What is a Small Business Loan?
A small business loan is a type of financing facility offered to small businesses by commercial banks and other lenders.
Small businesses can use this debt financing to fund their operations or startup costs. These loans are particularly useful for entrepreneurs looking to finance their startup ideas.
Common types of small business loans include:
- Term loans
- A line of credit
- Factoring or receivable loans
- Working Capital loans
- Merchant loans
- Credit cards
- Equipment loans
- Financial or operating leases
These loans come from a variety of lenders, and borrowers can use them for funding the business growth with various effects.
A small business loan can be used for any expense related to the business and can even be used for repaying another loan, also known as refinancing.
How Does a Small Business Loan Work?
As a small business owner, you can get primarily two types of loans. Either a fixed-term loan or a revolving line of credit facility.
You’ll also need to convince a lender of how much you need and where you want to spend it. A lender will also be keen on whether you can repay the loan and interest charges on the borrowed money.
Some common uses of small business loans include:
- Providing startup costs
- Equipment and machinery purchases
- Operational expenses
- Property purchase or lease
- Inventory purchases
- Business expansion
- Marketing and sales expenses
- Debt consolidation or refinancing
A small business loan can be used for any business expense or repaying another loan through refinancing as well. However, lenders will not allow the personal use of small business loans even when you operate the business as a sole proprietor.
What Do You Need to Qualify for a Small Business Loan?
Once you know which type of business loan you want and where to use it, you can then prepare to apply for a loan. Here are a few key items you’ll need to qualify for a small business loan.
Prepare a copy of legal business documents including registration, licensing, and incorporation/partnership contracts. Most lenders will ask for these documents to verify the business identity.
A business plan can help you secure debt financing in the early stages particularly. Lenders would want to know where and how will you spend the money and assess your ability to repay the loan.
Lenders will check your business and personal credit scores. It helps lenders to decide on several key factors like loan approval, amount, loan term, and interest rate.
You can expect a small business loan approval with a credit score of 630+.
Lenders will usually ask for financial statements and bank statements for your business. The idea is to assess your monthly and annual revenue.
It shows lenders your ability to repay the loan amount.
Lenders will ask for collateral in most cases when you apply for a term or secured loan. If your business/personal credit score is bad, you’ll need to back it with collateral too.
Some lenders may ask for personal guarantees for a small business as well.
Where to Get a Small Business Loan?
Small businesses have several options to look for debt financing depending on what type of loan they want and their creditworthiness.
Commercial banks offer readily available debt financing products to small businesses. However, their lending criteria and restrictions mean only a few can qualify for these loans.
Banks Backed by the SBA
If you’ve achieved a good credit score and can qualify for commercial bank loans, go for it with SBA loans. The small business administration (SBA) offers lower interest rates and extended loan terms but stricter qualification criteria.
Private online lenders provide flexible debt financing options. They usually do not require collateral and high credit scores.
However, they charge higher interest rates and loan fees as compared to commercial banks.
Peer-to-peer (P2P) lenders act as facilitators between lenders and borrowers. These loans come with flexible qualification criteria but higher interest rates which you can expect from private lenders.