Among the many challenges of running a small business is getting a small-business loan. Some entrepreneurs need outside financing to start or grow their businesses and cover day-to-day expenses including payroll and inventory.
Although finding, applying for and getting approved for small-business loans can certainly be difficult, the more prepared you are, the better. Here’s how to get a business loan in five steps.
1. Ask yourself, why do I need this loan?
Lenders will ask you this question, and your answer will likely fall into one of these four categories:
- To start your business
- To manage day-to-day expenses
- To grow your business
- To have a safety cushion
2. Decide which loan is right for you
Your reasons for needing the loan will dictate the type of small-business loan you get.
If you’re starting a business, it’s virtually impossible to get a loan in your company’s first year. Instead, you’ll have to rely on business credit cards, borrowing from friends and family, crowdfunding, personal loans or a microloan from a nonprofit lender.
To manage day-to-day expenses, or working capital (to cover, say, payroll, inventory, rent or other monthly bills) you’ll want:
- a quick, one-time injection of cash that is repaid over a short period of time;
- a line of credit, which allows you to borrow and repay only the money you need (similar to a credit card);
If you want to grow your business by expanding to a new location, adding a new product or service or buying a new piece of large equipment, you’ll want:
- a term loan, a lump sum of cash that requires fixed payments. Your loan shouldn’t outlast the product or equipment you’re buying. For example, if you’re purchasing a new pizza oven that you expect to use for five years, get a loan with a term of about five years.
If you don’t need cash immediately but want a safety cushion, in case of an emergency, you’ll want to get a line of credit or a term loan with the lowest rate possible.
Nerd note: Ideally, you should get a bank line of credit long before you actually need it, says Suzanne Darden, a business consultant at the Alabama Small Business Development Center. That way, you won’t need to scramble for cash when an emergency strikes.
3. Determine the best type of small-business lender
You can get small-business loans from several places, including banks, nonprofit microlenders and online lenders. These lenders offer products including term loans, lines of credit and accounts receivable financing. Below we’ve listed your three main routes to financing.
You should approach small-business loan shopping just as you would shopping for a car, Darden says. Once you determine which type of lender and financing vehicle is right for you, compare two or three similar options based on annual percentage rate (total borrowing cost) and terms. Of the loans you qualify for, choose the one with the lowest APR.
If you have collateral, good credit and don’t need cash fast? Banks.
Traditional bank options include term loans, lines of credit and commercial mortgages to buy properties or refinance. Through banks, the U.S. Small Business Administration provides general small-business loans with its 7(a) loan program, short-term microloans and disaster loans. SBA loans range from about $5, 000 to $5 million, with an average loan size of $371, 000.
Small businesses have a tougher time getting approved due to factors including lower sales volume and cash reserves; add to that bad personal credit or no collateral (such as real estate to secure a loan), and many small-business owners come up empty-handed. Getting funded takes longer than other options — typically two to six months — but banks are usually your lowest-APR option.
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