Small business loans are available from a large number of traditional and alternative lenders. Small business loans can help your business grow, fund new research and development, help you expand into new territories, enhance sales and marketing efforts, allow you to hire new people, and much more.
This article explains the 10 key steps you should follow to get a small business loan, with some practical advice and insight on the lending process.
1. Understand the different types of small business loans available
There are multiple types of small business loans available. The options vary depending on your business needs, the length of the loan, and the specific terms of the loan. Here are a number of small business loan choices:
PPP loans. The popular Paycheck Protection Program (PPP) reopened on January 11, 2021. This allows for loans to qualified small businesses—and if the proceeds are used as intended, the loan will be forgiven. Here are some key elements of such loans:
- The business must show that it suffered at least a 25% reduction in annual gross receipts or during any quarter in 2020 compared to the comparable quarter in 2019.
- The business had to have been in operation prior to February 15, 2020.
- The business has to employ 300 or fewer employees.
- If the business previously obtained a PPP loan, the business had to have used the full amount of the prior loan.
- Certain types of businesses are not eligible, such as publicly traded companies, think tanks, and organizations that engage in lobbying or political advocacy.
The PPP loan can be used for the following types of expenses:
- Payroll costs
- Utilities payments
- Operations expenses (such as software costs)
- Property damage costs not covered by insurance
- Costs of protective equipment, such as masks
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The amount of loan you can obtain is calculated as follows:
- Up to 2.5 times average monthly payroll for most businesses
- Up to 3.5 times average monthly payroll for accommodation and food services businesses
- In general, borrowers can calculate their aggregate payroll costs using data either from the previous 12 months or from calendar year 2019. For seasonal businesses, the applicant may use average monthly payroll for the period between February 15, 2019, or March 1, 2019, and June 30, 2019.
Businesses that receive a new PPP loan under the newly reopened program are eligible to have the loan forgiven through a simplified loan forgiveness application. Small businesses may apply for a PPP loan from a local lender or online lender.
SBA disaster loans. The SBA has a disaster loan program for businesses that have suffered from a declared disaster, including the Covid-19 pandemic. The COVID-19 Economic Injury Disaster Loan (EIDL) is intended to help affected businesses.
Key elements of the EIDL program are:
- Eligible borrowers include small businesses who have suffered substantial economic injury as a result of the Covid-19 pandemic.
- Loans are available to businesses based in any U.S. state, territory, or Washington, D.C.
- Loans can be used for working capital and normal operating expenses (i.e., continuation of health-care benefits, rent, utilities, and fixed debt payments).
- The interest rate on loans is typically 3.75%, and loans are payable over 30 years.
- EIDL loans are not forgivable, unlike PPP loans.
- There are no prepayment penalties or fees.
- Payments are deferred for the first year of the loan, although interest accrues.
Small businesses can apply directly online for an EIDL loan through the SBA website.
Small business line of credit. Under a small business line of credit, your business can access funds from a lender as needed. There will be a cap on the amount of funds accessible (e.g., $100,000), but a line of credit is useful for managing a company’s cash flow and unexpected expenses. There will typically be a fee for setting up a line of credit, but you don’t get charged interest until you actually draw down the funds. Interest is typically paid monthly, and the principal drawn down on the line is often amortized over years. However, most lines of credit require renewal annually, which may require an additional fee. If the line is not renewed, you will be required to pay it in full at that time.
Accounts receivable financing. An accounts receivable line of credit is a credit facility secured by the company’s accounts receivable (AR). The AR line allows you to get cash immediately, depending on the level of your accounts receivable; the interest rate is variable. The AR line is paid down as the accounts receivable are paid by your customers.
Working capital loans. A working capital loan is a debt borrowing vehicle used by a company to finance its daily operations. Companies use such loans to manage fluctuations in revenues and expenses due to seasonality or other circumstances in their business. Some working capital loans are unsecured, but companies that have little or no credit history will have to pledge collateral for the loan or provide a personal guarantee. Working capital loans tend to be short-term loans of 30 days to one year. Such loans typically vary from $5,000 to $100,000 for small businesses.
Small business term loans. Term loans are typically for a set dollar amount (e.g., $250,000) and are used for business operations, capital expenditures, or expansion. Interest is paid monthly and the principal is usually repayable within six months to three years (which can be amortized over the term of the loan or have a balloon payment at the end). Term loans can be secured or unsecured, and the interest can be variable or fixed. They are good for small businesses that need capital for growth or for large, onetime expenditures.
SBA small business loans. Some banks offer attractive low-interest-rate loans for small businesses, backed and guaranteed by the SBA. Because of the SBA guarantee, the interest rate and repayment terms are more favorable than most loans. Loan amounts range from $30,000 to as high as $5 million. However, the loan process can be time consuming with strict requirements for eligible small businesses. Visit the SBA website to see a list of the 100 most active SBA lenders.
Equipment loans. Small businesses can buy equipment, vehicles, and software through an equipment loan. This typically requires a down payment of 20% of the purchase price of the equipment, and the loan is secured by the equipment. Interest on the loan is typically paid monthly and the principal is usually amortized over a two- to four-year period. Loan amounts normally range from $5,000 to $500,000, and can accrue interest at either a fixed or variable rate. Equipment loans can also sometimes be structured as equipment leases.
Small business credit cards. While some business owners may be wary of using them, small business credit cards can also act as short-term small business financing. Interest rates will vary depending on the credit card issuer, the amount available on the card, and the creditworthiness of the holder of the card. Many small business credit card issuers require the principal owner to be co-liable with the company. Issuers of small business credit cards include American Express, Brex, CapitalOne, Bank of America, and many others. Many credit cards offer promotional introductory rates of 0% for a short period of time (six to nine months). Cashback and rewards programs allow you to earn rewards from purchases on the credit card.
2. Research available lenders
There are more lenders than ever willing to lend to small businesses, and many of the lenders can be found from a simple online search. Here are the main types of lenders:
- Direct online lenders. There are a number of online lenders that make small business loans through a relatively easy online process. Reputable companies such as PayPal can provide very fast small business cash advances, working capital loans, and short-term loans in amounts from $5,000 to $500,000. Sites such as Fundera offer access to multiple lenders, acting as a lead generation service for lenders.
- Large commercial banks. The traditional lenders to the small business market are banks such as Wells Fargo, JP Morgan, and Citibank. The loan approval process tends to be slower due to more rigorous loan underwriting criteria.
- Local community banks. Many community banks have a strong desire to make small business loans to local businesses.
- Peer-to-peer lending sites. There are a number of sites that act as middlemen between individual and institutional lenders and small borrowers, including SMBX, LendingClub, and Funding Circle. These lenders can make decisions relatively quickly.
- Bank lenders backed by SBA guarantees. A number of bank lenders issue loans backed by the SBA, and, as noted above, this backing allows lenders to offer more attractive terms.
3. Anticipate how lenders will view your credit and risk profile
Lenders ultimately make a judgment call on whether or not to make a small business loan based on the borrower’s credit and risk profile. Lenders will look at the following factors, so review them carefully and consider taking any appropriate remedial action:
- Credit score/credit report. Lenders will review your credit report, credit score, and history of making timely payments under credit cards, loans, and vendor contracts. So review your credit report and clean up any blemishes.
- Outstanding loans and cash flow. Lenders will review your outstanding loans and debts to determine that your cash flow will be sufficient to pay existing loans and obligations as well as the new loan contemplated.
- Assets in the business. Lenders will review the assets in the business (particularly current assets such as cash and accounts receivable) to see if there is a good base of assets to go after in the event of a loan default.
- Time in business. Lenders will tend to look more favorably on businesses that have been operating for several years or more.
- Investors in the company. Lenders will view the company more favorably if it has professional venture capital investors, strategic investors, or prominent angel investors.
- Financial statements. Lenders will scrutinize your financials, as set forth in the next section below.
4. Make sure your financial statements are in order
Depending on the size of your loan, your financial statements and accounting records will be reviewed carefully by the lender. So make sure they are complete, correct, and thorough—including balance sheet, income and loss statements, and cash flow statements. The lender will analyze your cash flow, gross margin, debt-to-equity ratio, accounts payable, accounts receivable, EBITDA, and more, so be prepared to answer questions on those topics. Consider having your accountant look over your financial statements to anticipate issues a lender may raise.
Lenders prefer financial statements that have been audited by a certified public accountant (CPA), but many small businesses don’t want to incur the costs of an audit. One alternative is to have the financial statements “reviewed” by a CPA (which is cheaper and faster). However, some lenders may not require either audited or reviewed statements.
5. Gather detailed information for your small business loan application
If you want to be successful getting a small business loan, you have to be prepared to provide detailed information and documents about your business; it is important to be prepared and organized. The following is the type of information that is often required from bank lenders, depending on the type of loan:
- Name of business (including any DBAs)
- Federal Tax ID
- List of executive officers and their background
- Legal structure (such as LLC, S corporation, C corporation)
- Financial statements for the past two to three years and year-to-date financials for the current year (balance sheet, income and loss statements, cash flow statements, shareholder equity)
- Projected financial statements (so that the lender can get a sense of your expected future operations and cash flow)
- State filings for the company, such as a certificate of incorporation, foreign corporation filings, and good standing certificates
- Copies of key man and general liability insurance policies
- Amount of loan requested
- Business credit report (such as from a credit reporting agency like Dun & Bradstreet)
- Potential collateral available for the loan
- Financial statements of the principal shareholder/owner of the business (especially in the case where a personal guarantee will be required)
- Business plan, executive summary, or investor pitch deck of the company (see A Guide to Investor Pitch Decks for Startup Fundraising)
- The tax returns of the company for the past two to three years (signed copies with all attachments and exhibits)
- Business bank statements
6. Be prepared to specify how much you want to borrow and the expected use of proceeds from the loan
The lender will want to know how much funding you are seeking and how the loan proceeds will be used. Will the loan be used for equipment or capital expenditures? Expansion or hiring? Increase in inventory? Enhanced sales and marketing efforts? New research and development of technology? New product development? Expansion into new facilities or territories?
You may want to borrow a little extra in case you run into a cash crunch that lasts a month or two. You have to avoid going into default under the loan.
7. Determine what security or guarantee can be provided
A lender is primarily concerned about the ability of the borrower to repay the loan. To the extent that a security interest can be given to the lender on company assets (company equipment, property, accounts receivable, etc.), the borrower should be able to increase its chances of getting a loan on favorable terms. Some lenders may insist upon the personal guarantee of the principal owner of the business. That is best avoided, if possible, as it puts your personal assets, and not just the business assets, at risk.
8. Analyze the key terms of the proposed business loan
To make sure the proposed business loan makes sense for your business, you will need to analyze the key terms proposed by a lender and compare them with terms available from alternative lenders. Here are the key terms to review:
- What is the interest rate on the loan and how can it vary over time? Many loans vary over time depending on the prevailing “prime rate” or some other benchmark.
- How often is the interest payable?
- When is the principal due or how is it amortized over the life of the loan? You need to be comfortable with the combined interest and principal payments from a cash flow perspective.
- What is the loan origination fee?
- What other costs or fees are imposed (such as underwriting fees, administration fees, loan processing fees, etc.)?
- What operating covenants are imposed on your business (such as a maximum debt-to-equity ratio or a minimum cash threshold held by the company)?
- What are the circumstances when the lender can call a default on the loan?
- Is there any security or collateral required?
- What periodic reports or financial statements are required to be provided to the lender?
- Are there limits on how the loan proceeds can be used?
- Can the loan be prepaid early without a penalty? And if there is a penalty, is the penalty reasonable?
9. Review your online profile and postings
A small business lender will perform due diligence, which can include reviewing the information available online about the business and its principal owner. So do the following review, anticipating such due diligence to see if you should make any changes or deletions to your online presence:
- Review your company’s website. Is it up-to-date and professional looking?
- Review its presence on LinkedIn, Facebook, Twitter, and other social media sites.
- Review any Yelp reviews your business may have received.
- Review the principal owner’s postings on LinkedIn and other websites.
10. Get further educated on the small business lending process
The more educated you are about small business lending options and procedures, the more likely you will be successful in obtaining a loan. Here are some additional articles to review:
Small business loans are available from many different lenders, with a myriad of choices tailored to the financial situation of your business. By anticipating what lenders will review and require, you greatly increase your chances of obtaining a beneficial small business loan.
About the Author
Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a venture capital fund in the San Francisco area. See all his articles and full bio on AllBusiness.com.
Copyright © by Richard D. Harroch. All Rights Reserved.