How to get a small business loan

This article is part of our How to start a business playbook, which covers topics like finding the right business idea, writing a business plan, and finding small business loans. 

When you’re starting or growing a small business, one of the most important considerations is how you’ll cover expenses. Unfortunately, a large percentage of businesses fail within the first five years due to cash flow issues. A large part of the problem is getting paid at the right time, at the right speed, which is what makes it so tricky to build a healthy cash flow. After all, when expenses come due, you need funds on hand to be able to pay them.

Whether you’re just getting started or have been in a business for a while, a small business loan is one of the ways you can balance cash flow, cover your costs, and invest in growing your business. A business loan is an amount of money lent to you by companies that you’ll need to repay, along with interest and fees. 

In this guide, we’ll talk about:

• Determining if you really need a loan and if your business qualifies for one
• Understanding your options when it comes to lenders and types of loans
• What to expect during the loan application process

How do business loans work? 

First things first: Let’s go over key terms and define what a business loan actually is so you know what you’re getting into.

An important term to know is “lenders.” Lenders are individuals, companies, or financial institutions that (surprise surprise!) lend money to businesses. This money is expected to be fully paid back, along with interest and/or fees. 

A “loan” is the money you borrow from the lender; it’s a form of debt. There are many different types of small business loans, each with their own requirements, conditions, and repayment terms. 

You need to a) qualify for a business loan and b) apply for a business loan in order to get one. Before lenders agree to give you a loan, they’ll evaluate your income and cash flow, both your personal and business credit scores, debt, collateral, and financial documents. They want to cover their butts, too! 

What are the different types of business loans? 

Once you understand how business loans generally work, it’s time to look into your options for small business loans. There are many different types of loans available to businesses—from government loans to working capital loans to franchise startup loans. Which loan you choose will depend on:

• Your business
• Your funding needs
• How you’ll use the funding
• Which lender you choose

Let’s go over some of your options!

Small Business Administration (SBA) loans 

If you’re doing business in the United States, you can access loans from traditional lenders that are guaranteed by the U.S. Small Business Administration (SBA). The SBA itself doesn’t lend money. Rather, the administration works with lenders to set business-friendly guidelines for loans—reducing risk for lenders and making it easier for small businesses to get approved.

SBA loans come with some additional requirements your business must meet, but they’re more accessible to business owners with less-than-stellar credit scores or little-to-no collateral (other assets used to secure a loan). The SBA currently offers four types of loans. These are the three most important ones:

7(a) loans 

The 7(a) Loan Program is the SBA’s flagship program. You can use (7)a loan money for almost any purpose if you’re a for-profit business. The basic idea is that the SBA guarantees these loans, so lenders are able to offer more flexible options, longer repayment terms, and larger amounts of money. 7(a) loans are great options for long-term financing and improving your cash flow. These loans can range anywhere from $500 right up to $5.5 million.

Microloan

Typical banks operate as for-profit organizations, so they’re more inclined to lend larger amounts of money that lead to the most profit for them. With SBA microloans, you can access a smaller amount of money that keeps the interest you owe low and the repayment terms more manageable. These loans vary in amount, between $5,000 and $50,000, but the average SBA microloan is about $13,000. 

You can use microloans for almost any business expense except debt repayment and real estate. If investors are involved, you might need to vouch for yourself and your business in order to secure the loan. Microloans also need to be paid back over a specific period of time. 

Nonprofit lenders also provide microloans, which are a good option if you’re a new or underserved business owner! 

Real estate and equipment loans

For larger expenses like real estate and equipment, the SBA offers the CDC/504 Loan Program. You can use 504 loans to buy a building, land, or machinery; build or renovate facilities; or refinance debt resulting from a business expansion. Their chief benefit is that they’re long-term loans with a fixed interest rate, and you can borrow up to $5.5 million.

Working capital loan

A working capital loan is a revolving credit line, which means you can borrow money up to a certain amount (the “credit limit”). Once you repay a portion of the money you’ve taken out, the amount of money you can borrow gets replenished. 

Basically, you gain access to a certain amount of capital, but you only withdraw it as needed. As you withdraw, you only pay interest on the money you take out—not the entire amount available to you.

Working capital loans can speed up your cash flow—especially if you’re faced with any sudden or unexpected expenses—and can be used however you’d like, including to cover operating costs as you grow revenue. 

They’re a great option if you need to get funding quickly, but know you’re able to pay it back within a shorter amount of time. They can be invaluable if it takes longer to turn a profit than you expect, but also tend to come with higher interest rates and shorter repayment terms.

Business factoring loan 

If your business offers length payment terms to customers (for example, letting them pay an invoice within 30 days, rather than right away), you can get a loan from a “factoring company” for the value of your outstanding invoices. This is a process know as invoice factoring. The money is repaid as the invoices come due, plus a fee. Much like a cash advance, this type of loan can have interest rates as high as 30%.

You can usually get your money as a lump sum within one or two business days, and use it for whatever you want. 

Business term loan 

Like working capital loans, business term loans are super flexible: you can use them for whatever operating costs you want. You receive the money as a lump sum (one big payment, rather than smaller installments), which you then pay back in installments over a determined period of time. 

While working capital loans are a better option for unexpected expenses, business term loans are better for expenses that are already on your radar, like monthly payments. Business term loans can also be a great way to improve your credit score.  

Merchant cash advance loan

This type of loan is essentially an advance on future credit card sales you expect to make. The loan amount is based on your typical monthly credit card transactions, and repayment comes out of future transactions.

Like working capital loans, though, these can come with sky-high interest rates. The amount of credit card sales you end up making affects when you’ll pay back your merchant cash advance loans…. Which means you’ll end up paying more interest if it will take longer for you to repay them. That’s why merchant cash advance loans are better if your business regularly receives a lot of credit card transactions. 

Equipment loans

If your business requires you to make large equipment purchases, an equipment loan makes it easier for you to make those upfront purchases while stretching out the repayment over time. These are also one of the easiest loans to get.

Professional practice loans

Designed for professional services businesses, this type of loan can help you cover the cost of buying a practice or real estate, refurbishing office space, or refinancing other debt. These are typically used in healthcare, accounting, legal, and insurance fields.

Franchise startup loans

Just as it sounds, this type of loan covers the startup costs of opening a franchise. Whether you need working capital or upfront funds to pay franchise fees, buy equipment, or build a store, a franchise startup loan will cover it.

Do you need a small business loan?

How do you figure out if a small business loan is right for you? The first step is to assess your expected costs. How much funding will you need to set up the business (from registering your business to hiring employees to renting a retail space)? The average small business owner needs about $10,000 to get started, but that can vary widely from one industry to the next.

If you have a business plan, then you’ve probably already created a strategy for your business’s finances and may already have an idea if you’ll need to take out loans. 

If you haven’t, here are some steps to take to determine if you’ll need financial support from a loan: 

• Write down each cost your business is expected to incur over a set period, and then add them all up. This will help you determine what you need the loan for and how much funding you need. 
• Once you have an idea of your initial startup costs, consider how long it will take for you to break even and turn a profit. 
• You’ll need enough funding to cover regular operating costs (like website hosting, purchasing inventory, and payment processing fees) during this time, so add that amount into your total startup costs. 
• After establishing your initial startup costs, it’s also important to forecast ahead—as far as five or 10 years. This can help you anticipate your cash flow and plan for big expansions, and determine when and why you’ll need to take out further loans. 

For some businesses, that might be an awful lot of money—much more than you have in your rainy day savings account. Depending on the type of business you’re launching, there may not be so many upfront or standard operating costs. For example, a freelance writer’s startup costs might be less than $100. If that’s the case, you likely don’t need a small business loan (at least not right now.)

How to qualify for a small business loan 

Now that you’ve established your business actually needs a loan, let’s find out if you’re likely to qualify for one. Every lender has their own set of requirements that businesses must adhere to get approved for a loan, but there are some common threads throughout most of the lending industry.

A good credit score

If you’re launching your first business, lenders will look at your personal credit score. They’re looking to see how you manage debt and how reliable you are about paying it back. Anything over 690 is typically considered a “good” credit score. If your FICO score (used to determine how likely you are to pay bills on time) isn’t looking so hot, try Experian’s tips for improving your credit score before you apply for a loan.

Years in business

This is where many new businesses get stuck. Lenders want to see a history of business success, so it’s often harder for brand new businesses to get a loan. This means it’s more difficult to get a loan if you haven’t been in business for at least a year or two. But that doesn’t mean startups can’t get one. Strong experience within the industry can make up for a fledgling business.

Strong business revenue

Again, a tough one for startups and new businesses to achieve. Most lenders will want your business to have strong business revenue—between $50,000 to $250,000. 

If you’re just getting started, highlight your revenue growth, instead of the total amount—lenders want to see you’re on track for success.

Ample collateral

In the event that your business fails for any reason, lenders want to ensure they can get all or at least part of their money back. That’s why having collateral (like real estate or machinery) makes your loan application more attractive to lenders.

Every lender has unique requirements for small businesses to get approved for a loan. If you don’t meet all the requirements above, don’t fret—some banks and most alternative lenders are flexible.

If you don’t meet any of the requirements, a business loan may not be right for your business. If that’s the case for you, look into some of these other small business financing options:

• Business credit card
• Personal loan
• Crowdfunding

How to apply for a small business loan 

Once you’ve decided what type of loan is best for your business and where you’ll get it, it’s time to prepare your application and figure out what to expect during the loan application process.

Step 1: The documents you’ll need to prepare 

The first step is to gather all of the documents and information you’ll need to submit along with your loan application. These documents give the lender a look into your business, financial, and personal history—helping them determine if you and your business are a good candidate for a loan. Here’s an overview of all the information you should have ready for the lender to look at.

Business information and legal documents

Before giving you a loan, lenders want to understand what your business is, where you came from, and what you do. They want an overview of your business and your history as a business owner. They also need to know how your business is set up since that can affect the type of loan you qualify for.

Here’s what business information and legal documents to prepare:

• Your business and personal credit scores 
• Your business bank account statements 
• Tax returns for your business and personal tax accounts 
• Business overview and history
• Business licenses, incorporation documents, and franchise agreements
• Business address, contact information, and tax ID

Financial documents and history

Arguably the most important part of your business loan application is the financial information. Your business’s financials are where lenders spend the most time and they’re an integral piece of lenders’ decisions.

How does your business make money? How do you manage that money? Are you profitable? If not, when will you be? Lenders want all these answers and more, so they’re looking for your:

• Financial plan
• Business and personal income tax returns (for at least the last three years)
• Profit and loss statements
• Cash flow statements
• Balance sheets
• Financial projections

Personal information

Contact information is important for obvious reasons, but that isn’t the only personal information lenders need. They’re also looking to find out about your personal finances and your relevant experience and education in the industry.

Lenders want to see how you handle personal financial obligations and why you’re uniquely qualified to make your business a success. If you’re just launching the business, your personal history is even more important (because your business doesn’t have any history, financial or otherwise.)

Be prepared to share personal information, such as your: 

• Address
• Education
• Work experience
• Credit score and history

Step 2: The questions you’ll need to answer 

Now that you have all your documents together, it’s time to prepare for the questions a potential lender may ask. The documents you submit include some of this information, but you should also be able to speak to your business plans and financials if the loan officer asks.

Some of the questions to prepare for include:

1. How much money do you need? 

You should have an answer to this question going into the application process. If you’re just launching, it’s likely based on the total startup costs we calculated earlier.

2. How will you use the money? 

Lenders want to understand what you plan to do with the money so they can see how it will improve your business’s financials—and whether you’ll be able to pay back the loan when it comes due. How you’ll use the money also determines which types of loans are available.

3. How will you repay the money? 

The loan officer will want to hear a detailed plan marrying your financial projections with the repayment terms. How will you get the money to repay the loan and interest?

4. What will you do if you can’t repay the loan? 

If your business falls on hard times and you can’t repay the loan, what will you do? Do you have business insurance that can cover your debts? Can you put up collateral to guarantee repayment?

5. What collateral can you offer? 

Speaking of collateral, many types of small business loans require some collateral—especially if you don’t have a proven track record of revenue. The lender will want to know what you can offer as collateral and its value.

6. Explain any blips in your business or personal financial history. 

A loss in your third year of business, a dip in your personal credit score, a late student loan payment… none of these precludes you from getting approved for a loan but the loan officer will definitely want to hear more about what happened.

7. Be able to speak to your expertise and industry knowledge. 

This is extra important for startups and new businesses. Without a proven track record of business success, your personal experience and relevant time in the industry are what must convince lenders your business is a good risk to take.

Step 3: The questions you’ll need to ask

When you’re looking for a small business loan, it can seem like you’re the one who has to impress the lender. That’s true to an extent, but it’s also your job to vet lenders and ensure they’re a good fit for your business. It’s also important to ask the right questions so you can be sure you’re choosing the loan product that works for your business needs.

Here are a few questions you should definitely ask:

1. Do you offer a loan term that fits my needs? 

You know how much funding you need, how you’ll use it, and when you should be able to repay it. Once the loan officer has that information, ask about what loans are available to meet those needs.

2. What are the interest rates? The total cost of the loan? 

Interest rates and repayment terms all add to the total cost of your loan. It’s vital that you have a clear understanding of how much the loan will cost your business (and what your other options might be.)

3. How long does the loan application process take? 

It’s best to know how long the process will take up front, so you can plan your business financials. Not to mention, if you need money yesterday but the lender takes six months to approve applications, you may need to find a different lender.

4. Do you report to the business credit bureaus? 

This is particularly important for new businesses. Just like when you graduate college with zero credit history, your business needs to be deliberate about building up your credit score. If a lender doesn’t report to business credit bureaus, your timely loan repayment won’t contribute to your score.

Consider your lender options 

When you’re ready to apply for a small business loan, you have a few options for where to look. You can get a loan from big banks, local banks, credit unions, or alternative online lenders. Each of these will have their own loan requirements and standard terms, so it’s important to weigh which one is right for you.

Here are a few things to consider:

Big banks

Large, multinational banks are often the first lenders that come to mind. They include banks like TD Bank, JPMorgan Chase, Scotiabank, and Bank of America. Working with a big, well-known bank means you can be confident everything is on the up and up with your financing. Traditional banks loans also tend to carry some of the lowest interest rates available to small businesses.

While their size can be a benefit for you, the borrower, these banks actually have the lowest loan approval rate—greenlighting less than 14.9% of loan applications as of October 2022 according to the Biz2Credit Small Business Lending Index™. Meaning your chances of successfully scoring a small business loan may be small. You should consider turning to big banks if: 

• Your business is two or more years old 
• You have a good credit score
• You don’t urgently need the loan  

Local and community banks

Local banks are exactly what they sound like: small institutions that operate in a relatively small geographic location. That includes the single location bank in your hometown and some smaller chain banks.

Community banks are one of your best options for a small business loan. With approval rates nearing 50%, you’re much more likely to get approved for a loan from a local bank. They still carry the lower interest rate of a traditional loan and the approval process can be quicker and more flexible at these smaller institutions. They might be right for you if:

• You’re in a small geographic area 
• You don’t qualify for big bank loans quite yet 

Credit unions

Credit unions are similar to local banks in their size and loan approval rates (around 42%), but there’s one important difference: credit unions are typically nonprofit. As such, loan interest rates tend to be lower at credit unions, the approval process is often faster, and you can even apply for a smaller and more flexible loan amount.

Most credit unions are staples in their communities—meaning they offer educational resources like workshops, networking events, and other help for small businesses. In short, they’re a great choice if: 

• You’re a new business 
• You need funds quickly 

Alternative and online lenders

When the recession hit in 2011, lending from most traditional banks plummeted, and the rebound has been slow, to say the least. In the wake of this financial reality, online and other alternative lenders sprung up to take their place. Today, alternative lenders approve small business loans at a whopping 60.7% (woo!).

Online lenders are the easiest way to get a loan, and they’re often the most flexible about loan requirements, the approval process, and repayment terms. That said, alternative lenders also charge the highest interest rates, meaning you end up losing out as you pay back the loan amount. Online lenders are a good choice if: 

• You’re a new business 
• You don’t have much collateral
• You need funding, fast 

Moving ahead with small business loans 

A small business loan can offer the funding you need to get started or provide that extra push to take your small business to the next level. Taking out a loan has its pros and cons, and isn’t right for every small business owner—but if it makes sense for you, a business loan can be an invaluable way to grease the financial wheels of your business. 

Be picky and diligent when applying for small business loans. Some red flags to look out for that probably signal a predatory lender: unreasonable repayment terms, loans that sound too good to be true, hidden fees, and fees that are way too high. Ask questions, always read the fine print, and trust your gut! 

Also, be honest with yourself about what loans you can afford to take out. A good rule of thumb is that your income should be at least 1.25 times your total business expenses, including your loan repayment and fees. 

If a loan sounds like something your business needs and you can afford, you have this guide (and us supporting you from the sidelines!) to help you make an informed decision and make it happen. If you want uber-personalized help, you can always book a 1:1 call with a Wave Advisor who can offer you certified and personalized bookkeeping support. They will take a deep-dive into your books and provide you with accounting coaching and financial advice.  

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