If you have a business, it’s probably just a question of time before you’ll be needing a business loan.
And if you do, you’ll be glad to know that you have several options.
Which one you’ll choose will depend on the type of business you have, the amount of money you need, the purpose of the loan proceeds, and the strength of your business and credit profiles.
Guide to Business Loans
Why You May Need a Business Loan
When you first launch a business, the most typical sources of financing and capital are personal savings, credit cards, home equity lines of credit, or even 401(k) loans. Alternatively, you may also obtain financing from family and friends.
They’re all reasonable sources, considering there’s usually no alternative. But once your business is up and running and has proven to be stable, you’ll almost certainly want to build credit specifically for the business.
There are several reasons why you will:
- To let the business function as a separate financial entity. As the business grows, you’ll increasingly want to separate your finances from those of the business. At a minimum, this will make tax preparation and financial statement compilations simpler and cleaner. It’ll also simplify your personal finances.
- To provide legal protection. If a loan is taken by the business, you may not be personally liable. This could become very important if the business fails, or needs bankruptcy protection.
- To grow your business. As your business grows, financial demands will increase. The ability of the business to borrow money will enable you to finance that growth.
- Keeping your cash flow available. Every business has ongoing expenses to cover. Having access to capital from business loans will keep your cash flow free to meet current expenses.
How to Apply for a Business Loan
Since there are different types of business loans available, criteria and requirements can vary widely. But as a general rule, you should be prepared to furnish some or most of the following:
- Application: completed loan application, which may be much more detailed than the kind you’ll fill out for a personal loan.
- Personal information: from you and other owners, including name, address, SSN, annual income, personal assets, and whether or not you’re homeowner.
- Credit report: Expect the lender will pull a personal credit report, especially if the business is new to borrowing.
- Basic info on the business: type of business, the age, legal structure (corporation, partnership, LLC, etc.), and annual revenues.
- Financial documentation: business and personal tax returns, recent financial statements, and several month’s business bank statements to verify cash flow.
- Loan amount requested, and its intended purpose.
- Business plan: Some lenders ask for a business plan which should spell out the future direction of the company.
- Payroll: If the business has employees, the lender may request payroll records (and also to confirm payroll tax payments are current).
- Other debts or significant liabilities of the business.
The lender may also have very specific requirements. This can include a minimum amount of time in business, or a minimum gross revenue requirement, such as $100,000 per year, or $10,000 per month.
As you’ll see in the next section however, there’s a loan source for just about every business type. That means if you don’t qualify for one loan type, there may be another available.
Business Loan Sources
There was a time when the primary source of business financing was banks. And while they still figure significantly in the mix, there are other sources.
Exactly which one you will choose will depend on the type and strength of your business, as well as the specific financing needs you have. Carefully evaluate each lending source against your business needs.
Commercial banks are a mixed bag. On one hand, they can offer a variety of business banking services, in addition to loans.
For example, many provide merchant accounts for credit and debit card transactions, support for international transactions, payroll services, and business checking accounts.
But the flipside is that commercial banks generally have the strictest business loan requirements. For example, they generally don’t like upstart businesses.
Here are a few key factors you should be aware of if you’re considering commercial banks as a lending option:
- Age: Most will require you to be in business for at least two or three years before they’ll even consider extending a loan.
- Cash flow: They’ll have fairly high minimum cash flow requirements
- Documentation: They’ll request a lot of documentation, more than some other lending sources.
- Options: You’ll have a choice of many commercial banks to work with.
- Versatility: Large banks, like J.P. Morgan Chase and Wells Fargo, usually have the widest variety of loans, which can include equipment financing, commercial mortgages, and loans specific to certain business types.
The downside with large banks is that they usually work with larger clients. For example, they may require minimum annual revenues of $1 million or $5 million. If you’re a small business, it may be best to work with a small, local bank.
They may not have the variety of services or loan types the big banks do, but they may be more willing to work with you. But just like the big banks, their requirements are likely to be tougher than other types of business lenders.
Peer-to-Peer (P2P) Lenders
P2P lending has come on strong in recent years, and they have a niche for just about every loan type. You can play P2P loans one of two ways.
The first is through a personal loan. Typical P2P lenders will allow you to borrow as much as between $35,000 and $40,000 for virtually any purpose as a personal loan.
Of course, this is not a business loan in the true sense. But if you absolutely need funding for your business, particularly if it’s new, this is a definite option. And best of all, P2P personal loans require no collateral.
But as the P2P space has grown, there are now lenders specifically offering business loans. Examples include:
Lending Club for Business Loans
Lending Club offers business loans, as well as personal loans. You can borrow up to $300,000 to purchase equipment or inventory, refinance existing debt, or cover current business expenses. Loan are fixed rate, with terms from 1 to 5 years, and interest rates ranging from 9.77% to 35.71% APR.
Lending Club requires you to be in business for a minimum of 12 months, and have at least $50,000 in annual sales. You must also own at least 20% of the business and have fair or better personal credit. They don’t permit recent bankruptcies or tax liens.
Loans under $100,000 require no collateral, and you don’t need to provide either a business plan or business projections. However, on the downside, they do require an origination fee of between 1.99% and 8.99% of the loan amount.
Exactly how much you’ll pay in both origination and interest will depend on your credit profile and the strength of your business.
Funding Circle is a P2P lender dedicated to business loans. You can borrow anywhere from $25,000 to $500,000 and there is no minimum annual gross revenue requirement. They do however require a minimum of two years in business.
Loan terms are from six months to five years, with interest rates ranging from 4.99% to 27.79%. There is no prepayment penalty, and the origination fee ranges between 3.49% and 7.99%. And like Lending Club, proceeds can be borrowed for just about any purpose.
StreetShares is one of the more interesting business P2P lenders.
They specialize in loans for veteran owned businesses, though anyone can apply.
But in addition to standard term loans, they also offer business lines of credit and contract financing. Term loans can be from $2,000 to $250,000, with terms of three months to three years. To qualify, you must be in business at least one year and have at least $25,000 in annual revenue.
You will be required to provide a personal guarantee on the loan, and you need a minimum credit score of 600. Interest rates can range between 8% and 39.99%.
Business lines of credit can be for $5,000 up to $250,000, and with terms up to 36 months. You can draw funds when you need them, and pay interest only on the amount outstanding. It’s a good way to have financing available on short notice.
Merchant Cash Advances (MCAs)
This is an entirely different type of financing. In fact, it isn’t even a loan. The lender provides a cash advance in exchange for a percentage of your daily credit card and debit card receipts.
The advantage with MCAs is that they’re typically not dependent on your personal credit or specific collateral. Since they’re tied to card revenues running through your bank, that cash flow represents both the collateral and the repayment source.
The downside of MCAs is that they’re expensive. A lender might advance you $10,000, but require $12,000 in repayment in just a few months.
Here are the basics of MCAs:
- Loan amount: Anywhere from a few thousand dollars to a couple hundred thousand dollars. It depends entirely upon the cash flow being generated by your card sales.
- Cash flow: What you get depends entirely upon the cash flow being generated by your card sales it and debit card sales.
- Repayment: Can be based on either a flat monthly amount, or a percentage of your credit and debit card sales.
- Qualifying: To qualify, you’ll typically need to provide several months bank statements, proving your credit and debit card sales. Your loan amount will be based on that cash flow.
Put another way, MCA’s are easy to get, but they’re expensive. What’s more, the term is typically limited to no more than a few months.
They work best for businesses that can’t get financing from any other source, and need it for only a short-term. Think of them as a last-ditch effort. Examples of MCA lenders include CAN Capital, Credibly and National Funding.
Small Business Administration (SBA) Loans
SBA loans are a small business loan program provided by the US government, though it’s typically available through participating banks. In fact, banks actually make the loans, but they’re guaranteed by the SBA.
Because of that guarantee, they carry lower interest rates than other types of business loans, and are also available for upstart businesses.
You can borrow anywhere from $500 to as much as $5.5 million for your business. Money can be used to purchase assets (including real estate) or provide operating capital.
To qualify, you must be a for-profit business and have invested equity. You also must be unable to get funds from any other loan source. You may even be able to qualify if you have bad credit.
Loan terms range from five years to 25 years, with interest rates as low as 6.75%.
And though the terms and interest rates are lower than other business financing options, SBA loans are very complicated to apply for. They require a considerable amount of paperwork, as well as longer approval times. Loans may also require collateral.
If you’re interested in applying for an SBA loan, check with banks in your area that participate in the program.
What to Watch Out For with Business Loans
Borrowing always involves risks. That’s also true with business loans. Here are a few you need to be aware of:
Business loans can be complicated
Business loans aren’t standardized like personal loans. Since each business is different, each lender has its own terms.
For example, the loan may require the business to meet certain financial minimums, such as liquid assets and cash flow. And on large, long-term loans, they may require financial statements periodically.
Have any business loans carefully reviewed by an attorney who specializes in this field. It’ll take a trained eye to spot and clearly explain some of the “gotcha provisions” lurking in the details.
The lender may require a personal guarantee
One of your main goals should be to have the loan completely in the name of your business.
But in many cases, the lender may require some sort of personal guarantee. That will be true on your first few business loans, or if the lender has any concerns about the strength of your business.
If you default, your livelihood will be in jeopardy
If you default on a personal credit card, the lender can freeze your credit line and begin a collection process.
But if you default on a business loan, it’s possible the lender can put you out of business.
Not only will you have a defaulted loan, but you may also lose your income.
Don’t get carried away with business loans
The debt service on any loan will cut into your business cash flow. It may even impair your ability to pay other expenses, like rent, inventory, payroll or outside vendors. This is another excellent reason to keep business borrowing to an absolute minimum.Never borrow more than the business can comfortably afford to repay,
Final Thoughts on Business Loans
If your business has reached that point where financing is necessary, you might want to investigate each of these loan sources. For example, you might start with a commercial bank, since it offers an opportunity to develop a business relationship.
But if you can’t get a loan there, you can try the P2P route. And only if that doesn’t work, you may want to look into MCAs.
If your business is brand-new, bank loans and MCAs won’t be an option. You may want to start with a personal loan from a P2P lender. Or, if you’re willing to deal with the hassle, apply for an SBA loan.
If none of those sources work, you may not be ready for a business loan just yet. But once you’re in business for a couple of years, and you’ve established a stable cash flow, you should be able to find lenders willing to make you a business loan of some type.