Small Business Loans Made Easy: Definitive Financing Guide

small business loans

Getting a small business loan can be overwhelming.

There are many options and things you need to be aware of. We sifted through the questions most commonly asked by business owners when they’re looking to apply for a business loan. Here are answers from the experts so you can make a better financing decision.

Let’s dive right in. This guide will cover:

  1. What is a Small Business Loan?
  2. Is it hard to get a business loan?
  3. What are all the different types of business loans?
  4. How do you qualify for a business loan?
  5. What is a good credit score to get a business loan?
  6. How can I get a small business loan without collateral?
  7. Do you need money down for a business loan?
  8. What documents are needed for a business loan?
  9. Where can I get a small business loan with bad credit?
  10. What is the typical interest rate for small business loans?
  11. Are there penalties to pay off a business loan early?
  12. Is a business loan tax deductible?
  13. How long is a short-term loan?
  14. What is the best loan for a small business?

What is a Small Business Loan?

A small business loan is a financing option used by business owners to get working capital in exchange for paying interest on a fixed loan amount. While we’d all love to have $1 billion in cash flow, the reality is that business loans are essential for some businesses as bridge capital. Especially for companies that have seasonal downtrends in sales volume (retailers, for example).

According to the Small Business Administration (SBA), over half of all small businesses fail within the first 5 years of operations. This makes having access to working capital even more important. Sometimes you have to spend money to make money, and business financing ends up being a necessity to grow.

Is it hard to get a business loan?

I’m going to let you in on a secret… it’s far easier to secure a working capital loan than most owners think. The problem is that most people are looking at the wrong sources for funding such as traditional banks and institutions. But, in most cases, they are slower than a turtle, require a pile of paperwork, and have a low acceptance rate. A bank will offer you the lowest interest rate, but it’s much easier and faster to get funded by an online lending company or alternative lenders. Founders want to focus on running their business, not spending a month or more going from bank to bank filling out paperwork.

What are all the different types of business loans?

There are six primary types of business financing options: SBA loans, business line of credit, term loans, invoice factoring, equipment loans, and merchant cash advance. Let’s delve into each one to see the pros and cons:

1. What are SBA 7(a) and Microloans?

The Small Business Administration’s 7(a) and Microloan programs provide a guarantee to lenders when they provide financing to business owners. The SBA itself doesn’t lend you the working capital. Instead, the bank or authorized lender is providing you a commercial loan that is partially guaranteed by the SBA up to 85%. An SBA loan can be used for all business purposes including buying equipment, consolidating existing debt, purchasing a new location, etc.

  • How much you can borrow: $100,000 to $5,000,000
  • Typical interest rate: 5% to 10%
  • Term length of loan: 5 to 25 years
  • How long does it take to get funded: At least 3 weeks (usually a bit longer)

Pros:

  • Backed partially by the SBA so low down payments
  • Term length is usually the longest as compared to other types of loans
  • Good interest rates
  • Can be used for any type of business

Cons:

  • Lot of paperwork and documentation needed
  • Time to get funded is long
  • Can require some collateral on the owner’s part even with the SBA backing

2. What is a business line of credit?

A business line of credit works similar to a credit card or home equity line of credit. Your business line of credit will be a fixed amount, but you only pay interest on the amount of capital that you use. You can withdraw funds as needed and pay it back based on a specified interest rate. A line of credit is best used for working capital to run your business. The key difference between a line of credit and a traditional business loan is the flexibility to use it on an as-needed basis.

  • How much you can borrow: $10,000 to $1,000,000
  • Typical interest rate: 6% to 30%
  • Term length of loan: 6 months to 5 years
  • How long does it take to get funded: As little as 24 hours

Pros:

  • Credit line is always available when needed
  • You only pay interest on funds you use
  • Builds up your credit rating
  • Owners with a bad credit rating can get approved
  • Competitive interest rates
  • No prepayment penalties

Cons:

  • Can require collateral
  • If your credit score is low, the interest rate will be high
  • Can be asked by the lender to provide updated paperwork on each withdrawal

3. What are term loans?

A term loan is a traditional business loan. You borrow a fixed amount of working capital with a specified interest rate, that you pay back with regular payments based on an agreed-upon term length. When most people think of business loans, they are thinking of a term loan. It’s the most popular type of financing option. Almost any type of business can qualify for a term loan. The core loan requirements are that you’ve been in business for at least 6 months and have at least $5K a month in revenue. A good credit score will get you a better interest rate, but even people with bad credit can secure a term loan (with a higher interest rate, of course).

  • How much you can borrow: $5,000 to $1,000,000
  • Typical interest rate: 7% to 35%
  • Term length of loan: 6 months to 5 years
  • How long does it take to get funded: As little as 24 to 48 hours

Pros:

  • Can be used by any type of business for working capital
  • Fixed payment structure and interest rate
  • Fast funding
  • No collateral needed
  • Many lenders to compare and choose from
  • Any range of credit score can get approved

Cons:

  • Might have prepayment penalties if you decide to pay off the loan early (negotiable with the lender)
  • Higher interest rate than an SBA loan (depending on your credit score)

4. What is invoice factoring and financing?

Invoice factoring (also called invoice financing) allows a business owner to borrow money by using unpaid invoices as collateral. Factoring is a flexible funding option to get money quickly based on outstanding receivables. A lender will give you 85%-99% of the invoice value upfront, with the most of the remaining amount also paid to you once the invoices clear.

  • How much you can borrow: Up to 100% of outstanding invoice value
  • Typical factor rate: 0.6% to 5% per month
  • Term length of loan: Until the invoices clear (your customers pay the outstanding invoices)
  • How long does it take to get funded: As little as 24 hours

Pros:

  • Immediate access to capital without waiting for customers to pay their invoices
  • The only collateral requirement is the invoices themselves
  • Factor fee is based on credit rating of the customers who have yet to pay the invoices

Cons:

  • Only available for B2B industries
  • The factor rate you get is based on how long it takes for the customer to clear the invoice

5. What is an equipment loan?

An equipment loan (also called equipment financing) allows a business owner to purchase or lease equipment needed for business purposes. Getting an equipment loan is quick and the capital can be utilized for many different types of purchases: vehicles, industrial machines, technology, etc. The equipment itself serves as the collateral for the loan. So no other collateral is needed for a business to get financing.

  • How much you can borrow: Up to 100% of the cost of equipment
  • Typical interest rate: 6% to 25%
  • Term length of loan: Based on the equipment’s expected life of use.
  • How long does it take to get funded: As little as 2-3 weeks

Pros:

  • Low documentation and paperwork
  • Competitive rates due to the collateral
  • Good personal credit is not required

Cons:

  • Your equipment can get too old to use (or replaced by newer technology) by the time you pay off the loan
  • You might not be able to deduct the full cost on taxes every year due to depreciation

6. What is merchant cash advance?

Merchant Cash Advance (also known as MCA or Cash Advance) allows a business to get working capital by giving the lender a small percentage of credit card sales plus an extra fee on top. Cash Advances are probably the easiest funding to get. The huge downside is the cost. You end up paying more than you would with a term loan, equipment financing, or invoice factoring. Almost anyone can get approved for a cash advance, even with bad credit. MCAs should be a last resort to get capital. Always explore other options first. The quick money MCAs offer is usually expensive.

  • How much you can borrow: $5,000 to $750,000
  • Typical factor rate: 1.10 to 1.39
  • Estimated term length: 3 to 18 months
  • How long does it take to get funded: As little as 24 to 48 hours

Pros:

  • Immediate access to capital
  • Low requirements
  • Almost any business can get approved
  • Bad credit is okay
  • Payments directly correlated to the fluctuation in sales

Cons:

  • The fees! This will cost more than a traditional business loan
  • May require a change in your credit card processing
  • Does not build your personal or business credit

How do you qualify for a business loan?

Business loan requirements can vary based on the type of loan you are looking to secure. At its core, there are three things you need to know before applying for a loan: time in business, your credit score, your annual revenue.

1. Time in business

The amount of time your business has been operational is the first thing lenders will look at to qualify your loan. The bare minimum is usually 6 months in business. While there are lenders who will fund startups and new businesses, expect higher collateral and credit score requirements. It’s recommended to be operational for 6+ months to get financing. The time in business is a risk management signal for banks and online lenders. The longer you’ve been in business, the lower risk for the lending company to provide you working capital.

2. Personal credit score

The owner’s personal credit score rating plays an important factor. Lenders will use your history to decide if they should approve your loan, and also base your interest rate offer on it. The higher your credit score, the better interest rate you will receive. That’s not to say business owners with bad credit can’t get funded. There are plenty of alternative financiers and loan brokers who can help you get money even with bad credit. But you have less leverage to negotiate a better interest rate with bad credit. In order to qualify for a business loan, you should try to have a credit rating of at least 550+.

3. Annual or monthly revenue

Your current revenue numbers help lenders decide if you’ll be able to make payments on your loan. It also helps them decide the maximum amount of capital they can loan you. Most banks and lenders will require the business generates a minimum of $10K a month ($120K annually) to qualify for financing. If you are a new business or startup without revenue, it might better to get initial funding from friends & family or a traditional venture capitalist (VC).

What is a good credit score to get a business loan?

The higher your credit score, the better your odds of approval and getting the best loan terms. With that obvious insight out of the way, here are recommended credit scores to for different types of loans:

  • Credit score for SBA 7(a) and Microloans: 640+
  • Credit score for a business line of credit: 550+
  • Credit score for term loans: 550+
  • Credit score for invoice financing: Not required at all or in some cases 600+
  • Credit score for equipment financing: 550+
  • Credit score for merchant cash advance: 500+

Note: you can get approved for a loan with lower credit score ratings than the above, but expect to have a higher interest rate, shorter term lengths, and lower total amount of capital available to you.

How can I get a small business loan without collateral?

Depends on what you consider to be collateral. If you are looking to get invoice financing or equipment financing, the invoice and equipment themselves are the collateral. If, however, you are looking for a completely unsecured business loan (which may only require a UCC lien or personal guarantee), here are your options:

1. Short-term Loans

Short-term loans are going to be your best bet to get truly unsecured financing without collateral. There are plenty of online lenders who offer both long-term and short-term funding products. Do be aware of the difference between long-term and short-term loans. The short-term loan products can have weekly payments over the length of the loan term. And the duration of the loan is between 3 to 18 months, as compared to 2 to 5 years for long-term loans.

2. Merchant Cash Advance

With merchant cash advance, instead of actual collateral, you are giving the lender a portion of your future revenue in exchange for immediate working capital. You get an upfront payment from the financing company, and pay it back with a percentage of your future sales (with a fee on top of it). As we mentioned before, MCA should be a last resort option due to how expensive it can be for you. Always consider a term loan first.

3. Business Credit Card

We are all familiar with what a business credit card is. But we rarely consider it as a financing option when there is a need for money. The right business credit card can be a great way to supplement other sources of financing. Pay extra attention to cards that offer 0% intro APR. You are essentially getting an interest free way to utilize capital without any extra cost to your business. American Express and Visa have several credit cards for businesses available that provide 0% APR for the first 15 months. We’d recommend Blue Business Plus from American Express. $0 annual fees, 0% APR for the first 15 months, then 12% APR after that. Can’t beat that!

Do you need money down for a business loan?

If you’re looking for a loan to manage a cash flow issue, a potential down payment can add a lot of stress. The good news is that there are many types of business loans that do not require a down payment. Here are four options where you won’t need to put money down for a loan:

Term Loans

Short term loans are the most common financing option for a reason. Lenders won’t require you to put money down to get approved. But some lenders (especially banks) will ask you to put up some collateral to reduce their risk of funding you. Alternative lenders are usually the best option if you’re looking for a term loan. There’s less paperwork and the process is much faster than with a traditional bank. Do note that there might be a small one-time origination fee to secure your short term loan.

Business Line of Credit

A line of credit also doesn’t require any down payment to secure. Business credit lines work similar to credit cards. You get a specific amount of total capital to use, and only pay interest on the capital you withdraw. Business lines of credit come in both flavors: secured and unsecured. Secured credit lines reduce risk for the lender, and are therefore easier to get approved for. The tradeoff is that you’ll likely put up some form of collateral or a personal guarantee to get a secured line of credit.

Invoice Financing

Invoice factoring required no down payment since you are essentially selling outstanding customer invoices to a lender. It’s a fast way to free up cash flow that is tied down to customers’ who have yet to pay your invoices. In most cases, you get 85% of the invoice value up front, and the remaining 15% once the customer pays their invoice. And of course, the lender will charge you a fee on the remaining 15%. One key benefit to invoice financing is that your approval is based on your customer’s credit rating and profitability, not your own.

Equipment Financing

The down payment for equipment financing can vary depending on the lender. It’s possible to get an equipment loan from a lender that doesn’t require any money down, and will provide you 100% of the money needed to buy new or used equipment for your business. The total amount you get approved for will depend on the actual value of the equipment you are purchasing. Do note that the equipment itself is the collateral, since the lending institution will sell it to recoup their loss in the event the borrower defaults on the loan.

What documents are needed for a business loan?

Applying for a commercial loan can be a time-consuming process. You can certainly optimize the process by getting your paperwork in order before even submitting an application. Here are the documents you need to secure financing:

Documents needed for term loans

  • Bank statements: 3 to 12 months of your most recent bank statements
  • Tax returns: for short-term loans, you might be asked for 1 year’s tax return. For long-term loans, up to 3 previous year’s tax returns.
  • Lender’s application form (usually 1-page)

Documents needed for business line of credit

  • Bank statements: 3 to 12 months of your most recent bank statements
  • Tax returns: 1 to 3 years of most recent tax returns
  • Lender’s application form (usually 1-page)
  • P&L statements (Profit & Loss)

Documents needed for SBA loans

  • SBA Form 4: your application for the business loan
  • SBA Form 912: your personal history statement
  • SBA Form 4i: lender’s application for participation (this will be completed by your lender)
  • Business Certificate
  • 1-year projections of business finances with a statement detailing how you plan to achieve those projections

Where can I get a small business loan with bad credit?

The credit bureaus like Equifax and Experian define “bad credit” as a score between 300 and 579. For most financing options like term loans, your credit score is a key deciding factor for lenders. Borrowers with bad credit signal a higher risk of missing loan payments or defaulting. The good news is that if your credit score is 500+, you still have options secure a business loan.

Lenders that fund borrowers with bad credit:

  1. Clarify Capital
  2. Kabbage
  3. OnDeck
  4. FundBox
  5. BlueVine

Things to keep in mind if you have bad credit:

  • The lower your credit rating, the higher the interest rate you will get quoted by lenders.
  • If you have outstanding receivables, take a look into Invoice Financing. Since invoice factoring is based on the value of the invoices, your personal bad credit score won’t be a factor.
  • If you don’t have an urgent need for working capital, work on improving your credit score using a business credit card first. Then apply for a loan once your score improves to get better loan terms from lenders.

What is the typical interest rate for small business loans?

While the interest rate you’ll get quoted by lenders depends on a variety of factors like credit score, time in business, and annual revenue, here is what you can expect:

  • Typical SBA loan interest rate: 5% to 10%
  • Typical Business Line of Credit interest rate: 6% to 30%
  • Typical Term Loan interest rate: 7% to 35%
  • Typical Invoice Financing factor rate: 0.5% to 5% per month
  • Typical Equipment Loan interest rate: 6% to 25%
  • Typical Merchant Cash Advance factor rate: 1.10 to 1.39

Maximum SBA 7(a) loans interest rates

Total Loan AmountSBA 7(a) Term Length 1-7 YearsSBA 7(a) Term Length 7+ Years
Under $25,0009.50%10.00%
$25,000 to $50,0008.50%9.00%
Over $50,0007.50%8.00%

Are there penalties to pay off a business loan early?

Let’s first view this question from a lending company’s viewpoint. For a lender, if a borrower pays off their business loan early, it would mean they don’t get the full ROI on the risk they took to fund a business owner (i.e. the interest rate they projected to earn on the loan). As such, many lenders might charge you a pre-payment penalty in the event you opt to pay off the loan early.

You can usually negotiate the pre-payment penalty before you secure capital from the lender. In case you do have a prepayment penalty clause, it is most often set as a percentage of the remaining balance. Even if you have a prepayment penalty, do calculate if paying the penalty is a cheaper option than continuing to pay interest on the remaining loan balance. However, majority of the unsecured options will incentivise you to pay off the note earlier.

Is a business loan tax deductible?

The interest that you pay on a small business loan is indeed tax deductible. It doesn’t matter which type of financing option you secured. Whether it’s a term loan, business line of credit, or credit card, you can safely deduct the interest you paid during the year. It also doesn’t matter whether you used business or personal collateral at the time you applied — go ahead and deduct that interest!

According to the IRS, there are a few requirements to aware of if you’re going to deduct your loan interest:

  1. You must have documentation to prove that you are liable for the loan. This could be a UCC-1 statement.
  2. You should have documentation that shows you are making payments on the loan.

Do note that the principal amount of the loan is not tax deductible, only the interest you have paid on it.

How long is a short-term loan?

A short-term loan has a term length between 3 months to 2 years. The average length of a short-term loan is 1 year. A term loan of this length allows a borrower the flexibility to get quick access to working capital without typing up your credit limit with a long-term loan.

What is the best loan for a small business?

It used to be the case that a bank was your only option of getting a small business loan. Times have changed. There has been a surge of new online alternative lending companies in the last few years. An online lender makes the process of getting a business loan quick, provide more flexible payment options, and transparent loan terms.

Best small business loans from online lenders:

  1. Clarify Capital
  2. Kabbage
  3. American Express

Best peer-to-peer small business loans:

  1. Prosper
  2. FundingCircle
  3. LendingClub

Have a question about small business loans that wasn’t covered? Ask us in the comment section below!

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