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All About Getting a First Time Business Loan

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Kevin Brouillard

Kevin Brouillard

Updated July 20, 2021
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All About Getting a First Time Business Loan; Applying for a first-time business loan requires a good credit score, proof of finances (bank statements, tax returns, etc) and more.
Many businesses use financing at some point, whether it’s to help with expansion, to buy equipment, or to address their cash-flow problems. And of course, startups may want funding to help cover the costs of setting up their businesses. But regardless of when a business decides it needs a loan, the first loan may present special challenges.Every business is unique, and there’s no one size-fits-all solution to getting a first-time business loan. And with many possible paths to investigate, it can become overwhelming just figuring out where to start. This guide will break down how to apply for a first-time business loan, what kinds of funding may work best, and what you can expect during the loan application process. 

How Do You Apply for a First-Time Business Loan?

There are many different kinds of loans you may want to look at when you’re applying for a first-time loan. But there are certain basic steps that it’s helpful to take, regardless of the loan type you end up selecting.

Checking Your Credit Score

Before choosing a lender and submitting a loan application, first-time business owners may benefit from evaluating their own financial situations. Figuring out your credit score is a useful preliminary step, since your credit is one of several factors that lenders consider when assessing how risky you are as a potential borrower. From the lender’s perspective, a borrower with poor credit has a higher risk of defaulting on loan repayments. When lenders look at a business owner’s loan application, they may often evaluate his or her personal credit score, rather than look for the business’s score, if the company has even had time to establish one yet. The rating scale for personal credit scores issued by FICO(®) runs from 300 to 850, and VantageScore now uses the same scale.  Credit scores are calculated from an applicant’s payment history, debt owed, credit history, new credit, and credit mix. Many lenders post what credit scores are required for their products. Sometimes, a low credit score can cause a lender to reject your loan application. In other cases, first time borrowers with poor credit scores may have to make larger down payments or put up more collateral to be approved. Checking your credit score may help you get a sense of how a potential lender might see you and what kind of funding issues you may encounter.If you need a business loan for the first time and your business lacks credit history, there are some things you can do to establish a credit score. Getting a business credit card and maintaining a successful record of paying it off each month is one strategy that can help you build credit over time. (To learn more, consider checking out our complete guide to building business credit.) Business owners can also apply for a personal loan to use for business purposes. Even if you’ve got bad credit, startup loans may still be within your reach.

Figuring Out How Much Money to Apply For

Businesses may seek to borrow money for a variety of reasons, including to meet startup costs, pay for expansion, or cover payroll. When you’re applying for a first-time business loan, it can be helpful to identify what the funds will be used for (and some lenders may require it). That’s because businesses may be able to improve their chances for loan approval by providing justification for the amount they’re requesting. For example, obtaining price quotes for new equipment or providing comparable listings for a real estate purchase can demonstrate your preparedness as a first-time business owner and/or borrower, as well as justify your need.

Debt-Service Coverage Ratio (DSCR) and How to Calculate It

Building a case for your business’s needs is just part of the process, though.You may also want to assess how easily you’ll be able to pay that money back. As you do, it’s important to remember that the amount you want to borrow may be only part of your total loan costs. Loans can carry interest, as well as fees, and those should also be factored in when you assess your return on investment. That’s where something called debt-service coverage ratio (DSCR) comes in. Lenders may weigh a business’s DSCR as they make their decisions about offering financing. Similar to the debt-to-income ratio, DSCR measures a business’s ability to pay its debts with cash. Knowing what yours is may not only help you assess how well you may be able to pay off your debt, but also how potential lenders may see your application.DSCR is calculated by dividing the sum of a business’s earnings before interest, taxes, depreciation, and amortization by its current and proposed debt obligations. If this is your first time getting a loan, you may have short-term debt to factor in, such as rental agreements or outstanding credit card payments. Borrowers may need a minimum DSCR to receive a loan. The threshold can vary by lender, requested amount, and current economic conditions. A DSCR below 1 indicates that a business would probably not be able to cover its debt payments in full. Therefore, applicants will generally need a DSCR above 1 to qualify for a first time business loan. For instance, SBA loans require a ratio of 1.15 or greater. 

Gathering Documentation

The requirements for getting a first-time business loan differ by type of loan, lender, and amount requested. In many cases though, businesses have to provide documentation and proof of their finances to demonstrate their ability to pay back a loan. If a business is up and running, these documents could include several months of bank statements, a year or more of tax returns, and/or income statements. First-time business owners may have to show proof of collateral to receive a loan.In addition to these documents, business plans can also play an important role in getting a first-time business loan, especially for fledgling and startup businesses. Business plans can include financial projections and a roadmap for growth. Getting started with a business plan template can help guide the process. 

Types of First Time Business Loans

When it comes to funding types, there are several choices to consider for a first-time business loan. Different types of business loans may have varying requirements, repayment terms, interest rates, and conditions. Here’s an overview of some leading options for first-time small business loans. 

Bank Loans

Especially for first-time business owners, it’s not uncommon for personal and business finances to be intertwined, at least during the startup phase. Regardless of the age of your business, seeking a loan from a bank or credit union you already have an account with can be a logical place to start. Bank loans can come in various forms, including term loans and a business line of credit. Term loans give businesses a lump sum that is repaid at a fixed interest rate over a designated period of time (known as a term). Generally, repayment is on a monthly basis. Term lengths can range from several months to multiple years. A business line of credit provides a set amount of funding that can be utilized at any time following approval. Repayment, which carries interest, starts only when money is taken out. Both options can offer businesses some flexibility as to how they spend their financing. This may be advantageous for businesses with a wide range of operational and/or startup needs.Interest on bank loans is generally low, with an average annual rate between 4% and 6%. However, compared to other types of financing, bank loans and lines of credit may carry stricter requirements, including high credit scores and providing more collateral to qualify. 

SBA Loans

Small businesses come in many forms and operate in a range of industries. In some cases, small businesses may not fit the mold for traditional bank loans. Enter the Small Business Administration (SBA), a federal agency that works with lending partners to provide loans, counseling, and education to small businesses. Known as SBA loans, this funding can be advantageous for small business applicants that may traditionally be considered too risky to borrow money. The SBA guarantees coverage of a certain percentage of the loan amount to the lender in the event that the borrower defaults on repayment. SBA loans break out into four categories: 
  • 7(a) loans. The most common SBA loan, this funding can be taken out for long-term or short-term working capital, to refinance existing debt, or to buy equipment, among other purposes. The maximum loan is $5 million.
  • 504 loans. These long-term fixed-rate loans are meant to provide financing (up to $5 million)  for fixed assets to promote business growth and/or job creation. 
  • Microloans. These small loans (up to $50,000) are made to small businesses and some nonprofits to help them start up and/or expand.
  • Disaster loans. Business owners may opt to take out Business Physical Disaster Loans or Economic Injury Disaster Loans when their businesses have been damaged by a variety of disasters.
Each type of loan has different eligibility, loan terms, and maximum funding amounts. The greater security for the lender usually means SBA loans have more competitive interest rates and terms than small businesses with less creditworthiness might qualify for otherwise. First-time business owners may also enjoy smaller down payments and flexibility in terms of providing collateral. Getting an SBA loan can require applicants to submit a detailed business plan, financial information, and projected earnings to receive approval. 

Business Acquisition Loans

Not every first-time business owner is starting from scratch. Purchasing an existing business may eliminate startup costs and allow for quicker cash flow. A business acquisition loan is a tool for doing just that. Potential lenders will likely consider the existing business’s financial performance, as well as the applicant’s finances and proposed plan for the business under new ownership. 

Invoice Financing

If your business is already serving customers, invoice financing is a possible option for getting a cash advance to tackle pressing needs.In invoice financing, outstanding customer invoices are used as collateral. The business secures a percentage of the total amount of the invoices’ face value as a loan or line of credit. The small business is still responsible for collecting payment from its customers unless it chooses invoice factoring, a form of invoice financing in which the invoices are sold outright to a factoring company. Since this financing method is structured according to a business’s customer payments, it usually represents a smaller sum. However, this can be beneficial for covering payroll, rent, or other important short-term costs. 

Equipment Financing

Purchasing equipment can be a significant cost for starting, maintaining, or expanding a business. Equipment financing is a type of loan that lets business owners make these essential, but costly, purchases without depleting their savings. The terms and rates of equipment financing are determined by the lender. Typically the equipment itself serves as collateral for the loan. Comparing the useful lifespan of any equipment with a loan’s repayment term is helpful for determining the return on investment when you’re considering this type of loan. In some cases, it may be possible or more financially feasible to use financing for a lease instead. 

Alternatives to First-Time Small Business Loans

Especially if your business is still a startup, you may face difficulties obtaining traditional funding. But there are still more options you could consider.
  • Personal loans for business. These are traditional loans that you may be able to get as an individual. Not all lenders will want to issue these for business use, so it’s important to check when you’re considering applying. And note that while paying your installments promptly for a personal loan may help your personal credit, it won’t help your business establish an independent credit history.
  • Crowdfunding. For this funding option, you set a monetary goal and create a marketing campaign to solicit funds online through a crowdfunding site. The idea is that people will give you money, either as a donation or as a loan, depending on how you structure your campaign and what site you use. Crowdfunding can help you raise excitement about your business and test the waters to see how interested people are in it, but be aware that different crowdfunding sites have different rules about making returns to your benefactors.
  • Loans from family and friends. Supportive members of your family or friends may be willing to loan you small amounts. If loans like this can meet your needs, they could be a possibility. It’s important to make sure that the terms of loans like these are clear and both parties feel they’re fair so that the relationship isn’t jeopardized.

Comparing Loan Options

The number of options for financing a business can seem overwhelming. Assessing your particular business needs and financial situation can help jump start the process. If you’re ready to apply for a first-time business loan, Lantern can help match you with financing options that can lead to business success.
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Frequently Asked Questions

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About the Author

Kevin Brouillard

Kevin Brouillard

Kevin Brouillard is a Returned Peace Corps Volunteer, educator, and personal finance writer. His work has appeared in online publications such as Earth Island Journal, Jetsetter, Oyster.com, and Tripsavvy. Kevin covers an array of financial topics for SoFi, including loans for students and small businesses.
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