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Applying for a Small Business Loan in 6 Steps

Applying for a Small Business Loan in 6 Steps
Lantern

Lantern

Updated October 30, 2020
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Editor’s note: At Lantern, we strive to help you make financial decisions with confidence. To do this, we occasionally feature content that includes information about our partners and their products or services. We do not provide, endorse, or guarantee any third-party product, service, information or recommendations—and our opinions are our own.
As a small business owner, you may be feeling the effects of the COVID-19 pandemic. It’s a challenging time to manage business expenses, while making sure you and your team are safe and healthy. If you need assistance getting a business loan or accessing other funding, check out the Small Business Administration's (SBA) coronavirus relief options, which include, EIDL Loans, SBA Express Bridge Loans, and SBA Debt Relief. Whether you’re just starting out or already have an established company, knowing how to apply for a business loan is important. You may need capital to purchase property, equipment, or inventory, or to fund startup costs. Whatever your needs, securing capital can be a crucial step to the success of your business. There are numerous types of loans, from first time small business loans to Small Business Association (SBA) loan programs. And, there’s the added question of which type of lender is right for your business. With a myriad of options available, getting a business loan might feel overwhelming, but we’re here to help. With our step-by-step guide on applying for a business loan, we’ll go over ways to plan for your business’ needs, strategies that may help your chances at approval, different types of loans and lenders, and common application requirements. Let’s dive in!

1. What Is Your Business Loan For?

Before you start looking for loans and lenders, try to establish why you’re getting a business loan in the first place. Small business owners may need funding for a variety of reasons including: 
  • Startup costs
  • Expanding a business
  • Managing cash flow and day-to-day expenses
  • Purchasing property for the business
  • Buying equipment or inventory

What Do Small Business Startups Need to Think About?

When you’re just starting out, there’s a lot more to think about that just how to apply for a small business loan–you have to think about all the startup costs, like:
  • Leasing property
  • Inventory
  • Supplies
  • Equipment
  • Utility costs
  • Marketing
  • Insurance
  • Payroll
  • Permits
  • Legal fees
  • Accounting
  • Website
  • Remodeling/repairs
  • Advertising
As much as you may want to jump in and get your business off the ground, doing some research and planning to accurately estimate how much funding you’ll need can potentially help you avoid a headache in the long run.

Expanding Your Business to Reach Your Goals

You may know how to apply for a business loan to start a business, but what about when you’re ready to expand? Most business owners want to grow, but like starting the business, you’ve got to consider the cost. Expanding might involve:
  • Leasing or purchasing more property
  • Expanding your inventory
  • Increasing payroll
  • Purchasing more equipment
  • New marketing campaigns
Expanding a business is no small feat, and even profitable businesses may benefit from getting a business loan. For example, by using a loan to fund expansion, you can secure capital without jeopardizing your business’ current cash flow, helping ensure your transition from a small to midsize business is a smooth one.

Managing Cash Flow When It Fluctuates

Many businesses deal with fluctuations in cash flow due to seasonality, the economy, world events, and other factors. Because it can be difficult to predict and financially prepare for such fluctuations, certain types of small business loans may help offset the gaps in cash flow. Specifically, short-term business loans and business lines of credit may offer financial assistance when cash flow is restricted. 

Purchasing Property Is a Big Step

At some point, you may find that you want to purchase property to support your business. It could be for a storefront, manufacturing facility, or simply a permanent office space to call your own. Whatever the reason, it’s a big investment for any business, and one that typically requires significant financing in the form of a long-term business loan, like a commercial real estate loan.

Buying Equipment and Inventory

No matter what type of business you manage, there are likely equipment needs. It could be as simple as office equipment, like computers and printers, or larger items like factory machinery. Additionally, you may need to replace broken equipment, and replenish inventory throughout the life of your business, so it’s good to know how to apply for business loans, like equipment financing and inventory financing, if that time comes. 

2. Calculating the Amount of Capital Needed

After you’ve established the specific reasons you’re getting a business loan, it’s time to calculate the costs. To help avoid problems later on, it’s important you don’t underestimate the costs of your business needs. Creating an adequate estimate can help you alleviate stress and avoid having to get another loan or other type of financing down the road.One way to help estimate costs and manage cash flow is to categorize the type of costs a loan could help cover. Start by determining if your expenses are:
  • One-time purchases or ongoing: One-time major purchases, like equipment or real estate, are often large expenses that can disrupt cash flow. Ongoing expenses are costs that happen monthly, quarterly, or annually, and don’t change much.
  • Essential and urgent, or optional: Essential operational expenses are typically prioritized over optional expenses. Consider the urgency of what you want to purchase and if it contributes to an essential function of your business: can the business operate without it? 
  • Fixed expenses: When you run your business, you’ll have fixed expenses that don’t change (or would change relatively infrequently). These may be rent, certain utilities, insurance costs, or regular business services. Consider what your business loan may need to cover and make adjustments to your desired loan amount accordingly.

Estimating Cash Flow

To the best of your ability, project what your cash flow will be for at least a few months out. Will you have enough revenue to keep the business running and make loan payments?You can use a formula like this one to help calculate your future cash flow: Cash Flow Forecast = Starting Cash + Projected Inflows (e.g. sales, investments, income)  − Projected Outflows (e.g. wages, rent, inventory costs) Business loans can be helpful for businesses if they need access to cash. However, applying for them can be time consuming, especially if you are applying for the first time or as a new business. Frequently, lenders see new businesses as riskier lending options than more established ones, so it may be challenging to secure a first time business loan. If you have other sources of startup funding, like savings, crowdfunding, or borrowing from a trusted family member, you may want to consider those before applying for a loan.

3. Common Eligibility Requirements for Business Loans?

While there isn’t a one-size-fits-all formula for small business loan eligibility, lenders typically base their decisions for approval, rates, and terms on how risky it would be to lend to your business. To assess risk, lenders usually examine a variety of factors like your: 
  • Credit scores
  • Business age
  • Revenue history
  • Debt-to-income ratio
  • Cash flow
It’s important to remember that individual lenders may have their own requirements, so compare carefully to ensure you’re eligible.

Lenders Want to Know Your Credit Score

No matter what type of business loan you’re seeking, lenders will generally want to know your credit history, which includes your credit scores. Credit scores can be good indicators of how responsible you’ve been with paying past debts, giving lenders an idea of what level of risk you may pose as a borrower. When you have a high credit rating, lenders see you as a trustworthy borrower and worth the risk of lending to at more favorable rates. A low credit score may make it more challenging to secure certain types of loans, but there are a number of lenders who offer bad credit business loans. Generally, traditional lenders like banks and credit unions want to see credit scores over 650 to be considered for a small business loan, and may even have higher requirements. Additionally, lenders will want to look at both your personal and business credit scores if you’ve been in business for over a year. If your business is new (i.e. without established business credit), lenders will generally rely on your personal credit score to determine eligibility.

Building Business Credit

If you’re applying for a business loan, having a well-established business credit history can potentially help you qualify for more competitive rates and terms. These tips can be helpful if you’re interested in establishing or building business credit
  • Separating your business finances from your personal finances by:
  • Opening a business credit card and/or business line of credit and making payments on-time.
  • Working with vendors and suppliers who will report your payments to the business credit bureaus; whenever possible, it can help to pay what you owe early.
  • Checking your personal and business credit reports annually. Any fraudulent or erroneous activity could negatively impact your business credit score. Personal credit scores can be accessed at no charge annually. Accessing your business credit report may cost a fee, depending on the bureau.  

Is Your Business Established?

Small business lenders typically want to see that your business has been established for at least two years before issuing a business loan. While there are small business loans for start-ups, your options may be relatively limited if your business is newer. 

Revenue History Matters

To gauge whether you’ll be able to repay your loan, lenders will want to know how much revenue your business brings in. Lenders may ask for records of both monthly and annual revenue and may even have a minimum revenue requirement for getting a business loan. Knowing your minimum annual revenue can help you determine if a lender is a good fit for your business. 

Knowing Your Debt-to-Income Ratio (DTI)

Lenders may assess your debt-to-income ratio (DTI) to make sure you can responsibly pay back the loan. To calculate your business’ DTI, divide your monthly expenses, like rent, outstanding debts, and inventory costs, by your gross monthly income, which is what your business earns before taxes and deductions.Debt-to-Income Ratio (DTI) = (Total Monthly Expenses ÷ Gross Monthly Income) * 100For example, if your monthly business expenses were $50,000 and your gross monthly income was $200,000, your DTI would be 25%. While individual lenders will have their own maximum DTI for loan eligibility, generally, if your DTI is high, it may be harder to qualify for a small business loan.

Is Your Cash Flow Sufficient?

When thinking about how to apply for a business loan, you have to assess if you will have the cash flow to pay back the loan. Lenders may use several pieces of information to calculate your cash flow, like revenue statements and business billings, when determining your eligibility. 

4. Choosing the Right Loan for Your Business

Once you’ve gathered all of the relevant information, you’re ready to start comparing loan options. Each type has its pros and cons, so we’ve put together a list that includes an overview of what each loan is, what it’s typically used for for, and what to keep in mind if you’re considering it. 

Small Business Administration (SBA) Loans

What is it?Curious about how to apply for a business loan backed by the SBA? SBA loans are unique because they are guaranteed by the U.S. Small Business Administration, meaning they pose less risk to the approved banks and lenders who offer them. Loans guaranteed by the SBA are popular because they can offer relatively favorable rates and terms.There are a number of SBA loan programs to suit the unique needs of small business owners, but the most popular program they offer is the SBA 7(a). These loans can be useful for well-qualified small businesses that need up to $5 million for almost any business-related purchase. Additional options include an SBA 7(a) Small Loan for up to $350,000, or SBA Express, which has a faster turnaround of 36 hours.Why choose it?SBA loans can be options for small businesses startups, veterans, women, and underserved communities. They typically offer more favorable interest rates, business loan terms, and loan amounts than non-SBA backed loans. SBA loans can be used for a variety of reasons, including financing larger one-time purchases (e.g. property, equipment,) and smaller, ongoing expenses (e.g. working capital, payroll), allowing your company to grow and build business credit.Keep in mind:Since SBA loans are competitive and backed by the U.S. Government, the qualification and application process can be longer and more difficult than a traditional bank or online loan. If you need funding quickly, don’t have a well-established business, or have poor business credit, you may want to consider a non-SBA backed loan.  

Term Loans

What is it?Term loans are those in which you borrow a set amount of money that’s paid back with interest on a predetermined schedule. Lenders will determine the interest rates and loan terms available to you based on your creditworthiness. There are both long- or short-term small business loans available. The type you choose to apply for will depend on your company’s needs.Why choose it?Term loans can be useful for funding larger purchases because they allow you to repay the amount over time, posing less of a risk to your business’ day-to-day cash flow. With long- and short-term options, you can decide what makes the most sense for your budget.Long-term small business loans typically have lower interest rates for well-qualified borrowers, but extending the loan over a longer term could lead to considerable accrued interest over the life of the loan.. A short-term loan may have higher interest rates than long-term loans, and are generally options businesses turn to when they cannot qualify for another loan or line of credit. The needs of your business will help inform which type of loan is best for you, but it can be helpful to weigh all costs associated with the loans you are considering before making a final decision.Keep in mind:While you can find term loans from several types of lenders, banks and credit unions may have lower interest rates than alternative lenders, such as online lenders. However, banks and credit unions may also have more stringent eligibility requirements than online lenders.

Business Line of Credit

What is it?A business line of credit can be a form of revolving or non-revolving credit that gives you access to funding up to your credit maximum. Like a credit card, interest is only charged on unpaid balances that carry over from previous billing cycles. With a revolving line of credit, you can withdraw and repay as needed but cannot spend over the approved credit limit. Non-revolving lines of credit end after you’ve spent and paid the balance in full. Why choose it?Instead of getting a business loan for short-term expenses, you may want to consider a line of credit. If you need to manage cash flow during seasonal fluctuations, or have unexpected purchases or repairs, a business line of credit (if you qualify for one) can provide quick funding without the commitment of a traditional small business loan. Keep in mind:A business line of credit can be a relatively affordable option, for shorter-term needs with interest rates generally falling anywhere between 5% and 20%. If you aren’t sure whether you’ll be able to pay the monthly balance on a line of credit, it may be worth exploring other financing options, like a term loan.

Microloan

What is it?  Microloans are a form of funding typically offered by nonprofit organizations and peer-to-peer lenders in amounts up to $50,000. Why choose it?  Getting a micro business loan is generally for small businesses who only need a small amount of financing. Mission-based lenders can be one option when searching for microloans because they may offer specialty funding for minorities and underserved communities. SBA microloans are also available and may have advantages like competitive interest rates.   Keep in mind: Generally, eligibility requirements aren’t as strict for microloans as they are for more traditional term loans.  Check with lenders to confirm interest rates so you can accurately estimate how much a microloan may cost. 

Equipment Financing

What is it? Equipment financing is used for the purchase of any business-related equipment like machinery or vehicles, where the equipment acts as collateral. Both small business startups and established businesses may benefit from equipment loans to keep business operations running smoothly.Why choose it?  If your business needs new equipment but doesn’t have the savings to purchase, equipment loans may offer favorable interest rates depending on how well established your business is and your creditworthiness. There are also leasing options if you anticipate the need to regularly replace or upgrade the equipment.Keep in mind: Generally, the equipment acts as collateral when pursuing equipment financing. This type of financing can also be limiting, as you can only use the funds for business-related equipment.

Invoice Factoring and Financing

What is it? With invoice financing, lenders use your business’ unpaid invoices as collateral to offer a cash advance. You are responsible for collecting unpaid invoices from clients and then repaying the lender once you receive payment. With invoice factoring, a lender purchases unpaid invoices from you then collects payment directly from your clients. Both types of funding can help business owners maintain cash flow in businesses that regularly invoice customers.Why choose it?  Business-to-business (B2B) organizations that offer products and services with irregular billing cycles can use invoice financing or factoring to pay for operating expenses without waiting for clients to pay. Lenders advance a percentage of the outstanding invoice amounts, which you can use to reinvest and/or grow your business more quickly than if you had waited for outstanding client payments.  Keep in mind:  Business-to-consumer (B2C) organizations who don’t invoice customers regularly will likely be ineligible for invoice factoring or financing.Additionally, because the lender takes on more risk with invoice factoring, the terms may not be as favorable as those for invoice financing. However, if you choose invoice financing, you are responsible for collecting payment from customers and paying the lender back. If customers are late on invoice payments, any late repayment fees from the lender will fall to you.Lenders may also charge non-refundable processing and repayment fees for invoice financing and factoring. Check with your lender about additional fees so you can set an accurate business budget.

Commercial Real Estate Loans

What is it?  Getting a business loan for commercial real estate allows you to purchase a building for business use. Examples of what you might use a commercial real estate loan for include an office space, retail shop, manufacturing plant, or warehouse. Why choose it? Businesses that are looking to establish or expand their business and need more retail, industrial, or other type of commercial space may find this type of loan helpful. Because commercial real estate can be pricey, paying for it without getting a business loan could put strain on the business’ finances and cash flow. Keep in mind:  Commercial real estate loan approval and structure typically factor in loan-to-value (LTV) ratio: the size of the loan divided by the value of the property, expressed as a percentage.Loan-to-Value Ratio (LTV) = Loan Amount ÷ Commercial Property ValueFor example, if you’re requesting a loan of $150,000 for a property appraised at $200,000 the LTV would be 75%, and you would be responsible for paying the remaining 25% ($50,000) of the real estate cost. Usually, the lower the LTV, the better the rates and terms you’ll receive on the loan. In general, most commercial real estate loans have LTVs between 75% and 80%. Commercial real estate loans may also carry additional costs for items like appraisal and inspection, along with local filing fees. Ask your lender about the fees and additional expenses to gauge whether a commercial real estate loan is the right choice for your needs and budget.  

5. Compare Types of Lenders for Small Business Loans

If you’re looking to get a business loan there are many lending options. Banks, credit unions, online lenders, and even peer-to-peer networks offer attractive loans for small businesses. But which type of lender is right for you?

Online Lenders

Online lending can be useful tools for small businesses that are just starting out or need funding quickly. Getting an online business loan may offer a number of advantages:
  • Fast application review, typically in a matter of hours or days 
  • Quick access to funds (if approved)
  • Compared to more traditional lenders, it can be easier to qualify for if you have little business credit or history
  • Easily compare several different lenders
  • Options for unsecured loans, which don’t require collateral
  • Offer other types of financial products
On the other hand, online lenders typically can’t beat the APRs found at banks and credit unions. Since there are so many online lenders, it’s helpful to compare to see what products, terms, and conditions they offer. 

Traditional Banks

Banks can be a source for a variety of financial products from term loans and lines of credit, to equipment loans and credit cards. Some banks are partners with the SBA and offer government-backed loans for approved borrowers, including their 7(a) programs. Interest rates and terms may be more favorable with a bank than other types of lenders, but getting a business loan with a bank typically takes time.Small businesses may find it more challenging to get a loan with a bank because they may require good credit, collateral, and an established business history. Funding may also take longer to get because of the more rigorous application and approval process.

Peer-to-Peer (P2P) Lending Networks

Peer-to-peer lending is a popular alternative to traditional loans because it cuts out the middleman, so to speak. Peer-to-peer lending networks/marketplaces match borrowers directly with investors (not financial institutions) based on specific metrics. These may include credit scores and even social media profiles—anything that helps each party decide if they want to partner.P2P marketplaces set the terms and rates for the loans, which can vary depending on the creditworthiness of the borrower. They also help facilitate the money transfer and monthly payments between borrower and investor.A P2P lending network may be an attractive option for small businesses who struggle to get financing elsewhere due to bad credit, little time in business, or long approval processes. As you’re researching your options, be sure to look into additional transaction fees charged by different P2P marketplaces, which could fall to you, the investor, or both. 

Credit Union

Credit unions are similar to banks, but are member-owned and not-for-profit businesses. Profits generated by credit unions are typically returned to members in benefits like reduced fees, more competitive loan interest rates, or higher rates on savings accounts. When you become a member, you have access to banking services like checking and saving accounts, loans, and credit cards.Many people choose credit unions because they offer competitive interest rates and terms that are comparable to traditional banks, and may have more flexible qualification standards. They also tend to be more community-based, which may be attractive to small businesses who want to invest back into their communities.

6. Gather Documents

By now, you hopefully have a pretty good idea of how to apply for a business loan: you know how much money you need, what you will use it for, and which type of loan and lender will provide you with the right financing for your needs. The final step is gathering the necessary documentation so you can submit your application(s) with ease.The exact documents you’ll need to provide will vary by loan type and lender. But to get you started, here are a few documents lenders typically require with an application:
  • Business and personal bank statements
  • Business and personal tax returns
  • Business legal documents, if applicable (lease or franchise agreement, articles of incorporation, business licenses, permits)
  • Personal identification and current resume
  • Business plan
  • Revenue statements
  • Accounts receivable and accounts payable

Compare Small Business Loans and Lenders

Now that you know how to apply for a business loan, it’s time to find the right lender. By filling out a simple form, you can compare different online lenders who provide funding for all types of small business needs. We can even help you find and compare SBA loans and those that could help support your small business during COVID-19. Simply apply, compare, and find the capital you need, fast!
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website on credit (https://www.consumer.ftc.gov/topics/credit-and-loans)The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.SOLC20043

About the Author

Lantern

Lantern

Lantern is a product comparison site that makes it easy for individuals to shop for products and compare offers with top lenders. Lantern is owned and operated by SoFi Lending Corp., the digital personal finance company that has helped over one million people get their money right.
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