5 Steps in Choosing the Best Type of Loan for Your Small Business

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A small business’s need for working capital doesn’t stop when they’ve officially opened their doors for business. They’ll likely need financial assistance through various phases of their business cycle. As a small business owner, having access to working capital is an invaluable resource. It allows you to turn your ideas into a profitable venture that leads to business growth and expansion.

There are different financing options available in the market and finding the best one takes time. In this article, we’ve narrowed down five steps in choosing the best type of loan for your small business.

1. Know Why You Need a Loan

The first step is to pinpoint exactly why you need a loan. This is because different types of loans cater to different needs. Identifying what you need the loan for will help you to narrow down your options. For example, equipment financing is likely the best option if what you need is to purchase or lease equipment. A business line of credit is ideal if you want to set aside cash for unforeseen expenses.

2. Determine How Much Money You Need to Borrow

The amount of money you are able to borrow depends on the type of loan you’re applying for. For instance, microloans are usually capped at $50,000, while SBA loans can fund up to $5,000,000. Don’t just assume the bigger the loan the better. Remember, bigger loans come with bigger repayments, interest rates and fees. It’s important that you thoroughly evaluate your finances so you’re only borrowing what you need. Borrow too much, and you’ll end up owing back more than necessary. Borrow too little, and you may come up short on cash during growth and expansion efforts.

When applying for funding, one of the most common mistakes business owners make is applying for the wrong loan amount. Evaluate your finances and consult a financial advisor who can help you accurately determine how much you need to borrow.

3. Check Your Creditworthiness

Once you have a loan amount in mind, the next step is to check your creditworthiness. Your credit rating plays a huge role in the loan type and amount that you’ll be able to get. Even if you decided that you need a business line of credit with a $150,000 limit, it doesn’t mean you’ll automatically qualify for one.

Most lending companies will check your credit rating before approving your loan application. They consider several factors when evaluating your creditworthiness, such as:

  • Business credit
  • Annual revenue
  • Personal credit score
  • Past bankruptcies (if any)
  • Number of years in business

The higher your credit rating, the better your chances are to qualify for a loan with favorable terms and rates. If your credit score is less-than-stellar, there are certain ways to increase it, like: paying your bills and vendors on time, checking for errors on your credit report and addressing them immediately, decreasing credit card spending, and separating your personal credit from your business credit.

4. Know Your Funding Options

After checking your creditworthiness, the next step is to look for lenders and loan offers. Running a small business can be complicated, but loan programs have developed over time to cater to unique business needs.

Banks and credit unions aren’t the only places you can apply for funding. Online lending companies offer fast and convenient access to small business loans, such as:

  • Business line of credit
  • SBA loans
  • Equipment financing
  • Asset-based loans
  • Business term loans
  • Inventory financing
  • Invoice financing
  • Purchase order financing

Online loans are easier to qualify for compared to those from banks and credit unions. However, these loans usually come with higher fees. That said, the ease of application, low borrower requirements, and quick turnaround all give online lenders the upper hand.

Pay attention to maximum loan amounts, fees, repayment terms, and APRs as you compare different lenders and loan options. There isn’t a one-size-fits-all solution to business funding. You’ll have to assess your business and decide which factors are important to you. Does your company need low monthly payments with long repayment terms? Or perhaps you need a loan with shorter repayment terms.

5. Gather the Necessary Documents

Once you’ve decided on a loan and a lender, you’ll need to submit a loan application. Gather all the required documentation to expedite the process. The documents needed usually depend on the lender and type of loan you’re applying for, but you’ll generally need a combination of the following:

  • Business financial statements
  • Business and personal bank statements
  • A comprehensive business plan
  • Legal documents like commercial leases, franchise agreements, articles of incorporation, etc.
  • Business and personal tax returns

It may feel like you’re in a race against time when applying for a loan, especially if you need funding quickly. Even so, be sure to take as much time as you need and carefully evaluate your options before proceeding.

The Bottom Line

There are different types of small business loans with unique purposes and features. Carefully evaluate your business’ needs and compare each loan option to find the best choice for your business. This process can be tedious, but doing most of the legwork early on can prevent future financial strains.

Ezra Cabrera
Ezra Neiel Cabrera has a bachelor’s degree in Business Administration with a major in Entrepreneurial Marketing. Over the last 3 years, she has been writing business-centric articles to help small business owners grow and expand. Ezra mainly writes for SMB Compass, but you can find some of her work in All Business, Small Biz Daily, LaunchHouse, Marketing2Business, and Clutch, among others. When she’s not writing, you’ll find her in bed eating cookies and binge-watching Netflix.

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