How to Get a Small Business Loan in 4 Simple Steps

How to Get a Small Business Loan in 4 Simple Steps

Compare Small Business Loans


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You can apply for a small-business loan through either a traditional lender, bank or credit union, or an alternative lender like an online lender. Traditional lenders will likely offer the cheapest and most attractive terms, but they are also difficult to qualify with. Online lenders, on the other hand, will offer most expensive loans but are far easier to qualify with and can typically process your applications much faster. Because getting a loan can be so complex, we've constructed a full guide to show you how to apply for a business loan.

Step 1: Determine the Right Loan Type

There is a large variety of small-business loans available and each serves a unique purpose. There is no one-size-fits-all model, so you'll have to determine which loan is right for your business. There are too many forms of niche financing for us to list them all, but we've compiled a view of the most common small-business loans below:

Term Loan
  • Lump sum amount loaned out with interest payments and repayment plan that begin immediately
  • For large purchases where it'll be advantageous to spread a large payment over a course of months or years
  • SBA loans are generally the most competitive term loans
Business Lines of Credit
  • Revolving line of credit that only incurs interest payments when used
  • For regular medium-sized expenses like payroll or ongoing projects
Business Credit Cards
  • Smaller revolving lines of credit that usually only incur interest payments when used
  • For small, daily expenditures like office supplies or dinners with clients
  • Often offer rewards or cash-back programs
Invoice Factoring
  • Businesses sell outstanding invoices at a discount for cash upfront
  • For businesses that may not qualify for other small-business loans and still need cash fast
Merchant Cash Advance
  • Upfront financing (like a standard cash advance) where the advance is repaid with a percentage of the business’s daily sales
  • Ideal for businesses that accept payments through cash, checks or credit cards (as opposed to invoices), have high sales volumes, need funding quickly or may not qualify for a traditional bank loan
Micro / Personal Loans
  • Lump sum amount loaned out with interest payments and repayment plans that begin immediately
  • For smaller purchases where it'll be advantageous to spread a payment over a course of months or years
Equipment Financing
  • Flexible loans for large pieces of machinery and equipment
  • Because the equipment you buy usually acts as collateral for the loan, equipment loans are more flexible and easier to qualify for than standard small-business loans

Step 2: Find the Right Lender

After you decide what small-business loan type is right for your business, you'll be able to narrow down on the number of lenders you'd like to borrow from, as not every lender offers every type of loan. The lender you borrow from is almost as important as choosing the right loan.

If you want a quick answer, here is our list of recommended small-business loans.

Traditional lenders vs. nontraditional lenders

Getting a business loan has never been easier. Traditional lenders like banks and credit unions have long dominated the market, but they've often been very difficult to qualify with especially since after the 2008 recession. However, the recognition of the underserved market of small businesses has led to a boom of online lenders. These lenders typically have higher fees and rates but much more lenient requirements.

Our advice is to first apply for a loan from a traditional lender, as they will often offer the best rates. If you don't qualify, try an online lender. Use the methodology below to determine which online lender you should borrow from, but we'd generally recommend using an online lender as a second choice after trying out traditional lenders, unless speed of funding is a major issue as traditional lenders can often take longer to process applications.

What to keep any eye out for

Application requirements: First and foremost, take a look at the requirements each lender sets. These requirements should be clearly spelled out. If they're not, we don't recommend applying.

These requirements are going to be the most immediate barriers of entry and help further narrow down your list of lenders. Before taking a look at these application requirements, we recommend having the following basic information handy:

  • Personal credit score
  • Age of business
  • The length of time that your business has been profitable
  • Annual revenue and cash reserves

Each lender will have different requirements, but these are the most basic things that lenders will look for.

Transparent fees and rates: There has been a recent trend among some online lenders to use fees and rates that make apples-to-apples comparisons difficult. For example, most lenders should use a standard APR to describe their rates. A few lenders might use something like an “AIR” or “factor” rates, which are different and not easy to convert to APRs. This practice is to disguise the true cost of their loans. If a lender does this and won't be clear about the cost of their loans in APR format, we don't recommend borrowing from them.

Loan amount and terms: Before you begin shopping around, we recommend having a sense of what you'd like the loan to be. The best way to do this is to have a dollar amount in your head, how long you'd like to repay that loan and how often you think you'd be able to repay this. Lenders vary widely based on these three details.

Generally, you don't want to request more than 10% of your company's value. For example, if your company is worth $100, you don't want to request a loan of $500. No reasonable lender would accept that and you would've just wasted valuable time on an application.

Step 3: Get Ready to be Evaluated

While there is no standard set of criteria when evaluating an applicant for a small-business loan, both traditional and alternative lenders will look at your ability to pay back the loan in a timely manner.

General Information

One of the most important things that lenders will want to see, especially from first-time borrowers, is a solid business plan. Being able to properly discuss your business and its plans for the future with accurate projections helps reassure lenders that the capital will be put to good use and that repayment is something you have carefully considered and planned for.

In addition, banks want to see preparation. Few things are worse than an application being delayed because you don't have your documents in order. In fact, we recommend having the following documents ready so you don't have to scramble at the last minute to gather them.

  • Social Security numbers and your company's tax identification number (EIN)
  • Both personal and business tax returns
  • Your resume
  • Personal and business bank statements
  • Relevant operating licenses
  • Any business legal documents

In this case, it's always better to overprepare than under.

Financial Information

Lenders will be looking at your company’s financial information to determine its ability to pay back the loan on a timely basis. Lenders look at what is known as a company’s debt-to-income (DTI) ratio. This figure is expressed as a percentage and is determined by dividing the total recurring monthly debt by gross monthly income. Most traditional banks will want personal and business DTIs to be below 33%-35%.

Whether lenders only look at your bank statements or want more detailed financial statements, it is important to have clear and accurate accounting practices. Traditional banks will want strong revenue, cash flow and profitability. One tool used to measure your ability to repay is the debt service coverage ratio (DSCR). Most traditional banks will look for a DSCR of at least 1.1, but more typically 1.25 and above (anything under 1 denotes negative cash flow). To determine your company’s DSCR, you will first need to calculate your company’s net operating income (also usually available from your company’s income statement), then divide it by the total debt service.

Net Operating Income = Operating Revenue – Operating Expenses

Total Debt Service = Proposed Annual Loan Payments

DSCR = Net Operating Income ÷ Total Debt Service

Step 4: Apply for Loans

Once you're ready to apply for a loan, there are a few things to keep in mind. First, determine if the application will trigger a soft or hard credit pull. Most applications will only trigger soft pulls and shouldn't affect your credit score. However, there are a few lenders out there who will perform hard pulls, which can negatively impact your score. If your application only triggers a soft credit pull, and there aren't any penalties to applying for multiple loans at once, we'd fully recommend applying to multiple lenders.

Second, compare your options carefully using a standardized cost metric. If you're comparing loans from traditional lenders like banks or credit unions, you're in luck, as most loans from those lenders are usually standardized by APRs. However, many online lenders use unique metrics that make comparisons tough. We convert loans into costs-per-dollar borrowed to make comparisons easier.

Try asking your lender what the APR of your loan is, since that's the most universal and comprehensive measure of the cost of a loan. If the lender fails to comply, you'll either need to walk away or perform a conversion yourself, which we don't recommend because it really isn't simple.

Additionally, a lender refusing to convert the cost of your loan to an easy-to-understand APR could be a sign that its trying to disguise the true cost of a loan. We don't recommend working with such lenders since that typically foreshadows larger problems you'll have down the road.

Once you're able to compare your loans side by side, consider the following:

  • How large is each loan? Is it enough for your specific need?
  • How expensive is each loan?
  • How frequently are your repayments? Does the repayment schedule work with your cash flow?
  • How long is the term of the loan?
  • Were you approved for the loan type that you were looking for?

How to Get a Small-Business Loan with Bad Credit

As mentioned above, lenders will be looking at your personal and business credit history and credit score. Traditional banks will usually want applicants with scores between 700 and 800, while alternative lenders can work with applicants with scores of approximately 650 and up, though some online lenders may require a credit score as low as 500 or have no minimum credit score requirements. Loans with minimal credit score requirements also tend to be the most expensive. If you absolutely need funding and think that you still come out ahead despite the high fees, we'd recommend using bad-credit loans to boost your business and to better your credit score. Use the loan as a stepping stone, improve your borrower profile to be able to qualify for better small-business loans, and benefit from cheaper rates.

If you don't absolutely need funding now or think that the fees are too high for your business, you can use the time to improve your credit score. There are various methods to improve your credit, you'll soon be in a much more competitive position for better loans.

Moving On to Your Next Loan

Again, it is absolutely imperative that you form a solid business plan and stick to it. Without a plan, you likely won't be maximizing the benefits of the loan. Be sure you understand what the loan will be used for, how much you need and what your projected returns will be.

Also, the term of your loan can be thought of as a test for your next loan. Generally, loans following your first loan are easier to apply for because lenders now have history to reference to see how you behave as a borrower. Do you make your payments on time? Do you have any liens or defaults? Did you breach any agreements?

When you shop for a new loan, ensure you don't have an active lien, which is like a public declaration that you owe somebody money. First speak to your current lender to see if you get any discounts for subsequent loans. No matter what the response to that question is, we fully recommend still shopping around. Even with a repeat customer discount, other lenders might be able to offer cheaper loans.

Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.