Getting a small business loan is one of the many challenges you’ll face as you start your design business. While it may seem daunting, we’re here to help with a guide that outlines everything you’ll need to do as you learn how to get a small business loan. How do you apply? What are the requirements for securing funding? What types of loans are best for budding entrepreneurs? How can you position yourself as a desirable candidate? Take it step by step, and you’ll discover that funding your new interior design firm is not as challenging as you might think. Here’s what you need to know.
1. Get clear on why you need the loan—before meeting with a lender
Every lender who will consider giving you a loan will ask: Why do you need this loan? How are you planning on using it? Prepare yourself by answering these questions ahead of time. Discern how the funds will help you start and grow your business. Typically, first-time entrepreneurs seek loans for the following reasons:
• To start a small business
A startup loan will provide funds to get your company off the ground, covering all the expenses related to launching a new small business.
• To afford daily expenditures
A working capital loan is a short-term loan option that will help you with your daily expenses until you are generating enough income to cover these costs yourself. This type of lending is often used to pay for invoices, inventory, marketing, and payroll until you start producing a steady stream of income.
• To grow the business
Some entrepreneurs will want to borrow money to make investments in the future of the small business and to help expand the company.
• To have a safety net
Having backup funds is critical to a new entrepreneur’s survival. Unforeseen expenses could pop up, or you might find yourself in an emergency situation if you urgently need to replace a piece of manufacturing equipment or order inventory. Cash-flow gaps often present the biggest challenge for a new small business owner; a working capital loan can help.
2. Figure out how much financing you can actually afford
How much financing you think you need may not coincide with how much you can afford to borrow. Be mindful to not end up in debt. It’s crucial to meticulously calculate how much you can afford in loan payments each month. Consider using an online business loan calculator to gauge what is reasonable based on the type of loan you’re applying for.
3. Decide what type of lender is the best fit for your small business
It can be difficult to secure a loan during your company’s first year, as lenders require cash flow to prove the ability to repay the loan. Often, new entrepreneurs rely on business credit cards, borrowing from friends and relatives, or personal loans. Once you are prepared to apply for your first small business loan, you must first determine which type of loan corresponds with your financial profile, credit profile, and the reasons you’re seeking financial backing.
As a small business owner, you have several lending options. Joe McClure, district director of the Montana District Office of the U.S. Small Business Administration, recommends first approaching the financial institution where you currently do business. “They have firsthand knowledge about you, your character, and your history,” he says. “If your bank says no, don’t be discouraged. Think of it as an opportunity to shop around. Some lenders do not make certain types of loans, so although you may not qualify for a loan at one institution, you may be approved at another.”
Let’s examine which types of lenders best suit your financial profile and your needs.
• Bank loans
The cheapest financing option for small businesses, bank loans can offer interest rates as low as 5 percent. According to Fundera, an online financial resource for small businesses, if you get a loan offer from a bank, you should take it, because it can be difficult to qualify for a bank loan, and it can be a long, detailed, and arduous process. The application can take weeks to complete, and it may be months before you hear whether you’re approved.
To qualify, you need a strong credit score (above 700), you should have personal or business assets to serve as collateral, and it will help if your business is already profitable. It’s a risk for banks to take a chance by lending to a first-time entrepreneur, so being able to show a profitable business will greatly help your chances of obtaining a loan. A bank loan is best for those who want to borrow more than $250,000.
• SBA loans
Though Small Business Administration (SBA) loans are a bit more expensive than bank loans, they are still fairly affordable, are slightly easier to qualify for, and have a simple online application process. SBA doesn’t actually fund the loan, but it guarantees up to 85 percent of the loan amount that’s provided through an SBA-approved lender bank. With the SBA’s support, the loan becomes less risky for the lender, and as such, it’s more likely that you will be approved for this type of loan. But you’ll still need exceptional personal credit to qualify.
There are three types of programs to help you qualify for an SBA loan: The 7(a) program is for loans up to $5 million that can be used for working capital; the microloan program is for loans less than $50,000; and the CDC/504 program is for commercial real estate. The SBA sets maximum interest rates for these loans between 5 and 10 percent.
• Medium-term alternative loans
With a simple online process, you can get approved for a medium-term alternative loan and receive the funding (from $50,000 to $2 million) within two weeks—making this an excellent lending option for small business owners. However, interest rates fluctuate and can go up to 20 percent, which is more than twice that of a bank or SBA loan. Repayment terms are between one and five years.
• Short-term alternative loans
There are a lot of positive things about short-term alternative loans: Your loan can be approved and funded on the same day that you apply; you do not need to have above-average credit to qualify (a credit score above 500 is required); and it’s possible to be funded if you’ve only been in business for a year. However, all these conveniences come at a price: APR on short-term loans can range from 8.5 percent to a whopping 80 percent, depending on your credit profile. Your repayment plan is just three to 18 months with a program of daily or monthly payments.
• Business lines of credit
Functioning similar to a small business credit card, a business line of credit allows you to borrow money from a pool of funds as needed; once you repay what you borrow plus interest, the funds become available for you to borrow again. This is an easy way to gain access to cash in a pinch.
• Invoice factoring
Potentially a good fit for you if you tend to have clients who are slow to pay (and, as a result, you end up short on cash), invoice factoring allows you to collect on outstanding or delinquent payments. An invoice factoring company will advance you a portion of an invoice amount while holding the remaining amount in reserve. You’re charged a fee (around 1 percent) on the reserve amount for every week the invoice is unpaid, but once your client pays up, you receive the reserve amount in full, less the factor fee. This lending method is popular among small businesses due to the fact that it’s easier to qualify for than other loans.
• Equipment financing
This type of loan specifically covers purchasing equipment. The lender covers the upfront cost of the equipment, and you pay back the loan with fixed monthly payments plus interest at a rate of 8 to 30 percent. It’s easy to qualify for an equipment financing loan because the equipment serves as collateral.
• Merchant cash advances (MCAs)
With the loosest eligibility standards, a merchant cash advance is also easy to obtain, but this is by far the most expensive type of lending. A financing company will advance you lump sum money that you pay back with a percentage of your daily credit card sales. While this method puts cash in your hand quickly, it ends up being expensive in the long run. It’s best to go this route only if you’re unable to qualify for any of the other lending options.
4. Verify that you’ll qualify
Before you go through the process of formally applying for a loan, do some research to make an educated guess as to whether you will qualify. For any type of loan, these are the factors that go into approval:
• Your credit score
It’s advisable to get a copy of your free credit report every year, but at the very least, you should find out your credit score before applying for a loan. You wouldn’t want to waste your time applying for a bank loan or SBA loan if your credit score isn’t excellent. But you still have options with not-so-stellar credit, such as short-term loans from microlenders. Know where you stand before you begin the process.
• How long your small business has been running
Unfortunately for first-time entrepreneurs, your small business usually needs to be up and running for at least a year before many financing companies will even consider lending you funds. And banks will usually require two years in business.
• Your annual revenue
Lenders often require a minimum annual revenue, usually from $50,000 to $150,000. Do the math to confirm whether your annual revenue falls within this range.
• Whether you can afford the repayment plan
Be realistic when you look at your company’s finances. Come up with a budget based on revenue and expenses to figure out exactly how much per month you’ll be able to repay on a potential loan. Use a business loan calculator to plug in the numbers and see what you can afford.
5. Organize all your documentation
Now that you’ve reviewed your options and have a sense of what type of loan is right for you, it’s time to gather your paperwork to complete your loan applications. Regardless of the lender, the bare minimum you'll need on hand includes the following business and personal documents: tax returns; bank statements; financial statements; and any legal documents, such as articles of incorporation or a commercial lease.
Fundera provides a more in-depth 20-point list of information and documentation needed to apply for a small business loan, though your bank or lender will have their own requirements. Here’s a helpful checklist of what to have on hand before you begin the application process:
Personal Credit Score
Business Credit Score
Time in Business
Business Licenses and Permits
Employer Identification Number (EIN)
Proof of Collateral
Annual Business Revenue and Profit
Personal and Business Tax Returns
Copy of Your Commercial Lease
Disclosure of Other Debt
Accounts Receivable Aging and Accounts Payable Aging
Ownership and Affiliations
Legal Contracts and Agreements
6. Apply for, and secure, your loan
You’ve done all your homework, and now it’s time to begin the formal application process, either online or on paper. You can apply for several small business loans within a time frame of about two weeks, so it’s a smart call to compile all your documentation and submit your applications all at once. Don’t apply for more than three loans, as each lender will pull your credit report, which can affect your credit score.
After you’ve applied, the lender will let you know if you’ve been approved, and then your loan enters the underwriting process, which is when all of your information is verified. Provided all documentation is copacetic, you will receive the formal loan agreement to sign. But before you freely provide your John Hancock, carefully review the document: Make sure you understand the terms of the loan, interest rate, repayment schedule, and any fees you may incur. Once you feel comfortable with this loan agreement, sign on the dotted line and get ready to grow your business.