Learn how you can access capital for your business with the best small-business lenders.
Small-business loans can help you start or expand a business and even keep it afloat during a disaster, such as the pandemic. Loan programs from direct lenders and the Small Business Administration can infuse working capital and other financial support when you need it the most.
Read on for more about small-business financing options, including SBA loan programs, working capital loans and real estate loans. Find out how you can choose the best business loan to establish, grow or maintain your small business.
What you’ll learn:
- How do small-business loans work?
- What small-business loans are available?
- Who can apply for a small-business loan?
Methodology: U.S. News conducted an in-depth review of the best small-business loan companies to recommend the best business loans from traditional and alternative lenders. Factors including customer service ratings, product availability and loan terms were used to select the best small-business loan providers.
These lenders are a good starting point for most businesses. But there is no one-size-fits-all loan that is perfect for every business, so you should carefully research each small-business financing option yourself.
Small-business loans are used for business expenses. Some loans are for general business funding, and others, such as working capital loans, real estate loans orequipment financing, are for specific uses.
Typically, small-business term loans offer a lump sum that you’ll pay back with interest over time. But you can select from a variety of business loan types and should research your options to find the best fit.
Consider the types of small-business loans you can choose from:
SBA loans. The SBA partly backs loans from lending partners, reducing their risk and improving access to capital for small businesses. Four main SBA programs – 7(a), 504, microloans and disaster loans – provide funds for most business purposes.
Term loans. A business term loan delivers a lump sum with a fixed term and repayment amount. Each payment includes principal and interest.
Business lines of credit. Business lines of credit are similar to credit cards and can be used to purchase inventory or equipment, invest in marketing, or manage seasonal sales fluctuations. You can borrow from your credit line as needed and only pay interest on the amount you use.
Equipment loans. Equipment financing is a type of term loan that can be used to purchase and spread out the cost of machinery or equipment for your business. Usually, the equipment is collateral for the loan.
Invoice financing. If your small business struggles with cash flow because you’re waiting on invoices to be paid, you can use invoice financing, also known as factoring. With invoice factoring, you sell your unpaid invoices to a lender at a discount.
Merchant cash advances. With a merchant cash advance, the lender provides you with a lump sum based on your future sales, usually at a high cost.You’re responsible for paying the amount of the loan plus fees, either as a cut of your sales or with fixed daily or weekly transfers from your business bank account.
Real estate loans. A commercial mortgage is a term loan used to buy, develop or refinance commercial property, such as a warehouse, mixed-use building or retail center.
Franchise loans. These loans can help with standard business opening expenses and franchise-specific costs, such as marketing fees or the franchise fee, which you pay upfront to open a franchise. Some franchisors may offer funding to help you establish your franchise.
The SBA partly guarantees loans made by approved commercial lenders and provides disaster assistance loans. Federal backing aims to reduce risk for lenders and help small businesses get loans. Here is more about the SBA’s loan programs:
7(a) loan program. The Small Business Administration’s primary lending program, 7(a) loans are the most common and flexible type of SBA loan. SBA’s 7(a) loans can be used for many purposes, including working capital, business expansion and equipment purchases. Special 7(a) loans help with short-term capital needs and international trade and export activities.
Borrowers apply through participating lenders and repay loans in monthly installments.
For businesses that need quick access to funding, the SBA Express loan program streamlines the application process. You will receive a response within 36 hours of applying, compared with five to 10 business days for a standard 7(a) loan. The maximum loan amount is $500,000, and the SBA provides a 50% guarantee.
Microloan program. New or expanding small businesses are eligible for loans of up to $50,000. These loans can be used to fund working capital, inventory, equipment, furniture, supplies or machinery. Microloans can’t be used to pay debts or to purchase real estate.
504 loans. This SBA loan program provides businesses with long-term, fixed-rate financing for major assets. The maximum loan amount is generally $5 million, with 10-, 20- or 25-year repayment terms. Certain energy-efficient or manufacturing projects may qualify for more than one 504 loan of up to $5.5 million each.
Disaster loans. These low-interest loans made directly by the SBA can be used to recover from a declared disaster. Businesses may use disaster loans to repair or replace machinery and equipment, inventory, and real estate that was damaged or destroyed.
The SBA also offers economic injury disaster loans in declared disaster areas to cover working capital and normal expenses, such as rent, utility and fixed debt payments.
Your business must meet these general SBA loan requirements, including:
- Operate for profit.
- Do business in the U.S. or its territories.
- Have reasonable invested equity.
- Explore alternatives, including using personal assets, before seeking a loan.
- Larger loans are available. Small-business loans are typically a lump sum and offer more financing than personal loans.
- Get funding without losing equity. Small-business loans can provide you with the money needed for your business without having to give up any equity to investors.
- Have more flexibility. Many small-business loans can be used for a variety of business needs.
- Significant documentation required. Small-business loan applications can require a great deal of documentation, which may make the process lengthy.
- Limited options with bad credit. Small-business loan applications are based in part on credit, and there are few loan options for businesses with bad credit.
- May require down payment. Some small-business loans require a down payment, such as collateral or capital investment, which could be lost if you default.
You can get a small-business loan everywhere from a brick-and-mortar bank or credit union to an online lender. Here’s what you can expect based on your choice:
Banks and credit unions. They typically serve larger, more well-established businesses, including small businesses. You’ll have a better chance of getting funding from a traditional bank if a loan has SBA backing. Approval could also be easier if you have a relationship with a lender, such as a business bank account.
Online lenders. Their products are similar to what banks and credit unions offer: The difference is no physical branches. Expect a quick and easy online application process for term loans, lines of credit and other small-business financing options.
Some online lenders are considered alternative lenders, which can offer more flexibility than commercial banks because their loan products are less regulated. Alternative lenders provide loans to borrowers that otherwise may not have access to small-business financing, such as startups or businesses with a shaky financial history.
“Small businesses should be aware there are multiple channels available for borrowing needed funds,” says S. Michael Sury, lecturer of finance at the University of Texas–Austin.
Online lenders may offer SBA loan programs. You can also find peer-to-peer lenders online that will connect your small business with investors willing to fund your loan.
Size alone won’t be enough to qualify for a small-business loan. You must convince the lender that your business is worth the risk. Your eligibility will depend on how much your business needs to borrow, your credit and your business plan.
- Determine how much funding your business needs. Examine your business expenses and consider how much you can spend on a loan payment. You can figure out the loan amount your business can afford by calculating your debt service coverage ratio, a measurement of your firm’s cash flow to pay debt obligations.
The formula is simple: net operating income / total annual debt = DSCR.
Lenders are looking for borrowers with a ratio of at least 1. This means your cash flow is equal to your monthly loan payment. But lenders prefer a 1.35 DSCR because it provides a bit of a buffer. If your annual net operating income is $135,000 and your total debt is $100,000, your DSCR is 1.35.
- Check your credit score. Lenders often consider your personal credit, especially with startup financing, but your business credit score may be used if you have one.
“As a sole proprietor, your personal credit may be considered in the business loan application if you are using personal credit to secure the business debt,” says Rod Griffin, senior director of public education and advocacy for the credit bureau Experian. “Doing so is fairly common for a small-business owner.” Note updated title: https://www.experian.com/blogs/ask-experian/author/rod-griffin/
The minimum credit score required for approval varies, but generally, the higher your credit score, the lower your interest rates and the better your loan terms. That’s why clearing inaccuracies on your credit report before beginning the application process is important.
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Note that failure to pay a loan taken out on your personal credit could affect your credit history and ability to qualify for new credit, Griffin says.
- Draft a strong business plan. A comprehensive business plan sets a solid foundation for your small business. Lenders will want to see your estimated costs and projections for revenue, as well as balance sheets for at least two years.
Bad credit business loans are available, but your options may be limited. Minimum credit score requirements depend on the type of loan and the lender.
Make sure you know the credit score you need for the loan you want. If you have a 500 credit score, you may be ineligible for traditional small-business loans and need to consider alternatives such as short-term loans, lines of credit, invoice financing and merchant cash advances.
Expect to pay higher interest rates for these alternatives, and your business plan and your revenue will face more scrutiny. Also, understand that you may not be able to borrow as much as a small-business owner with good credit.
Small-business loans require significant documentation. You’ll need to apply and then provide supporting documents, which often include:
- Resumes for all partners.
- Your business plan.
- Personal and business tax returns.
- Details of other business loans.
- Six to 12 months of personal and business bank statements.
- Documents showing the value of personal or business property that can be used to secure the loan.
- Accounts payable and accounts receivable.
- Legal documents, including licenses, leases, articles of incorporation, and contracts or agreements.
Evaluate eligibility requirements, loan options, costs and customer service to choose the best small-business loan. Focusing on these factors will help you to identify a lender that can approve your loan with acceptable terms and offer good customer service.
Knowing your chances of loan approval can save you time. When researching small-business loans, look for these minimum requirements:
- Credit score.
- Years in business.
Small-business financing options vary widely. As you shop around, consider whether each lender’s offerings meet your needs.
Find a company with the type of loan you’re looking for, such as a term loan or line of credit. Consider the funding’s purpose. For example, you might get a different loan for payroll than you would for real estate.
If a lender doesn’t offer loans in the amount you need, find one that will. Settling for a lower amount could burden you with a loan that falls short of adequately addressing your capital needs.
Your loan’s repayment term is the time frame you have to pay back the loan. Short-term business loans have higher monthly payments than long-term loans, but you will typically pay less in total interest because you have the loan for less time. The opposite is also true. A longer repayment term could mean lower monthly payments but more in total interest charges over the life of the loan.
Keeping loan costs minimal allows you to invest profits back into your business and not back to the lender. Look for a lender with the lowest costs, including:
- APR.Theannual percentage rate is the interest charged on your loan every year, plus all fees and costs associated with the loan. Keep in mind that advertised interest rates may be where rates start; a rate check can estimate an APR for your small-business loan.
- Down payment. In some cases, the down payment for your small-business loan is covered by collateral. Other small-business loans require an equity investment. Down payment requirements vary, but expect to invest at least 10% to 30% of your own capital when taking out a loan.
- Factor rate. A factor rate is typically used for merchant cash advances and short-term business loans to determine how much you will owe in interest. This rate is expressed as a decimal instead of a percentage, as with APRs. Your factor rate is determined by your industry, time in business and stability, and monthly credit card revenue. With factor rates, you generally pay more in interest than with loans that charge APRs.
- Fees. Compare origination and underwriting fees, along with closing costs. If you’re getting an SBA loan, expect a loan guarantee fee.The lender pays this fee and usually passes it to you at closing. Note that lenders can’t charge a separate origination fee on an SBA 7(a) loan, though they can levy packaging fees that are reasonable and customary for the services performed. A small-business loan can also include late payment, check processing and prepayment fees.
Vet lenders online, starting with the Better Business Bureau and the Consumer Financial Protection Bureau. The BBB posts customer reviews and complaints, and the CFPB allows you to search for disciplinary actions taken against a lender.
You can also check with your state attorney general if you have concerns about a lender operating in your state, and check U.S. News’ business loan reviews to gather helpful information.
- Personal loans. Some personal loans are based on credit history, and may not provide as much funding as small-business loans.
- Family loans. If family members are able, you might ask them to loan you money for your business. Family loans can save you money on interest, but they should still include a clear repayment plan.
- Crowdfunding. Crowdfunding allows you to raise money online from a large number of people. In exchange for providing financing, crowdfunding contributors may expect rewards or equity.
- Grants. There are numerous grants available to small businesses, some which target specific sectors or equity groups, while others are for specific needs.