Are you looking for information on how to get a small business loan?
Maybe you’ve already tried to get one, but lenders rejected your application?
We’re not going to sugar-coat it — getting one can be a challenging endeavor. To make it easier, we’ve put together a concise 4-step guide to walk you through the entire process.
Whether you’re running a startup or directing an established company with plenty of banking experience, the following 4 steps outlining how to get a business loan will greatly increase your chance of success.
Step 1: Understand Why You Need a Loan
Step 1 may sound a bit self-evident. However, you’d be surprised by how often people start asking about how to get a business loan without really knowing why they need one in the first place.
If you can’t explain why you want the loan and what impact it will have on your business, you’re going to run into problems. A lack of planning won’t look good to potential lenders.
It’s important to know exactly what you’re after, and to be able to clearly elaborate on it.
Some common reasons people apply for a business loan include:
- Starting up a business
- Building a financial safety net for a business
- Financing development
- Expanding (markets or locations)
- Hiring employees
By way of example, let’s introduce Alexander, owner and CEO at Alexander’s Awesome Anvils®. Alexander is looking to add a new product to his portfolio. When preparing to apply for a business loan, he might write down something like the following:
I am seeking a loan to fund the addition of a sixth anvil to my highly popular existing line of five fair-trade handcrafted anvils.
Unlike my other anvils, anvil #6 will be forged entirely of pure platinum by monks in the mountains of Japan. I have secured an exclusive contract with these monks, so this anvil will be unique to my company.
I have also identified a new audience segment of upper-class young adults interested in such a luxury product, which would allow me to repay the loan without issue.
Lenders who see such specificity will be much more likely to consider your loan application. Put in the effort, and you’ll be able to make your pitch as compelling as possible.
Step 2: Determine How Much You Need to Borrow
Once you’ve completed step 1 and determined the why, it’s time to ask how much.
The most important thing here is to be realistic. Don’t try to borrow more than you actually need, and definitely don’t try to borrow more than you’re able to repay.
Potential lenders will want to know about something called your debt-service coverage ratio (DSCR). Here’s the basic formula for calculating DSCR:
Annual net operating income / annual debt obligations (including principal and interest)
Your income should be a good amount higher than your debt obligations. In the context of how to get a business loan, you should plan for a DSCR of 1.25 to 1.35. The exact figure will vary depending on who you’re applying with, but in general that’s a good range to shoot for.
Continuing now with the Alexander’s Awesome Anvils® example – Alexander’s annual net operating income is $180,000, and his annual debt obligations come to $100,000.
So, he divides 180,000 by 100,000 and calculates that he has a healthy DSCR of 1.8. This means he can take on an additional $35,000 or so of debt and still be in a pretty good place financially.
Step 3: Establish The Type of Loan You Need
There are several different kinds of lenders you’ll come across when researching how to get a business loan.
- The U.S. Small Business Administration (SBA)
- Credit unions
- Nonprofit microlenders
- Online lenders
- Crowdfunding sites
- Small business grants
- Payment processors offering merchant cash advances
What kind of lender you get a loan through will largely be determined by things like how long you’ve been in business, how high your credit score is, and how much your annual revenue is.
Traditional & SBA Loans
Traditional bank loans and SBA (Small Business Administration) loans provide the highest loan amounts, longest repayment terms, and lowest interest rates. But, you’ll have to work hard to earn one of these loans. These loans typically require companies to have 1-2 years of healthy revenue history, plus good credit.
If you’ve been in business for a while, can show a good stable annual income (anywhere from $50,000 to $150,000), have good credit (above 680), have collateral to offer, and don’t need money super fast, you’ll probably be able to land an SBA loan or a bank loan. These lenders will also appreciate it if you’re personally invested in your company.
Startups, however, tend to have difficulty getting a traditional loan because they don’t always have collateral or a cash flow in place to support repayment. If you’re a startup, you’ll probably need to rely on other sources of financing, such as nonprofit microlenders or online lenders. The downside with many of these lenders is they often have higher interest rates and larger down payments.
If you need a loan with bad credit, online lenders are probably the only way to go. They may have the highest interest rates, but their approval rates are higher, too.
Merchant Cash Advances
One other option for businesses with at least a little bit of credit and profit history is to apply for a merchant cash advance. Merchant cash advances are nice because they don’t require collateral, they don’t have fixed payments, and they get you cash fast — usually within 24-48 hours of being accepted. The downsides are a higher APR and the fact that you’re tied to the same payment processor for the duration of your contract.
And remember: Whatever loan you apply for, be sure to analyze the terms and ask smart questions. For example:
- What are the minimum requirements?
- Is the interest rate variable or fixed?
- What is the payment frequency?
- Is there a loan origination fee, or any other associated fees?
- Is security or collateral required?
- How long will it take to get the funds?
- What’s the interest rate?
Our friend Alexander at Alexander’s Awesome Anvils® has been bringing in a stable income for about 3 years now, and he has excellent personal and business credit with a strong DSCR. He’s also got a whole warehouse full of fair-trade handcrafted anvils to put up as collateral. So, Alexander’s planning to apply for an SBA loan to fund his new product launch.
Step 4: Assemble the Necessary Documents
You’ve done your research on how to get a small business loan — now it’s time to get your documents lined up and ready to go.
Depending on the lender and type of loan you’re applying for, the necessary documents will vary. But there’s one you can pretty much always count on:
The Business Plan
Every lender will want to see a detailed business plan, and the more specific it is, the better. Your business plan should provide at least the following:
- Business overview
- Product or service description
- Organizational structure
- Market, industry, and competitor analysis
- Marketing and sales strategy
- Financial plan and projections
To improve your chances of getting a loan, consider having your business plan audited or reviewed by a certified public accountant. The extra expense is likely worth it, because it will build your credibility.
Other Documents You’ll Likely Need:
- Business and personal tax returns from the past 3 years
- Business and personal bank statements
- Business financial statements and projections
- Business legal documents
- Federal tax ID
- State filings
You may also have to provide a copy of your business insurance policy. If you’re planning on running your business from your home, your physical assets (like your stock and equipment) may be covered by your preexisting homeowners or renters insurance.
Make sure your online presence is pristine, too. Lenders will be paying attention. You’ll want your social media accounts to be polished and professional.
And if you don’t already have a website, consider hiring a designer to build you a snappy one. Or you can create one on the cheap using WordPress.
Are You Ready to Get Your Loan?
Well, that brings us to the end of our 4-step guide on how to get a business loan. We hope you’ve found it enlightening!
And as a last note – if you’re looking for a business loan, you might also be interested in saving money on payment processing. There are other options out there — don’t get stuck with a bad deal!
Sources & Additional Resources
The SBA has all kinds of great learning resources for small businesses. Here are a few of our favorites:
- How to Write a Business Plan
- Legal Requirements for Small Business
- Financial Options for Small Business
- 10 steps to start your business
- Introduction to Accounting
And here’s a list of sources we consulted for this article, which we think you might find useful:
- Business News Daily: 6 Factors That Keep You from Getting a Small Business Loan
- Entrepreneur: What Does It Really Take to Get a Small-Business Loan?
- NerdWallet: Microloans: 13 Top U.S. Nonprofit Lenders
- NerdWallet: Small-Business Grants: Where to Find Free Money
- U.S. Small Business Administration: Funding Programs: Loans