This article addresses:
- The 7 best financing options
- How to prepare for getting a business loan
- How to compare small-business lenders
Securing financing as a small business owner can feel like an overwhelming process, especially if itâs your first time. Whether youâre looking for a business loan to expand your business, buy a company, or simply help you through a tough time, there are many different funding options.
Thankfully, itâs not as hard as it seems at first. Once you know what youâre looking for and what the options are, youâll be well on your way to getting the financing you need. From a fast approval process to low monthly payments, with this guide, youâll find the right type of financing for you and learn how to get that loan for your small business.
1. The seven best financing options
Choosing the right financing option for your business is the single most important part of getting a business loan.
Choosing the right type of loan is the best way to secure a loan that meets your needs.
Traditional term loans.
Term loans are what come to mind when most people think about taking out a business loan. A term loan is a loan that provides you with a lump sum upfront, and then over the course of a set period of time, you repay the loan with regular payments.
Although you can get a term loan from most lending institutions, the best rates will come when you can get a loan that is backed by the Small Business Administration, or SBA.
Because SBA loans are backed by the federal government, lenders are willing to provide a much lower interest rate than a traditional loan. These loans also offer the longest repayment terms available, typically 5 to 25 years.
This type of small business financing has a high borrowing maximum â up to $5.5 million. However, they do tend to have a lengthier application process that requires a lot of paperwork and usually includes a longer waiting period to get approved.
Itâs important to note that for SBA 7(a) loans, there are prepayment fees, but they only apply when a borrower âvoluntarily prepays 25% or moreâ of a loanâs outstanding balance on a loan 15 years or longer. In addition, the prepayment must also be made within 3 years after the initial loan disbursement. Also, be prepared to pay an origination fee to have your application processed.
Depending on your business history and credit, you can get SBA loans from traditional banks, online lenders, or nonprofit microlenders.
Startup financing includes options such as business credit cards and personal loans. Small business lenders usually require cash flow to support repayment of the loan, so new businesses in their first year typically can’t get business loans. Instead, youâll have to rely on these other financing options.
Business credit cards are a great option if your business needs access to cash quickly. Theyâre much easier to get than a large loan or a line of credit. And if you shop around, you might be able to find offers for 0% APR for up to 15 months or offers of 0% APR on balance transfers. Depending on the type of credit card you choose, you can secure financing even with a low credit score.
An additional perk that comes with business credit cards is that you can earn points while spending. If you pick the right credit card and read up on their terms, you may be able to earn a good quantity of points if youâre putting your business expenses on this card. Make sure to do your research to find the best card for you, because if you carry a balance once the 0% APR expires, you can expect to pay very high interest rates.
A business line of credit.
Lines of credit are similar to credit cards, in that they give you access to cash when you needed, but you only pay interest on the amount that you use. Most revolving lines of credit are usually in the $10,000 to $1M range and have higher interest rates from 7 to 25 percent. Borrowers can be approved for a line of credit in as little as one business day, making this a convenient option.
One caveat of a line of credit is that they do require excellent credit scores. Both your business and personal credit history need to be in tip-top shape to qualify. If you are approved for a line of credit, it can last multiple years as long as you remain current on your payments. However, banks may add âcall optionsâ to your line of credit. This gives them the right to âcallâ your loan at any time, which means you must repay it in full and stop drawing on that credit line.
Technically, invoice factoring is not a loan. However, it is a type of financing that can be useful, especially if you have bad credit. If your accounts receivable is high and your customers havenât paid up yet, this is a way to get the money you need quickly. For invoice financing, you sell your invoices at a discount to a factoring company in exchange for a lump sum of cash. The factoring company then owns the invoices and gets paid when it collects from your customers, typically in 30 to 90 days.
While a bank loan would likely require stellar personal credit plus collateral, which is a physical asset such as real estate that the lender could sell if you default on your loan, invoice financing doesnât require these qualifications.
Working Capital Loans
A working capital loan is a loan that is taken to finance a company’s everyday operations. These loans are not used to buy long-term assets or investments and are, instead, used to provide the working capital that covers a company’s short-term operational needs.
The immediate benefit of a working capital loan is that it’s easy to obtain and lets business owners efficiently cover any gaps in working capital expenditures. Sometimes, you will be required to have some form of collateral, other times you may be able to get by with just a personal guarantee. However, for a working capital loan that doesnât require collateral, youâll need to have very good credit.
Merchant cash advances
A merchant cash advance is a type of loan where a merchant cash advance company, like Fundbox, approves your business for a specific amount of funding and provides you with a lump sum of capital upfront. You repay the money you receive, with fees, using a percentage of your future sales.
Merchant cash advance repayments can be structured in two ways:
Percentage of debit/credit card sales. This is the traditional way an MCA is structured: a merchant cash advance provider automatically deducts a daily (or weekly) percentage of your debit and credit card sales until the advance is repaid in full.
Fixed withdrawals from a bank account. Instead of deducting repayments from your debit and credit card sales, merchant cash advance companies can also withdraw funds directly from your business bank account. In this case, fixed repayments are made daily or weekly from your account regardless of how much you earn in sales, and the fixed repayment amount is determined based on an estimate of your monthly revenue. With this method, itâs crucial that your checking account doesnât get too low!
2. How to Prepare for Getting a Business Loan
In order to get financing for your business, youâll have to know what the requirements are for the type of loan youâve chosen and ensure that you are eligible. Especially when filling out a loan application that has more strenuous requirements and a longer approval process, itâs crucial that you are prepared with all of your documents ahead of time:
- Know your credit score. You can get your credit report for free from each of the three major credit bureaus: Equifax, Experian, and TransUnion, as well as personal finance websites like NerdWallet.
- Prepare records showing how long youâve been in business. You need to have been in business for at least one year to qualify for most online small-business loans and at least two years to qualify for most bank loans.
- Have proof of your annual revenue. Many lenders require a minimum annual revenue, which can range anywhere from $50,000 to $250,000. If your revenue isn’t high enough, consider looking into short-term business loans, SBA microloans, or even equipment financing.
Depending on the lender, youâll also need to submit a combination of the following:
- Business and personal tax returns.
- Business and personal bank statements.
- Business financial statements.
- Business legal documents (articles of incorporation and commercial lease, for example)
- Business plan.
If youâve done your research and prepared all of your documents ahead of time, you should have no problems during the application process.
3. How to compare small-business lenders
There are three main sources of small-business loans: online lenders, banks, and nonprofit microlenders.
Online lenders provide small business loans and lines of credit from about $1,000 to $5 million. The average annual percentage rate on these loans can range widely, depending on the lender, the type and size of the loan, the length of the repayment term, the borrowerâs credit history, and whether collateral is required.
These lenders rarely have APRs as low as what traditional banks offer, but their online application is faster and approval rates are higher. You can get approved in as little as 12 hours to a few business days.
You should consider an online lender if:
- You lack collateral.
- You lack time in business.
- You need funding quickly.
Biz2Credit is an example of a leading online lender. Indeed, we recently helped this ayurvedic spa get the business funding it needed.
Traditional banks offer loan options including term loans, lines of credit, and commercial mortgages. However, taking out a small-business loan from a bank can be tough if you have low sales volume or cash reserves. Add high credit score requirements and collateral to that, and many small-business owners come up empty-handed.
Banks are usually the lowest-APR option, but funding takes longer with a bank than it does with an online lender.
When to get a business loan from banks:
- You’ve been in business for at least two years.
- You have good credit.
- You don’t need cash fast.
If you donât meet these requirements, a microlender may be a better option for you.
Microlenders are nonprofits that typically lend short-term loans of less than $50,000. The APR on these loans is typically higher than that of bank loans and the loan amounts are lower. The application may require a detailed business plan, financial statements, and a description of what the loan will be used for, making it a lengthy process.
These loans work best for smaller companies or startups that canât qualify for traditional bank loans due to a limited operating history, poor personal credit, or a lack of collateral.
You should consider a microloan if:
- You have bad credit or no credit history.
- You are a new business.
- You can’t get a traditional loan.
- You only need a small amount of cash.
For businesses with minimal credit scores and credit history, this is a great option.
Getting a business loan isnât hard. In fact, most successful companies have used debt financing to grow. Now that you have a basic understanding of the types of loans available, the types of lenders, and the things that you need to qualify, youâre ready to get started with your application so that you can get your business the help it needs.