The early phases of starting a company presents small business owners with an abundance of challenges. You’ve spent countless hours creating, designing or building a product or service to alleviate a specific problem. You believe you have the skills and vision to make this new venture a success. However, a lack of funding prevents you from taking your startup business to the next level.
Unfortunately, insufficient funding is cited as one of the main reasons small businesses fail.
CB Insights, a private equity company, researched why many startups fail. Their research found that 38% of small business owners cited a lack of cash or failure to raise additional capital as the main reason for its failure.
Fortunately, there are various ways to raise money for your startup business. One avenue is to obtain a business loan or line of credit.
Since your business is brand-new, you probably won’t have an established credit history or operational history to show a low credit risk. While those circumstances may present challenges for your startup, it’s still possible to get a loan to fund a new business.
If you believe your startup can benefit from a business loan, keep reading to discover the different types of business loans, how the process works and how you can increase your approval odds.
Determine Which Type Of Business Loan You’ll Need
Every business has different funding goals and needs. There is no one-size-fits-all financial solution to obtaining the funds you need. That’s why it’s important to understand the different types of small business loans available.
Here are some common types of loans that can help bring your startup to the next level.
- Business term loan: Most financial institutions offer business term loans as a long-term financing option. Term loans are a lump sum of capital you borrow from a lender. The funds are paid back on a fixed schedule over a specified period, also known as the term. The annual percentage rates (APRs) on the best small business loans can be as little as 6%. The maximum limit may vary depending on your need and qualifications but can generally extend from $250,000 to $500,000.
- Business line of credit: While term loans are good options for long-term financing, a business line of credit is helpful for short-term funding needs. A business line of credit is where the lender extends the funds for a specified amount, and the borrower can access the financing as needed. Interest accrues on the amount accessed per month. Moreover, funds repaid are automatically available for borrowing again up to your credit limit.
- SBA 7(a) loan: The U.S. Small Business Administration (SBA) offers the 7(a) loan program. The 7(a) loan program is the SBA’s most common loan program. It’s designed to help small businesses with financing needs. Eligible borrowers may receive up to $5 million. The funds can be used for various expenses such as long- and short-term working capital, business expansion, purchase of equipment and much more. Interest rates can range from 2.25% to 4.75% on top of a base rate.
- SBA Microloan: The SBA offers another loan program called microloans. SBA microloans are designed to help small businesses and some not-for-profit childcare centers commence and expand. Eligible borrowers may receive up to $50,000. However, according to the SBA’s website, the average microloan is about $13,000. The repayment terms and rates may vary, but generally, they last as long as six years, with interest rates ranging from 8% to 13%.
How To Get A Small Business Loan
The process of getting a startup business loan is similar yet notably different from obtaining a loan for personal needs. When trying to secure a small business loan, you should ensure you’re following these crucial three steps.
- Create a detailed business plan
- Check your business and personal credit history
- Compare lenders and apply
Let’s delve more into these steps and discuss how each one plays a significant role when trying to secure more capital for your new business.
Draft a comprehensive business and financial plan
Creating a detailed business plan can help your business appear more attractive to lenders. As a result, you’ll increase your odds of getting approved for a loan. This is especially important for startups with little or no track record.
A detailed business and financial plan should show lenders how your business will grow, what materials you need to get started, where the funding will come from, sales vs. expenses and how your skills and experience will push the business forward.
Moreover, you should address the future of the company in your proposal. Outline what challenges and victories you may foresee over the next five years to determine the business’s success.
Not sure where to get started?
When drafting your comprehensive business and financial plan, you should include the following elements.
- An executive summary
- A company overview
- Explanation of products or services
- Marketing and sales strategy
- Market and competitor analysis
- Brief outline of the management team
- In-depth financial forecasts
Since your startup doesn’t have a long track record, your proposal will help lenders determine the risk of providing you a loan.
Evaluate your business and personal credit history
With any line of credit or loan, credit scores are an essential metric lenders use to evaluate risk.
Your personal and business credit score are separate metrics. Your business credit score assesses your creditworthiness based on recent behaviors, including if the business has any collections, judgments, liens or bankruptcies.
A good business credit score can help you secure a loan with favorable terms and rates when you have a more established business.
However, as a startup, you may not have built a business credit score yet. In that instance, lenders will depend on your personal credit score and history.
While credit score requirements may vary depending on the type of loan, you generally need a high credit score to obtain a startup business loan.
Lenders understand that approximately 90% of startups fail within the first decade. A respectable credit score may help offset the risk.
Research lenders and apply
Once you’ve drafted your comprehensive business and financial proposal and evaluated your credit situation, it’s time to research lenders for the best terms and rates.
You may qualify for a startup business loan from various lenders depending on your personal and business eligibility. When comparing lenders, you should consider the following factors.
- Annual percentage rates
- Lender reputation
- Fees and other costs
Once you’ve honed in on a lender or two, you should familiarize yourself with the application process and ensure you have all proper documents.
The application process may vary depending on the lender. We recommended getting in contact with the financial institution before starting the application. A loan specialist will point you in the right direction.
