how to get a loan to start a business

How to Get a Loan to Start a Business: Your Guide to Startup Loans

Dane Panes | February 14, 2022

Contents

    Key Takeaways

    • Small business loans provide an additional cash injection to start a business and keep it going. Business owners can use it for buying inventory, hiring employees, purchasing equipment, machinery, furniture, and office supplies, and more.
    • There are several things you need to do before applying for a loan. You need to check your personal credit score, gather the necessary documents, write a business plan, and calculate the costs of taking out a loan.
    • Here are six steps on how to get a loan to start a business: determine your startup costs, review your qualifications, know your loan options, find the right lender, collect the documents and fill out the paperwork, and lastly, submit your application and wait for approval.

    Business owners often turn to small business loans to get an additional cash injection to sustain the business operations. However, securing financing could be one of the most daunting processes when starting a business. With the heightened standards, it could be tougher for new companies to qualify for a loan – let alone one that offers favorable terms.

    Applying for financing to get your business up and running doesn’t have to be complicated. We’ve laid out this guide on how to get a business loan to start a company to help you navigate the application process with ease.

    Why Do Businesses Need a Business Loan?

    Businesses take out business financing for a lot of reasons. One of which is working capital.

    As a startup, there’s a high probability that you won’t be earning profit right away. Some months, you’ll be lucky enough to break even. At times, your income may not be enough to cover your monthly financial obligations. If not addressed, these cash flow gaps could cause problems in your operations. By securing financing, businesses can create a cushion for these cash flow gaps.

    Aside from working capital, here are other reasons why businesses may apply for a loan:

    • Buy inventory
    • Purchase equipment
    • Buy office supplies and fixtures
    • Hiring staff

    What You Need to Do Before Applying for a Business Loan

    Here’s what you can do to improve your odds for a business loan approval:
    • Check your credit score.
    • Find out the necessary documents.
    • Write a business plan.
    • Know the costs of taking out a loan.

    a. Check Your Credit Score

    Your credit score is one of the first things lenders will look at when assessing your loan eligibility. Both your business and personal credit score will matter. But since you’re still about to open a business or in the early stages of business operations, lenders will most likely look at your personal credit score to assess your creditworthiness.

    Credit scores are a three-digit number ranging from 300-850. Credit bureaus generate your credit score based on your payment histories, how much debt you have, and the length of your credit history.

    A business or person’s credit rating is classified into five categories:

    • Poor: 300 to 579
    • Fair: 580 to 669
    • Good: 670 to 739
    • Very Good: 740 to 799
    • Excellent: 800 and up

    In general, the higher the borrower’s credit score is, the less risky they are as a borrower. That said, those with lower credit scores may need to improve their credit scores to improve their chances of qualifying for a loan with great terms.

    If you’re looking to improve your credit score, here are some practices that can help:

    • Pay your bills on time. Late payments can knock off as much as 100 points off your credit score. So, as much as possible, pay your bills on or before the deadline. This includes credit card debts, phone bills, utilities, and suppliers.
    • Reduce your credit utilization. A high credit utilization poses a red flag to lenders. Ideally, you should have a credit utilization of less than 30% if you’re planning to apply for a business loan. This shows that you’re responsible enough to handle your finances and credit.
    • Apply for credit sparingly. You may not know it, but applying for multiple credits within a short period can cause a big dent in your credit score. These numerous applications can make you look riskier to lenders, as this usually suggests that the applicant may be having trouble financially.
    • Check your credit report for mistakes. You’re entitled to a free copy of your credit report once every 12 months. When checking your report, look out for errors. It could be as simple as a misspelled name or incorrect account information. Study your payment history, as there might be a single payment that was not reflected. If you spot an error, call the bureau immediately to fix it. This could be of big help to improving your credit score.

    Note: The credit score requirements may vary from one lender to the next. Banks, in general, will require borrowers to have a good credit score (670 or higher), which makes them a less than ideal credit source for new businesses. However, alternative lenders may be willing to work with borrowers with fair or poor credit scores. As a good rule of thumb, keep your credit score within the 670 to 850 range to increase your chances of getting loans with flexible terms.

    b. Find Out What Documents You’ll Need

    If you’re planning to apply for a loan for your startup, one thing you should know is they may require extensive documentation. In fact, the documentation process is usually the longest one when applying for a business loan.

    That said, having all the documentation ready by the time you submit your application could help in expediting the loan process. So, be sure to have a list of the papers the lenders may require for the application. This list may include the following:

    • Proof of Identification
    • Proof of Business Registration, Permits, and Licenses
    • Credit Report
    • Tax Returns
    • Bank Statements
    • Balance Sheets
    • Profit and Loss Statements
    • Financial Projections
    • Owner’s Resume (Including co-owners holding more than 20% of the company’s shares)
    • Collateral documentation (if applicable)

    To get a complete list of the documents, give the lenders a call and ask them what they will need so you can obtain everything before submitting your loan application.

    c. Write a Business Plan

    Since startups usually don’t have an established financial track record, it’s more challenging for lenders to determine their ability to repay the loan.

    However, having a well-written business plan will improve your chances of qualifying for a startup loan. This will allow lenders to study your business, including your strategies and financial projections. From there, they will determine if your business is viable and sustainable.

    Moreover, a good business plan will demonstrate your knowledge and expertise about your business, thus increasing the lender’s confidence in your success.

    When writing your business plan, it should include everything that has to do with your business. Specifically, it should have the following components:

    • Executive Summary
    • Business Description
    • Company Mission and Vision
    • Business Goals
    • Market Research
    • Marketing Strategies
    • Financial Projections (including worst- and best-case scenarios)
    • Competitor Analysis
    • Owner’s and Manager’s Resumes and Experience

    Think of your business plan as a chance to win some investors over. You may see your business brimming with potential, but the lenders may not have the same view. If you want to succeed in getting the funding, you need to show and demonstrate why your venture is worth investing in.

    d. Know the Costs of Taking Out a Loan

    Taking out a loan comes with additional costs. Aside from repaying the principal amount, know that you’ll also have to pay for the borrowing fees. This includes the annual percentage rate (APR), closing costs, processing fees, and prepayment penalties (if there are any), among others.

    The amount you’ll have to pay for the fees will depend on the lender you choose to work with. As a rule, traditional lenders offer the most flexible rates but tend to be the most difficult source to qualify for. However, that doesn’t mean to say that you can’t get an affordable rate from alternative lenders. Typically, those with good to excellent credit scores may have better chances of qualifying for financing with lower rates.

    When applying for a loan, always ask the lenders about the loan fees and interest rates. Calculate how much payment you’ll have to make each month and whether or not you will be able to afford it. The last thing you want is to end up knee-deep in debt.

    Here are six steps on how to get a loan to start a business:

    1. Determine your startup costs.
    2. Review your qualifications.
    3. Know your loan options.
    4. Find the right lender.
    5. Collect the documents and fill out the paperwork.
    6. Submit your application and wait for approval.

    1. Determine Your Startup Costs

    Understanding your startup costs is vital because it will determine how much loan you need (and afford) and what type of financing you’ll apply for. Every business is unique, and thus, will have different initial expenses. However, they do share some standard costs. This includes:

    • Office supplies, like computers, cash registers, tables, chairs, etc.
    • Inventory
    • Equipment
    • Registrations, permits, and licenses
    • Fixtures like cubicles, desks, lighting, and others.

    Aside from the startup costs, you’ll also have to consider your operating expenses for the first few months, such as:

    • Utilities
    • Rent
    • Tax
    • Mortgage payments
    • Payroll

    Research what expenses go into your business. When calculating the costs, be sure to use realistic estimations. If you set the loan amount too high, there’s a high chance that the lender won’t approve your loan. On the other hand, if you ask for too little, it might not be enough to cover your initial and ongoing costs.

    2. Review Your Qualifications

    As mentioned, lenders will have different business loan requirements. Banks, for instance, may only loan money to the most creditworthy borrowers. On the other hand, alternative lenders may be willing to work with borrowers with poor credit.

    When it comes to business loan applications, lenders will consider several eligibility factors. Specifically, the lenders will look at your credit score, business plan, loan amount, and your ability to provide collateral.

    Here’s a breakdown of each:

    a. Credit Score

    As mentioned, your credit score will tell lenders about your credit behavior. The higher it is, the better your chances are at loan approval.

    If you’re applying from banks, chances are, you need a credit score between 680 to 850. They typically reserve their low-rate business financing only to creditworthy customers. If your credit score falls below that threshold, you might have better chances of qualifying for business financing from alternative lenders. The downside is, you might have to pay higher interest rates and fees as it’s the lender’s way of mitigating the risk.

    If you can afford to postpone the loan application process, you can always work on improving your credit score. Once it reaches a good point, you can then submit your loan application to lenders.

    b. Financial Projections

    Typically, the lenders will look at the business’ revenue and cash flow when assessing your ability to pay the loan. However, since you’re still in the process of getting your business up and running, the lenders will turn to your financial projections as their way of determining your business’ profitability.

    Your financial projections should be included in your business plan. It should contain your future sales, profits, cash flow, revenue, etc. Ideally, you should prepare at least three financial projections: pessimistic, optimistic, and most likely forecasts. This will help you and the lenders foresee the impacts of each scenario.

    It’s also a good idea to include a contingency plan in case some event throws off your forecasts. This will show the lenders that you have thought the project through and that you’ll fare well if something unexpected does happen.

    c. Collateral and Personal Guarantee

    Some lenders will require collateral if you’re applying for a loan to start a business. Collateral can either be a personal or business asset that you pledge to act as security for the loan. It could be real estate properties, vehicles, equipment, or inventory that the lenders can seize in case of nonpayment.

    Pledging collateral typically affords the borrowers with higher loan amounts and lower interest rates. However, there’s also the risk of losing a valuable asset if, for some reason, you cannot fulfill the loan repayments.

    Aside from collateral, most business loans may also oblige you to sign a personal guarantee agreement. A personal guarantee is a person’s legal promise to repay the loan using their personal assets if the business becomes unable to. This provides the lenders with assurance that they will be able to recoup their losses in the event of a default.

    3. Know Your Loan Options

    One thing to know about being a startup is that your loan options will most likely be limited. Since you haven’t established a solid financial and credit track record, lenders would be less willing to extend credit to you.

    But that doesn’t mean that you won’t be able to find a great financing solution for your business. Here’s a breakdown of each of the financing options you might be able to qualify for:

    a. Business Lines of Credit

    If you’re looking for a financing solution that will help you cover almost any business expense, a business line of credit would be an excellent choice. With one, you can draw cash whenever the need arises and only pay back the amount you owe, plus interest. The best part about lines of credit is, you can repeatedly draw money from your credit line as long as you don’t exceed the preestablished credit limit.

    The proceeds from your credit line can be used for a variety of purposes, including:

    • Additional working capital
    • Buying additional inventory
    • Equipment acquisition
    • Purchasing office supplies and fixtures
    • Cover payroll
    • Creating a safety net in case of emergencies

    Lines of credit can be secured and unsecured. Secured business lines of credit or those that require collateral may afford you a higher credit limit. The terms for an unsecured line of credit, however, may not be as flexible.

    b. Business Credit Cards

    Business credit cards work similar to that of a business line of credit, and it can be utilized for the same purposes (additional working capital, equipment, inventory, or office supplies). They’re also a revolving credit, which means that you can tap into the funds, pay what you owe, then reuse the funds again if the need arises.

    Business credit cards are usually the go-to financial resource of many startups. It’s the easiest to qualify for because most of the time, lenders only look at the business owner’s personal credit score to determine their qualification. Even if they don’t have a good credit score, it won’t be hard to find a provider that would still be willing to work with them. Business owners may just have to commit to paying high fees to offset the risk the lenders are facing.

    Furthermore, many credit card companies offer 0% introductory APR. This basically means that you won’t have to pay any interest on the funds you use within a specified time. However, you have to make sure that you pay off your credit before the date the APR is set to increase.

    With a business credit card, most lenders won’t require collateral but may require a down payment. They may also ask the business owners to sign a personal guarantee agreement.

    c. SBA Microloans

    SBA microloans are one of the best startup loans available to small business owners. It offers low-interest short-term loans to help businesses establish and expand. With one, eligible borrowers can get as much as $50,000 to jumpstart their business.

    Although SBA Microloans are designed specifically to help underserved businesses (i.e., women-, veteran-, or minority-owned companies), startups can qualify for it, too. SBA microlenders (usually non-profits) don’t require excellent credit. In fact, it’s common to find a lender that would be willing to work with borrowers with a credit score as low as 575.

    However, they would have to demonstrate strength in other areas of the loan application to make up for the low credit score. For instance, they would need to pledge valuable collateral or present a solid business plan. You’ll also have to demonstrate your ability to repay the loan through your financial projections to improve your chances of approval.

    Moreover, you’d also need to demonstrate that you can’t qualify for the same credit amount and terms from other lenders. SBA microloans are usually the last-resort financing options for small business owners.

    SBA microloans can have a 6-year repayment period with an interest rate hovering between 8% to 13%, depending on the lender and your qualifications.

    4. Find the Right Lender

    Though banks offer the best loan terms and rates, qualifying for a traditional bank loan could be nearly impossible for new businesses. The majority of banks may require firms to have at least two years of business history, substantial revenue, and excellent credit background. And, because startups are risky by nature, the risk-averse banks may not be willing to extend credit to them.

    This leaves businesses with two choices: Alternative Lenders and Non-Profit Microlenders.

    a. Alternative or FinTech Lenders

    If you’re looking for the best source of funding for your new business, applying for financing from alternative lenders is your best bet. These lenders are more open to taking risks and are, therefore, more likely to work with businesses that haven’t been able to establish their financial and credit background yet.

    With online lenders, businesses can get between $1,000 to $5 million in funding. While online lenders charge higher APRs than traditional lenders, approval rates are higher for these lenders, and funding can occur as fast as 24 hours after approval. This makes them a perfect choice for businesses looking for a quicker way to access financing.

    b. Non-profit microlenders

    Non-profit microlenders are a great funding source for new businesses that can’t meet the qualification for traditional business loans.  In essence, microlenders offer short-term business financing. Once approved, they can provide a maximum of $50,000 in funding to small, startups businesses.

    However, the application process can be a lengthy one compared to alternative lenders. That is because microlenders usually require applicants to present financial details, a detailed business plan, and a description of what the loan will be used for. Their interest rates might also be higher than that of a conventional business loan but lower than alternative lenders. In general, they charge between 6% to 30% APR.

    Although the process of applying from a microlender may be extensive, they can be a better choice for businesses that can’t qualify for a traditional bank loan or those who are looking for a smaller capital boost.

    5. Collect the Documents and Fill Out Paperwork

    Once you have picked the right loan and decided on a lender, the next step is to find out what documents they’ll need. As outlined above, the lenders will require you to submit financial statements, tax returns, business plans, and more. Locating these files now will help streamline the loan application process.

    Don’t forget to fill out the paperwork you need beforehand. Some of the fields in the application forms may require you to consult with a business attorney or accountant, so be sure to do that to avoid mistakes that could affect your application.

    6. Submit Your Application and Wait for Approval

    After getting everything ready, it’s time to submit your application. Some lenders may offer online applications (i.e., online lenders). If that’s the case, you will need to convert your documents into soft copies and upload the files on the lender’s database along with your application form.

    Other lenders may require you to visit one of their branches personally to submit your application. As you submit your application, the lenders may conduct a short interview and ask you questions like how you’ll use the funds or repay the loan. One thing to remember in these situations is to be transparent and honest as possible. If the lenders find out that you’re providing false information, it will hurt your chances of approval.

    Once everything has been submitted, the only thing left to do is wait for the lender’s decision. For online lenders, approval can take as fast as one business day. For non-profit lenders, approval could take a few weeks, so best apply for it if time is on your side.

    Get the Funds You Need to Start a Business Today!

    Starting a business can be the most exciting but overwhelming experience of your life. But to keep it open, you need to be able to secure enough funding. Business loans are a great financial resource, and while navigating the entire application process could be daunting, there are many resources that can help make the whole thing easier.

    Use the guide above as your starting point. Once you get a grip on how business loan application works, it will be easier for you to get the funding you need to see your business succeed. Good luck!

    About the Author

    Dane Panes started freelance writing in 2017. Since then, she has written about a lot of topics for different businesses. She started writing for SMB Compass in March 2020 and has been a full-time content writer ever since. Now, she focuses mostly on topics related to entrepreneurship and business financing.