How to Get a Business Loan: A Beginners Guide

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Whether you’ve been in business for years, or you’re just starting your business, getting a business loan is easier than you might think. In this article, you’ll learn about the different types and terminology of loans, when you should and shouldn’t seek one, and how to get a business loan in five steps. But first, you’ll want to learn the basics.

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What is a business loan?

As the name suggests, a business loan is a loan that can help you start, expand, or maintain your business. A lender gives you the money that you then pay back along with interest. In many cases, you need a business plan and forecast that explain how this loan will help your business make more money. The lender will also be interested to see how you plan on paying the loan back.

Secured vs. unsecured business loans

Shortly, you’ll learn about the different types of business loans, but first, it’s important to understand the difference between a secured and unsecured loan. These aren’t specific types of loans — they’re just terms that explain the conditions of the loan.

What is a secured loan?

Secured loans protect the lender by adding collateral to the equation. Collateral can take many forms. The idea is that if you fail to meet the payment terms and can’t afford to pay back your loan, the lender will take assets from you.

Collateral could be parts of your business, personal belongings, or equipment. In a personal mortgage, collateral is usually cars, expensive possessions, or the house itself — the same idea holds here.

Secured loans are used in situations where there’s some skepticism or uneasiness for the lender. This could mean you have poor credit, you’re looking for a large loan, or your business doesn’t have a strong track record.

What is an unsecured loan?

Unsecured loans are the opposite. If your business is performing well, the loan is a reasonable amount, and you have strong credit, an unsecured loan might be offered. In this case, the lender doesn’t require any collateral, which makes the loan a lower risk for you.

How business loans work

Since not all businesses are the same, not all business loans are the same. Each loan operates a little differently and carries different pros and cons. Here’s how each one works:

Business term loan

In a business term loan, a payment term is prearranged. This is also called an installment loan because you pay it off in installments.

You and the lender agree on a schedule and how much money will be owed for each installment. Lenders often agree to monthly or quarterly payments. Every payment goes partially toward the principal and partially toward the interest. This is a one-time loan that’s ideal for large sums of money.

Short-term business loan

A short-term business loan pretty much explains itself. You need fast money that you can pay back in a short period of time.

Since the terms are shorter, the risks are usually lower. This means that people with poor credit scores or businesses with a rocky history can still get this kind of loan. Rather than an interest rate, some lenders might opt for a single fixed fee. The approval process is typically faster too, which helps in emergency situations.

Merchant cash advance

With a merchant cash advance, you sell a little bit of tomorrow to afford today. You give a lender a portion of your future sales in exchange for money right now.

For example, a lender might give you $10,000, but they’ll take 5% of all of your sales until they recoup $15,000. The interest rate and end amount will vary depending on the lender, the loan amount, and your business’s performance. Typically, the lender gets paid back an installment every day via a withdrawal from your business’s bank account.

Personal loan for business

If you’re just starting up, you’ll probably be facing a personal loan for business. These are built for people who don’t have a record of business or the necessary business documents. 

You’re evaluated for this loan through your personal credit score, and the chances are high that this loan will be secured with collateral. You might be asked to provide your personal income records to qualify.

Crowdfunding

One of the newest forms of loan is crowdfunding. You can choose from a number of online platforms that offer crowdfunding. A lot of investors donate money if your business idea sounds good to them. 

The process is the same as going to a lender for a loan, but in this case, there are hundreds or possibly thousands of lenders listening to your pitch. They all throw in a little bit of money, and typically they gain early access to your product.

On some sites, you have to pay interest or give a portion of your sales to the platform over a certain period of time.

Traditional bank loan

In a traditional bank loan, you get a loan from a bank of your choosing. You present your business paperwork and convince the bank why you deserve the money. The bank will most likely have strict criteria that you’ll need to meet, but it will also offer some of the lowest rates you’ll find. This option is good for any kind of business and is built from your credit and history.

Microloan

Any loan that’s less than $50,000 is considered a microloan. Since the amount is lower, the stakes are usually lower too. This is a good loan if you are starting a business, looking for a small purchase or upgrade, or have bad credit.

If you’re looking to put together a strong email marketing campaign and need some upfront cash, a microloan might be the right option.

SBA guaranteed loan

A Small Business Administration (SBA) loan gets its name from the federal organization that acts as a resource and contact point for small business owners. 

Since the loans are government-backed, you’ll find a lot of them are low-cost. These loans don’t come from the SBA directly — it acts as the middleman for lenders. Part of the overall loan is backed by the SBA, which means better terms and rates for you. Some people might take out an SBA loan to refinance previous loans that their business took on.

Business line of credit

If you watch Shark Tank, you’ve probably heard of a business line of credit before. A line of credit works sort of like a credit card — you have a limit of money that you can use for your business. You can take out as much money as you need, up to the limit.

This type of business loan is good if you’re not sure exactly how much money you’ll need. It’s a good alternative to cash-flowing your business since you only pay interest on the money you pull out and there’s a flexible amount.

Business credit card

A business credit card is a lot like a line of credit. It’s used to finance daily purchases and has the same rewards, signing bonuses, and benefits that you might find on your personal credit card.

It can be used for smaller sums of money on a more regular basis. It typically doesn’t accrue interest unless the balance goes unpaid for a certain amount of time. 

Equipment loans

If you’re running a business that needs special equipment in order to operate, you might consider an equipment loan. These loans are specifically used for equipment and can’t be used in other parts of your operation.

You get the benefit of immediately buying the equipment without the cash on hand. The interest rates can vary depending on how expensive the equipment is. You need to give a good explanation to the lender how this piece of equipment will help your business and make you more money.

Commercial mortgage

Just like a personal mortgage, a commercial mortgage gives you the cash you need to buy property. This is a loan used in commercial real estate to purchase a building, upgrade a building, buy a lot and build on it, or flip a building.

A commercial mortgage is usually structured over 20 or 30 years with interest rates that more or less mirror consumer rates. If you’re going to be making money in the real estate market, this could be the right choice for you.

Online loan

If you don’t want to deal with the long process of getting a bank loan, you can try an online loan. You’ll wind up paying a much higher annual percentage rate (APR) and will need to agree to a more aggressive payment schedule. In exchange, you’ll get the money much faster.

Sometimes the loans get approved the same day and you get the money the following day. If you can’t afford to wait but you can afford the extra interest, this could be a good choice.

Invoice financing

If you need help with unpaid invoices, invoice financing could be your solution. In this case, you can sell your unpaid invoices to a third party, which gives you a lesser amount in cash upfront.

If you can’t afford to wait for your client to finally pay their invoices, you can settle for less money with this type of financing. The party that you sell the unpaid invoices to will pursue your clients and get the final payment for themselves. If not, they might sell the invoices to yet another party that puts the invoices through a collection service to get paid.

At any rate, this is a way of cutting your losses if you’re afraid a client won’t pay or you can’t afford to keep waiting.

Useful terminology

Shortly, you’ll learn the five steps of getting a business loan. Before that, it’s helpful to learn some useful terminology in business loans that will help as you go through the process.

Terms

The term is how long it will take to pay off your loan. In most cases, the term will be established when you first sign the paperwork.

Principal

The principal is the amount of money that you’re borrowing. It doesn’t include any fees or additional payments due. Taking out a $100,000 loan means that your principal is $100,000.

Interest

Interest is money that you owe on top of the money that’s lent to you. The total amount of interest is determined by the interest rate and the number of months or years that you choose to pay off the loan. 

Some loans might be structured so that you pay a majority of interest at the beginning of the loan before chipping away at the bulk of the principal.

APR

APR stands for annual percentage rate. This takes into account the term, principal, interest, and all fees. 

Cash flow

Cash flow refers to how much money is needed for daily, weekly, monthly, and yearly business. It covers all day-to-day expenses. If you look at your business’s bank account, you’ll get a snapshot of your cash flow.

Default

Default is a word you don’t want to hear during this process. It means that you couldn’t meet your arranged terms for your loan, which could result in late fees, a lower credit score, and other penalties.

How to get a business loan in 5 steps

1. Gather what you need

The first step of getting a business loan is the most crucial. For a lot of lenders, you’ll have only one chance to make a case for yourself. If they think it’s too risky, you won’t get the loan. If you don’t have the answers to their questions or know your operation inside and out, they might consider you a risk. So what do you need to have and know?

  • Your business’s annual revenue
  • History and performance of your company
  • Your personal and business credit scores
  • Your purpose for the loan
  • Any collateral that you can bargain with
  • A business plan
  • How much working capital you need
  • Tax returns, bank statements, relevant contracts, licenses, and registrations
  • Unpaid invoices

When in doubt, bring the information anyway. You want to make sure you can answer any questions from the lender. Be prepared to defend any black marks on you or your company.

2. Determine which loan is right for you 

The purpose of the previous section was to teach you about the types of loans and prepare you for this step. Consider the different loan types and determine which one might be right for you.

If you have questions, you can always reach out to a local lender and ask for their advice. Alternatively, you can ask a friend who owns a small business for their insight.

3. Shop between lenders

This is an important step. Just like when you get a quote for a project, you want to make sure you have multiple options to consider.

You’ll notice varying terms and interest rates among lenders. By fielding multiple lenders, you’ll be able to walk away with the best deal. You can shop between banks, online lenders, lender marketplaces, and peer-to-peer lenders. As you go through the process, you’ll learn more about what questions to ask and how to present your information.

4. Fill out an application

If you like the terms and rates that the lender offers, you can fill out an application. This process can be lengthy, but as long as you have all the right paperwork and answers from step 1, you’ll get through it successfully.

5. Wait

After applying, it might take between a day and half a year before you hear back. Keep in mind that there’s a chance your application could be denied. During this time, all you can do is focus on your business.

When is the right time for a business loan?

A big loan can change the trajectory of your business for better or for worse. As long as the timing is right, you have a good chance of coming out ahead. If you’re on the fence, here are some helpful points to consider:

Will this money unlock future money?

This is the question you need to ask yourself before getting a business loan. If you take out this loan, will you somehow unlock future money? More specifically, is a lack of money today the reason you may not succeed tomorrow?

Keep in mind that with any of these loan types, you’ll pay back more money than you receive and there is a level of risk associated with it. However, if a loan will unlock the future of your business and lead to more money, there’s no reason to shy away.

Look long-term

Looking long-term is another way to gauge the need for a business loan. Don’t just think about a month or two down the line. If you receive this loan tomorrow, what difference does it make five years down the road?

By zooming out and looking at the loan in the grand scheme of things, it will help you avoid making an impulse decision that hurts your company. Sure, everyone wants to have more money — but not if that money hurts you down the road.

Expansion

One of the most common reasons that people take out a business loan is to expand to a new location. If you do some market research and find a prime location, you’ll be looking around for money to make the jump.

The loan will give you the money that you need to expand and open at a new location, thereby creating a new stream of revenue and more money. Just be sure you’ve done your homework and the numbers work out.

Cash flow management

Some industries rely on big and infrequent purchases from clients. This leads to a cash flow problem. If you’re in a situation where you have invoices that need to be paid or you’re living in a feast-and-famine cycle, you might consider a business loan.

This loan will make sure you stay open in the interim and don’t come up short when payday approaches. A business loan could be an umbrella during this storm. As long as the invoices are guaranteed to be paid, there’s a lower risk for these loans. Even short-term microloans might work in situations like this.

Building your business credit score

How to get a business loan - improve your credit score - try for "very good" or "exceptional"
An example of a credit score for your business. | Source: Experian

Credit is built by paying off current loans and showing that you’re a responsible recipient of debt. Some businesses might take out loans to build their business credit score. This higher score will allow you to make bigger decisions in the future. By taking on small loans and paying them on time, your score will rise.

What’s the wrong reason for a business loan?

On the flip side, a business loan could harm your company. If you’re not ready to take on debt, you could get stuck in a hamster wheel. It might lead to making bad decisions that hurt your business. Take a look at some of the wrong reasons to take out a business loan:

For a big risk

You should never take out a business loan if there’s a huge risk associated. In other words, don’t take a business gamble with your loan. If the gamble doesn’t work out, your company could be in trouble.

Hoping and crossing your fingers won’t work in the business world. You need to have a clear plan with an understanding of what this money goes toward, what it will do, and how you’ll get the money back plus more.

An example of a big risk might be buying a piece of equipment or expanding to a location without knowing anything about how it will work out.

If the terms are bad

You should never sign a loan that asks for terms that you know you can’t hit. Some lenders put together very unfavorable terms if they think you’re a high-risk borrower. This doesn’t mean you have to agree. In fact, they might hurt you a lot in the long run and ruin your business. Carefully consider the terms before agreeing to anything.

After maxing out your current lines of credit

Taking on loans after maxing out your current lines of credit will hurt your business’s credit score. By lowering your credit score, you’ll have a harder time taking out loans in the future and the terms will be worse.

Try to pay your current debts before taking out more. Having too much debt on the books could hurt the terms of any loan you get.

Trying to climb out of a financial hole

Taking on debt to escape debt is a never-ending cycle. If you’re too caught up with debt, you won’t be able to progress your business. There are other ways to fix the finances of your business without incurring more debt.

Why you might get denied

Certain businesses aren’t going to get approved for a business loan. If you fall into one of these categories, you might get denied:

  • Your business is brand new. Some lenders don’t want to take on this risk.
  • You don’t make enough money. If you don’t demonstrate a track record of making money, a lender may doubt your ability to pay them back.
  • You can’t afford the payments. If the lender knows you won’t be able to meet their terms, they won’t gamble their money on you.
  • You have a poor credit score. Poor credit might be the result of not paying back a previous loan. A lender might deny your application or ask for aggressive interest and terms.
  • No business plan or forecast. If you don’t know what you’ll do with the money, your lender has no idea how they’ll get their money back.

Conclusion

Understanding how to get a business loan might be the first step in massive growth for your business. Make sure you understand when and when not to get one, and follow the five straightforward steps for getting a business loan.



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