before they lend you money. But they offer lines of credit, short-term loans with a balloon payment, installment loans, and financing for real estate and equipment.
• Online lenders are best for borrowers who don't have collateral, who haven't been in business very long, and need cash now. There are online loans for as little as $1,000 and as much as $5 million. Interest rates range from prime plus 2 percent to over 100 percent, and collateral may be required.
• Microlenders offer micro loans, usually under $50,000. They usually work with businesses that have a poor credit history, or that have not been in business very long, or who don't have collateral. They will need to see tax returns and financial statements, and they may require a business plan. They charge a higher APR than banks. But they make loans when other lenders do not.

6. Gather your documents

Depending on your lender, you will need to have business and personal bank statements, business and personal tax filings, financial statements from your CPA, your business plan, and your articles of incorporation, franchise agreement, and lease agreements. Having all of these documents handy saves lots of time.

7. Apply for your loan!

Now you are ready to apply for your loan. Start with the lender who offers the lowest APR, and use your documents to complete your application. Keep in mind that every application will result in a hard pull of your credit report, slightly lowering your credit score, so start with the most promising opportunities first.