Loans for small businesses are used for business expenses. Some loans are for general business funding, and others, such as real estate loans or equipment financing, are for specific uses.
Small-business term loans offer lump sums that borrowers pay back with interest over time. But you can select from a variety of business loan types and should research your options to find the best fit.
You can consider multiple types of small-business loans:
SBA loans. The SBA backs loans from lending partners through its 7(a), 504 and microloan programs. This backing reduces risk for lenders and can improve access to capital for small businesses. The SBA also provides direct loans when it issues a disaster declaration, such as following a hurricane.
Term loans. A business term loan delivers a lump sum with a fixed term and repayment amount. Each payment includes principal and interest.
Business lines of credit. Business lines of credit are similar to credit cards and can be used for expenses such as purchasing inventory and managing seasonal sales fluctuations. You can borrow from your credit line as needed and only pay interest on the amount you use. Business lines of credit can be unsecured or secured, meaning they are backed by collateral.
Equipment loans. Equipment financing can be used to spread out the cost of machinery or other equipment purchases. Financing options for equipment include term loans, business equipment loans and SBA 504 loans. The equipment may be collateral for the loan, or there may be personal guarantee requirements.
Invoice financing. If your small business struggles with cash flow because you’re waiting on invoices to be paid, you can use invoice financing, also known as accounts receivable financing. With invoice financing, a lender funds your unpaid invoices at a discount.
Merchant cash advances. With a merchant cash advance, the lender provides you with a lump sum, and you generally have between three and 12 months to repay the loan. The lender collects payments either as a cut of your sales or with fixed daily or weekly transfers from your business bank account. The eligibility requirements are low, but merchant cash advances are also an expensive way to borrow.
Real estate loans. A commercial mortgage is a term loan used to buy, develop or refinance commercial property, such as a warehouse, office building or retail center.
Franchise loans. These loans can help with standard business opening expenses and franchise-specific costs, such as marketing fees or the franchise fee, which you pay upfront to open a franchise. Some franchisors may offer funding to help you establish your franchise.
The SBA partly guarantees loans made by approved lenders and provides direct disaster assistance loans. Federal backing aims to reduce risk for lenders and help small businesses get loans. Here is more information about the SBA’s loan programs:
7(a) loan program. 7(a) loans are the most common type of SBA loan. The SBA’s 7(a) loans can be used for business expansion, equipment purchases and many other purposes. Borrowers apply through participating lenders and typically repay loans in monthly installments. Standard 7(a) loans can go up to $5 million, and the SBA can typically guarantee up to 85% of loans up to $150,000, and up to 75% of loans greater than $150,000. There are also special 7(a) loans for short-term capital needs and export activities.
Microloan program. New or expanding small businesses can apply for microloans of up to $50,000. These loans can be used to fund working capital, inventory, equipment, furniture, supplies, fixtures or machinery. Borrowers cannot use microloans to pay debts or buy real estate.
504 loans. This SBA loan program provides businesses with long-term, fixed-rate financing for qualified major assets. The maximum loan amount is generally $5 million, with 10- or 20-year repayment terms. It’s possible to receive up to $5.5 million on up to three qualified energy projects.
Disaster loans. Businesses may apply for low-interest disaster loans directly from the SBA to cover physical damages or to pay for projects that will protect their businesses from future disasters. The SBA also offers economic injury disaster loans in declared disaster areas to cover working capital and normal expenses, such as rent, utility payments and fixed debt payments.
The SBA says most businesses are eligible for SBA assistance, but the agency does have requirements. To qualify for a 7(a) loan, your business must meet standards including that it:
- Operates for profit.
- Does business in the U.S. or its territories.
- Has an owner with reasonable equity to invest.
- Has received other funding, including personal assets, before seeking a loan.
Keep in mind that lenders offering SBA-backed loans also have qualification requirements.
Pros
- Large loans are available. Loans for small businesses can offer large amounts of financing.
- Get funding without losing equity. Small-business loans can provide you with the money needed for your business without having to give up any equity to investors.
- Have flexibility. Many small-business loans can be used for a variety of business needs.
Cons
- Significant documentation required. Small-business loan applications can require a great deal of documentation, which may make the process lengthy.
- Limited options with bad credit. Small-business loan applications are based in part on credit, and there are few loan options for businesses with bad credit.
- May require down payment, collateral or personal guarantee. You may need cash upfront to make a down payment, and you could lose your collateral if you default. A personal guarantee can put your personal assets on the line.
You can get a small-business loan anywhere from a brick-and-mortar bank or credit union to an online lender. Here’s what you can expect based on your choice:
Banks and credit unions. They typically serve more well-established small businesses. You may have an easier time getting funding from a traditional bank if a loan has SBA backing. Approval could also be easier if you have a relationship with a lender, such as a business bank account.
Online lenders. Their products can be similar to what banks and credit unions offer, but they exist without physical branches and can offer more flexibility than commercial banks because their loan products are less regulated. Alternative lending from online companies can help borrowers who otherwise may not have access to small-business financing, such as startups or businesses with shaky financial histories. Online lenders may offer SBA loan programs. You can also find peer-to-peer lenders online that will connect your small business with investors willing to fund your loan.
To get a small-business loan, you must convince the lender that your business is worth the risk. Your eligibility will depend on factors including how much your business needs to borrow, your credit and your business plan.
- Determine how much funding your business needs and can afford. You can figure out the loan amount your business can afford by calculating your debt service coverage ratio, a measurement of your firm’s cash flow compared with its annual debt obligations. For example, if your annual net operating income is $135,000 and your total debt is $100,000, your DSCR is 1.35. If your DSCR is 1, this means your net operating income and annual debt are the same. A DSCR above 1 provides a bit of a buffer.
- Check your credit score. Lenders often consider your personal credit, especially with startup financing, but your business credit score may be used if you have one. “As a sole proprietor, your personal credit may be considered in the business loan application if you are using personal credit to secure the business debt,” says Rod Griffin, senior director of public education and advocacy for the credit bureau Experian. “Doing so is fairly common for a small-business owner.” The minimum credit score required for approval varies, but generally, the higher your credit score, the better your loan terms.
- Draft a strong business plan. A comprehensive business plan sets a solid foundation for your small business. Lenders will want to see your estimated costs and projections for revenue, as well as balance sheets for at least two years.
Can You Get a Business Loan With Bad Credit?
Bad credit business loans are available, but your options may be limited. Minimum credit score requirements depend on the type of loan and the lender. If you have a poor credit score, you may be ineligible for traditional small-business loans and need to consider alternatives such as merchant cash advances.
Expect to pay higher interest rates, and expect your business plan and your revenue to face more scrutiny. Also, understand that you may not be able to borrow as much as a small-business owner with good credit.
Small-business loans require significant documentation. You’ll need to apply and then provide supporting information, which can include:
- Your resume.
- Your business plan.
- Personal and business tax returns.
- Details of other business debt.
- Personal and business bank statements.
- Documents showing the value of personal or business property that can be used to secure the loan.
- Legal documents, including licenses, leases, articles of incorporation, and contracts or agreements.
Evaluate eligibility requirements, loan options, costs and customer service to choose the best small-business loan. Focusing on these factors will help you to identify a lender that can approve your loan with acceptable terms and offer good customer service.
Knowing your chances of loan approval can save you time. When researching small-business loans, look for minimum credit score, years in business and revenue requirements.
Small-business financing options vary widely and can serve different purposes. As you shop around, consider whether each lender’s offerings meet your needs. Find a company with the type of loan you’re looking for, such as a term loan or line of credit.
If a lender doesn’t offer loans in the amount you need and can repay, find one that will. Settling for a lower amount could leave you unable to address all of your needs.
Your loan’s repayment term is the time frame you have to pay back the loan. With a shorter loan term, you will typically have higher monthly payments but pay less in total interest because you have the loan for less time. The opposite is also true. A longer repayment term could mean lower monthly payments but more in total interest charges over the life of the loan.
Keeping loan costs minimal allows you to invest profits back into your business and not back to the lender. Look for a lender with the lowest costs, including APR or factor rate. Be sure to evaluate fees, such as origination fees and closing costs. Depending on the kind of loan you’re getting, you may also need to consider the down payment.
- Personal loans. Some personal loans are based on credit history and may not provide as much funding as small-business loans.
- Family loans. If family members are able, you might ask them to loan you money for your business. Family loans can save you money on interest, but they should still include a clear repayment plan.
- Crowdfunding. Crowdfunding allows you to raise money online from a large number of people. In exchange for providing financing, crowdfunding contributors may expect rewards or equity.
- Grants. There are numerous grants available to small businesses, some of which target specific sectors or specific needs.
U.S. News conducted an in-depth review of the best small-business loan companies to recommend the best business loans from traditional and alternative lenders. Factors including customer service ratings, product availability and loan terms were used to select the best small-business loan providers.
These lenders are a good starting point for most businesses. But there is no one-size-fits-all loan that is perfect for every business, so you should carefully research each small-business financing option yourself.
Your business must meet these general SBA loan requirements, including:
- Operate for profit.
- Do business in the U.S. or its territories.
- Have reasonable invested equity.
- Explore alternatives, including using personal assets, before seeking a loan.
It’s possible for a startup to receive a business loan; however, it will be more difficult than compared to a more established business.