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Depending on the type of business you are starting, there could be a considerable amount of upfront costs involved in getting your company up and running. Getting into certain industries will require a significant amount of money to cover the initial startup costs. Alternatively, if you already have an existing business, but are looking to grow and develop it, you may also need access to more capital.

Whichever is the case, if you don't have access to this sort of capital, you will have to seek it out. One of the best ways you could do this is by applying for a business loan. In this article, we will discuss what you need to know about getting a business loan for an existing or new business. This will include the following topics:

Secured Loans versus Unsecured Loans

There are a wide variety of business loans out there, but all will either be secured loans or unsecured loans. Secured loans are backed by collateral, assets you own, such as your home or vehicle, that your lender can take possession of if you fail to pay back the loan. This provides the lender an avenue of recourse and a form of financial protection if you don't repay the loan. It also motivates the borrower to pay back the loan on time. By providing collateral through a secured loan, you can generally receive better interest rates and terms on your loan and can be more likely to be approved.

Unsecured Loans don't require any collateral and are a higher risk loan for the lender. Generally speaking, this higher risk and uncertainty means that getting approved for these types of loans will be more difficult, as there will be more stringent requirements. Additionally, unsecured loans typically have higher interest rates than secured loans.

Loan Eligibility

The eligibility requirements will vary depending on the lender and the type of loan you are trying to get. However, most lenders and loan types will look at the following items when considering whether or not you are eligible for the loan:

  • Capital

    Lenders will analyze your ability to repay a loan by looking at your earnings, savings, any debt you may have, and projected earnings.

  • Credit

    Your credit score and history will be looked at to help determine whether or not you are deemed eligible for the loan.

  • Collateral

    If applying for a secured loan, the lender will examine any assets you have that can be used as collateral to secure the loan.

  • Conditions

    The conditions of your loan will also be considered. Conditions include the purpose of the loan, the loan amount, interest rates, what industry you are in, your experience in the industry, the amount of time you have been in business, etc.

Required Documents

No matter the type of lender or loan you apply for, you will be required to provide certain documents, which may include the following:

A well-detailed and thorough business plan will be one of the most important documents you must produce when applying for a business loan. If you have not yet written your business plan, please view our article, How to Create a Great Business Plan: A Complete Overview.

How to Compare Loans for the Best Terms

There are a wide variety of loans with varying terms available to new businesses. Therefore, before committing to a loan, it is critical that you compare and contrast different options so that you can receive the best terms for your particular situation. To compare loan options, you should consider the following items:

Interest Rate and Annual Percentage Rate

The first thing you must evaluate is a loan's interest rate and annual percentage rate or APR. A loan's interest rate is the amount a lender charges the person borrowing the money. It is a percentage of the total amount of the loan (the principal). As you pay back the loan over time, you are charged this interest rate on your remaining balance. For business loans, the APR is the yearly cost of the loan plus any additional fees. Next, you should determine if the interest rate is fixed or variable. A fixed-rate won't change over time, while a variable rate is subject to change.

Additional Fees

When looking at various loans, you should also see if there are any additional fees. Some of these fees can be hidden, so it's essential that you carefully examine the fine print of your loan, and you can ask the lender directly about any hidden fees. You can get a general idea of the fees of a loan by looking at the APR and seeing how it differs from the interest rate. When considering different loan options, looking at the APR is a more accurate way to compare the loans' costs rather than just comparing the interest rates. Some of the additional fees a loan may have include the following:

  • Application Fees
  • Origination Fees
  • Processing Fees
  • Prepayment Fees
  • Late Payment Fees
  • Non-Sufficient Funds (NSF) Fees
  • Closing Costs
  • Administrative Fees
  • Draw Fees
  • Guarantee Fees

Amount of Loan

What is the maximum amount you can borrow? When analyzing different loans, weighing how much you can borrow versus the interest rate and APR could help you determine which loan makes the most financial sense for your business.

Downpayment

Is there a downpayment required to receive your loan? If so, how much is it?

Repayment Terms

Another aspect to look at when considering a business loan is the specifics of its repayment terms. These can include:

  • What Is the Loan Term?

    What is the set period of time you have to finish paying off your business loan?

  • What Are the Payments?

    How much money and how frequently will you be expected to make payments on your business loan?

  • Can You Make Prepayments?

    Are you allowed to make advanced payments toward your principal in addition to your monthly payments that will reduce the amount of interest you end up paying over the course of the loan? Are there any prepayment fees involved?

  • Is There a Balloon Payment Involved?

    Is there a larger payment involved that you would agree to make at the end of your loan?

  • Collateral Required

    Will you need any collateral to take out your loan? If so, what type of collateral is required?

  • Reputation of the Lender

    You should also evaluate the lender's reputation when thinking about taking out a loan. Reading online reviews and talking to other entrepreneurs who have taken out loans from a particular lender can give you a better idea of what you can expect from them. If you encounter a lot of negative reviews, you could consider searching for another option.

Consider All of These Factors Carefully

It's important to consider all of these factors carefully and weigh their pros and cons regarding how they affect the overall loan. For example, you could have two loans for the same amount with the same APR, but one has lower monthly payments and a longer loan term. Initially, you may think this loan would be the more affordable option. However, due to the exact same APR and lower monthly payments affecting the principal (the overall amount you owe at a given point), you would wind up paying more in interest over the course of the entire loan. Therefore, if you're looking to save money over the long term, this would not be the better loan for you. Alternatively, if you know you could not make the higher monthly payments of the other loan or that it would be hard for you, perhaps the longer-term loan with lower monthly payments and a higher amount of interest paid upon completion could be a good option for you.

Loan Sources

Business loans can come from various lenders. Different factors will come into play when determining the best source for your loan. Here we will discuss four of the most common, which include:

Small Business Administration

The U.S. Small Business Administration, or SBA, partners with lenders and has various types of loans for small businesses. They guarantee 75-90% of the loan to the lenders they partner with. This allows them to offer better loan terms and easier qualifications for the borrower. However, SBA loans can take longer to get approved when compared to other lenders and can involve more paperwork. This makes SBA loans better suited for companies that can wait the time it may take to get approved. If you need faster access to the funds, another loan source may be better for your particular situation.

Banks

A bank is probably the first institution that comes to mind when people think about business loans. Generally speaking, banks offer better terms concerning interest rates and fees for business loans when compared to other sources, such as alternative lenders. But business loans from banks can be harder to qualify for and get approved, and it can be even more challenging for new businesses. Therefore, banks may be a better lending source for existing businesses with steady and documented income rather than new companies.

Credit Unions

Credit unions operate as cooperatives, meaning they are controlled by their members. Credit unions provide similar services and loans when compared to banks but may offer these services only to credit union members. The fact that credit unions are typically registered as nonprofits allows them to loan money at lower interest rates and with more borrower-friendly terms than for-profit financial institutions. Credit unions can provide loans that are more accessible to lower-income and first-time borrowers, making them a great option for new businesses. However, credit unions may have fewer loan options compared to larger financial institutions, and you will typically need to be a member in order to apply.

Alternative Lenders

Alternative lending, also known as peer-to-peer (P2P) lending, marketplace lending, social lending, or crowd lending, is done through online platforms. Alternative lenders can finance borrowers that typically have a harder time getting loans through other sources. This means the loans' eligibility requirements are much less stringent and are easier to meet. These loans can be approved in a matter of hours, and funds can be received in less than a week. However, due to the ease and speed of application and approval, alternative lenders generally seek higher returns on their loans through higher interest rates and fees when measured against other lenders. This can make alternative lenders a good option for new businesses that have yet to demonstrate the profitability a traditional bank may seek or may not have the time to wait to get approved for an SBA loan.

Well-known alternative lenders include:

  • Kabbage
  • Bluevine
  • OnDeck
  • Fundbox
  • Funding Circle

Types of Loans

While looking at various funding options, there are many different types of business loans you can consider. The following loans are some of the most popular:

SBA Microloans

SBA Microloans are small business loans for up to $50,000 that are fully funded by the Small Business Administration and are specifically aimed at startups and new businesses. The SBA issues funds to community-based nonprofit organizations that act as intermediary lenders and administer the loans. This program is also intended to reach businesses in lower-income areas and businesses that other lenders may typically deny. The process can take a few weeks, and the intermediary lenders each have their own unique lending and credit requirements. Typically the intermediaries require a detailed business plan, some form of collateral, and a personal guarantee from the borrower.

SBA 7(a) Loans

The most common SBA loan program, the SBA 7(a) Loan Program, has over six different types of loan programs and offers help to small businesses with special requirements. These loans are backed by the SBA but given out by private lenders. SBA 7(a) loans can be for up to $5 million and have loan terms of up to 25 years. In order to qualify for these loans, you need to have been in business for a minimum of two years, have a personal credit score of 690 or higher, and be able to demonstrate that you have earned consistent income.

SBA 504 Loans

SBA 504 Loans are long-term affordable loans with a relatively low-interest rate intended for the purchase or construction of pre-existing buildings or land, brand new facilities, and long-term equipment and machinery. SBA 504 loans can also be used in the renovation, modernization, or improvement of existing facilities, land, utilities, streets, parking lots, and landscaping. The loans can be for up to $5.5 million with loan terms of up to 25 years with a 10% down payment. There is a long application process that requires specific documentation and approval of a bank and an SBA certified-development-center or CDC.

Term Loans

Business term loans are offered by conventional banks, credit unions, and alternative lenders; some SBA loans also fall under this category. A term loan is when you borrow a lump sum and pay off the loan with fixed equal payments of the same amount over a set period of time. These loans are amortized, with most of the payment going toward interest at the beginning of the loan and then more going to the principal at the end of the loan. Generally, longer term loans that have lengthier repayment terms and lower rates are popular among banks but have strict requirements and take longer to get approved for. Shorter term loans are popular with alternative lenders online and have shorter repayment terms, are easier to qualify for, and are faster to get approved, but they can have much higher interest rates with larger and more frequent payments required.

Line of Credit

A line of credit is a loan that functions like a credit card. With a business line of credit, you are given access to a specific amount of money, and you can use however much you need but will only pay interest on the amount that you use. Once you have paid back the amount you spent, the funds are added back to the total amount that you are allowed to borrow. Banks, credit unions, and alternative lenders all offer lines of credit. There can be secured and unsecured options, as well as SBA-backed lines of credit provided through SBA lending partners. Interest rates, fees, and eligibility requirements will vary depending on your lender.

Equipment Financing

Equipment financing loans are explicitly used for purchasing any equipment or machinery you may need for your business. You can get these types of loans from the SBA, banks, credit unions, and alternative lenders. There are even certain companies that focus exclusively on equipment financing loans. Your loan repayment terms, conditions, interest rates, and eligibility requirements may differ depending on who the lender is, your qualifications, and the projected value of the equipment over time. Generally speaking, though, equipment financing loans are affordable, with many options that offer low-interest rates and longer payment terms. The equipment you purchase with the loan money acts as the loan's collateral. This can influence interest rates and the ability to get approved in your favor. Once you pay off the loan, you own the equipment.

Equipment financing loans can also have a negative side. If you have purchased equipment that has since become outdated, you still have to pay off the loan. Nevertheless, these loans can be great for existing businesses and new companies that need access to expensive equipment in order to run their business.

Invoice Financing

If you have clients that have unpaid invoices with your company, you may be eligible to receive invoice financing. Invoice financing is a cash advance for your unpaid invoices, typically around 50-90% of the total amount of your invoice. Invoice financing can function as a loan or as a line of credit, and it is easier to qualify for, as your unpaid invoices act as collateral for the cash advance. However, the costs of borrowing money through invoice financing can be higher than other business loan options.

Lenders that offer invoice financing have different models in how they charge fees, but typically a percentage of the invoice value is charged, usually 1-5%, on the amount lent. Usually, these fees are also recurring weekly or monthly until the borrower receives payment from their client and then pays back the lender. After payment for the loan amount plus the fees are sent to the lender, the borrower will keep any remaining funds.

Invoice financing can be good for business-to-business companies waiting for payments and may be experiencing cash flow problems. They can be easy to get approved for, and funds can be delivered extremely fast. However, they can be quite expensive with high APRs and risky if a business' clients pay late or fail completely to pay their outstanding invoices. Invoice financing is popular among alternative lenders, with banks being less likely to offer this sort of lending.

Merchant Cash Advance

With merchant cash advances (MCAs), a cash advance is provided based on future debit or credit card sales. MCAs will give you an amount of money, and your future debit or credit card sales will be used to pay back this money plus additional fees. This is typically done by automatically deducting a percentage of your daily or weekly debit and credit card sales until the cash advance and fees are paid back. Alternatively, the cash advance can also be paid back by the MCA company withdrawing money directly from your business bank account. MCAs don't have the usual repayment terms that other financing options do, as repayment of the funds is based on your sales.

Merchant cash advances are easy to qualify for, and funding can be received quickly, sometimes within 24 hours. However, this is one of the most expensive forms of financing, and due to the conditions involved, businesses can get caught in a cycle of debt. This type of financing is so expensive that it is best reserved for financial emergencies or when no other financing options are available. In addition, MCAs are not considered loans but are commercial transactions with your future sales being purchased. This means they are not federally regulated in the same way traditional loans are. Due to a lack of federal regulation, many companies providing merchant cash advances have often been accused of having misleading and predatory business practices.

Next Steps

You can take these next steps to learn more about the different business loans before applying for one.

  1. View and compare various loans online. You can visit the websites of banks, credit unions, the Small Business Administration, and alternative lenders to see what loans they offer and the terms.
  2. Work the math out on paper or your computer before applying for a loan to see how different loans will work and fit into your financial situation and overall business plan.
  3. Meet with loan officers or financial advisors to assist you in the process of figuring out which business loans are good and viable options for you.
  4. SBDC business counselors can also be a great resource to utilize in helping you decide which business loan is the best for you. You can schedule an in-person meeting, video conference, or phone call through your local SBDC.

Conclusion

Whether you are an existing or new business, there is a lot to consider and terms you will need to wrap your mind around when thinking about getting a business loan. Interest rates, APR, monthly payment amounts, length of the loan term, is the loan amortized, whether you can make prepayments towards the principal, and whether or not there are prepayment fees are all things you will need to understand about the loans you are considering. Do you need the money as soon as possible, or can you wait a while? How eligible are you? Do you have the necessary collateral? Would you prefer paying smaller monthly payments but perhaps more interest in the long run or larger monthly payments with less interest over the length of the loan?

By reviewing the information presented in this article, you can better understand the different types of loans and lenders and which ones would be the most beneficial to your particular situation and business. Taking out a business loan is a serious matter, so it's important that you take your time to understand all that is involved.

Are You Starting Your Own Business and Need Assistance?

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