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A business loan can provide the money you need to expand operations, cover daily expenses, and purchase equipment or inventory. If you have never applied for a business loan, you may not be sure where to start or what documents are needed.
Here’s a simple guide that walks you through the process of evaluating your options and preparing your business loan application in five easy steps.
1. Decide why you need financing
There is more than one type of small business loan. Determining why you need financing will help you choose the right type of loan. Here are some common scenarios:
- Buying new equipment Some lenders offer equipment loans. This type of loan is designed to help you purchase business equipment, such as machinery or office furniture. The loan is secured with equipment, so that the lender can forfeit it if you fail to repay the loan.
- Borrow a small amount of money. If you need to borrow a small amount of money, consider applying for a small loan. The US Small Business Administration (SBA) has a Microloan program that allows qualified applicants to borrow up to $50,000. In addition, there are non-profit organizations that provide micro-loans, such as Kiva and the Women’s Microfinance Initiative.
- Establishing a business. Since most lenders have a minimum time to business, it can be difficult to find a loan that will give you a loan to start a new business. If you are just starting out, you may have to apply for a small loan or business credit card. You may find it easier to qualify for a business credit card than other types of business loans as approval depends on your personal credit score.
- Pay for daily operations. A working capital loan — a short-term loan used to cover everyday expenses, such as rent and payroll — can help you cover temporary cash flow problems.
- Borrow money based on need. If you don’t know the exact amount you need to borrow, a business credit line may be a good option. Once the lender issues you a line of credit, you can withdraw money up to a certain amount to cover business expenses and pay interest only on the amount you borrow.
2. Check your eligibility
Although business loan requirements vary, here are four things lenders are likely to consider when reviewing your small business loan application:
- Balance level. When you apply for a business loan, the lender will review your personal and business credit scores. It helps the lender assess the likelihood of repaying your loan. In general, the higher your credit score, the higher your chances of being approved for the loan and getting a lower interest rate.
- Guarantees and/or personal guarantees. Some lenders require you to pledge collateral — something of value, such as equipment or inventory — that you can seize if you default on the loan. Some lenders may also require a personal guarantee, which means that you have to secure the loan with personal assets, such as your savings, your home, or other valuable possessions.
- time at work. A traditional bank typically requires the business to be in operation for at least two years, while an online lender typically requires only one year. If you’ve been running your business for less than a year, don’t be discouraged. Some online lenders will only approve qualified applicants who have been in business for six months.
- annual revenue. Your total annual turnover is also an important factor. Before applying, ask the lender about the requirements and review your business finances to see if you meet them.
3. Compare Commercial Lending Options
There are many places where you can find small business loans. Here are three of the most common types of lenders.
Online lenders offer a variety of loan products for small business owners, including term loans, cash advances to merchants, lines of credit, and small loans. Loan approval rates were higher for online lenders than for traditional banks as of 2019 — 80% versus 74%, respectively — according to the 2019 Small Business Credit Survey by the Federal Reserve.
One reason for this is that online lenders often have less stringent requirements than traditional banks. As a result, you may find it easier to get approved for a business loan from an online lender if you have less than excellent credit. In addition, online lenders often have a faster turnover – some may issue funds as soon as possible on the same business day.
However, the main downside to getting a business loan from an online lender is that they often charge higher interest rates than traditional banks.
Related: Average Business Loan Rates: What Will You Afford?
Traditional banks offer many of the same types of business loans that online lenders offer. The main advantage of applying for a small business loan from a bank versus an online lender or microlender is that it usually offers low rates to well-qualified applicants.
A disadvantage of applying for a business loan from a bank is that they often have stricter eligibility requirements. If you have a poor personal credit score (FICO score less than 580), you will likely have a hard time qualifying without a signer – someone who agrees to repay the loan if you fail to meet your repayment obligations.
Conventional banks may also not be the best option if you need quick access to funds — applicants have been more frustrated with long waiting times, according to a 2019 SBCS survey. For example, processing SBA loans through a bank can take several weeks to months.
Microcredit institutions are usually nonprofit organizations that issue small loans of up to $50,000 to qualified applicants, often designed to provide financing to business owners who do not qualify for traditional business loans. Microcredit institutions usually have less stringent eligibility requirements.
For example, the microlender Kiva does not have a minimum credit score requirement. Instead, it approves applicants on the basis of “social capital”. To qualify, you must get a certain number of people to lend you money through the Kiva platform before your loan application becomes public on their website.
Related: Business Loan Calculator: Estimate Your Payments
4. Gather the required documents
Once you understand your lending options, gather the required documents. The lender is likely to require these items:
- Personal and business tax returns
- commercial licenses
- Personal and commercial bank statements
- Profit and loss data
- Financial Statements
- Action Plan
- Building rental contract
If you are not sure what documents are required, contact your lender before applying.
5. Submit your application
The final step is to submit your small business loan application. Depending on the lender you decide to work with, you can do this online or in person.
Here is some information a lender may request:
- your name
- Trade Name
- Social Security Number (SSN)
- Required loan amount
- The purpose of the loan
- Business tax ID
- annual revenue
Once you submit your application, you will have to wait for the approval decision. If your loan is approved, the lender will send you a loan agreement to sign before issuing your money or a line of credit from which you can draw.
Frequently asked questions (FAQs)
What credit score is required for a business loan?
Because lenders have different eligibility requirements, the personal credit score you need to qualify for a business loan varies. However, minimum credit score requirements may range from 500 to 680.
The business credit score needed to qualify also varies from lender to lender. Additionally, it depends on the type of loan you are applying for and the degree of business credit the lender is using. For example, when it comes to SBA loans, you will usually need a business credit score of at least 155 to pass the SBA pre-screening process. However, most lenders set minimum requirements for scores between 160 and 165.
How can I get a business loan without cash?
Although most lenders have annual revenue requirements, it is possible to obtain a business loan if your business does not have any money. Some lenders do not provide document business loans – loans that do not require business income verification. To qualify, you will likely need to have excellent credit and provide a personal guarantee.
Can I get a business loan with bad credit?
Although you will likely find that it is difficult to get approved for a small business loan with bad credit, it is possible. Some lenders specialize in offering business loans to borrowers with poor personal credit scores. However, if approved, the lender will likely charge you a higher interest rate.
To receive a lower interest rate and boost your odds of being approved, consider applying with a co-signer who has a good credit score (at least 670, according to FICO) and a decent income, if possible. A co-signer is someone who agrees to repay your loan if you default. Before you ask someone to sign for you, make sure they understand that a missed payment can cause damage to their credit.