Small Business Startup Loans: Everything You Should Know

Written by
Reviewed by Matt Pelkey
• 10 minute read
Business owner on tablet device

When you’re in the very earliest stages of your entrepreneurial journey, one of the first things you’ll need to figure out is how your startup costs will be funded. But finding funding can be tough, especially when your business is just getting started.

That’s where startup loans can help.

A small business startup loan can provide funding to help get your business off the ground. Just about any type of business funding can be used for this purpose — from lines of credit to term loans to credit cards. The best fit for your business will depend on its unique needs. Before you decide, make sure you understand all of your funding options and how they work. Here’s what you need to know about startup business loans

What Is a Startup Business Loan?

A startup business loan isn’t a specific type of loan. It’s a term used to describe the funding used to launch or grow a new business. “Startup financing” is another term that refers to any type of small business funding used for this purpose.

What Are Startup Business Loans Used For?

Some of the common uses for startup business loans include the following:

  • Purchasing equipment or inventory.
  • Working capital to cover payroll and everyday expenses.
  • Remodeling and renovation.
  • Acquiring real estate for the business.

The purpose of the loan generally helps to determine the type of funding that would be best for your business.

What Is Required To Get a Small Business Startup Loan?

When you apply for a small business startup loan, lenders will generally look at criteria such as your personal and business credit, the age of the business, the business’s cash flow, the business’s existing debt obligations and the industry your business is in. Depending on the lender, a business plan may also be requested.

Due to these requirements, getting approved for a startup business loan can be a challenge for businesses with little credit or business history. Typically, a small business lender will require some or all of the following:

  • The business has been operating for at least one year.
  • The business has a business bank account.
  • The business owner has a minimum personal credit score of at least 625.
  • There are financial statements that show the business is capable of repaying its debt.

What Are The Most Popular Types of Business Funding for Startups?

Business term loan. Business term loans are structured similarly to the way personal loans are. A borrower receives a lump sum of money from a lender up front and repays it (plus interest and sometimes fees) in installments over a fixed period of time known as the “term.” If this period of time is just a few months or a couple of years, it may be considered a short-term loan (or short-term business loan). Longer-term loans are generally just referred to as small business loans.

Business line of credit. A business line of credit is a popular form of small business funding best used as working capital for ongoing expenses. Similar to a credit card, you are given a credit line up to a certain amount upon approval. This may be referred to as your credit limit. From that amount of credit, you can draw funds to be used for any business expense when needed. You repay funds (with interest and sometimes fees) according to its agreed-upon repayment terms. As the funds are repaid, they become available to draw from again — without needing to reapply.

Business credit cards. Business credit cards are oftentimes a small business owner’s first foray into business financing. Business credit cards work much the same as personal credit cards do, with many even offering rewards. Business credit cards can help the small business owner separate their personal finances from the business. They can also be a good way of establishing positive business credit history before applying for larger amounts with a small business loan or business line of credit.

SBA loans. SBA loans are a commonly sought after form of financing, but they can be very difficult to receive approval for. If approved, small businesses can receive a term loan or SBA microloan from a bank with very favorable interest rates and terms. That is because the loan will be guaranteed by the U.S. Small Business Administration. These loans are known to be fairly restrictive in terms of how they can be used, and the application process can be arduous. For some businesses, the favorable rates are worth the effort and time.

Equipment financing. Equipment financing may refer to either equipment loans or equipment leasing. With either type of business funding, it is used specifically for equipment. With an equipment loan, the equipment acts as collateral to secure the loan. With equipment leasing, you generally have the option to purchase or keep the equipment after the end of the lease period. Leasing may be a better option for startup equipment that is at risk of becoming obsolete or in need of replacing.

Merchant cash advance. Merchant cash advances are not actually small business loans, but rather a cash advance on the business’s credit card sales. This way of structuring the funding allows a funding provider to review a business’s typical sales as a way of determining how much a business can repay, and then withdraw a certain amount of the business’s daily credit card sales as its method for getting repaid. This type of funding can be good for startup businesses that face difficulties getting approved for more traditional forms of business funding, but receive a steady stream of credit card payments from their customers.

Microloans. Microloans are ideal for the smallest of small businesses that have difficulty finding funding from other sources of startup funding. Microlenders offer small dollar loans that are structured like term loans and can be used for the same uses that most forms of business funding can be used for. The main difference is in the size of the loan, who is issuing it and what type of business is best suited for this type of financing.

Invoice factoring. Invoice factoring is not a small business loan, it is more like a merchant cash advance. Rather than the advance being determined by the business’s credit card sales, it is based on their invoices. With invoice factoring, a factoring company will review the creditworthiness of your company and the companies you do business with. They will look at your past invoices and see how successful your business was at collecting on those invoices. If you have a positive history of getting them paid, the factoring company will purchase your outstanding invoices. The factoring company may pay something along the lines of 85 – 90% of the value of the invoices. In addition to taking this cut, the small business will often have to pay fees if their customer is late on paying the invoice.

How Should I Determine How Much Funding I Need?

To determine how much startup business funding you need, first identify exactly what you need the money for. It may be tempting to apply for a larger loan amount than you need, but the more you borrow, the more you need to repay. On the flip side, make sure that the loan amount you receive can cover the extent of your business’s needs and not leave you back in the situation of needing more funds.

If your need is for a specific business investment or expense, the loan amount you’re looking for should be pretty easy to calculate. Just make sure that your business plan is modified to factor in the business loan. That can be especially important for newer businesses.

If your need is for ongoing expenses — or if you anticipate that your business funding needs will recur — you may want to consider a business line of credit. With a line of credit, you can receive a credit limit and draw from your available credit whenever you need funds. The available credit then replenishes as you repay.

Do Banks Give Loans to Startups?

Whether or not a bank will lend to a startup depends on a number of factors, but it essentially comes down to the bank and the borrower. Some banks are much more restrictive about who and what types of businesses they will lend to, while others are more flexible. Having a well-established business and relationship with your bank certainly helps, but otherwise it often comes down to these “Four Cs”:

Capital. Lenders like to see profitable business assets that can be used to make monthly payments on your loan.

Collateral. There are sometimes opportunities to secure your loan with collateral such as equipment or personal assets. 

Cash flow. Some might call this capacity. But what this refers to is the business having a track record of (with bank statements to verify) money coming into the business.

Credit. Some may identify this factor more broadly as “character,” which ties into having a good relationship with your lender. But ultimately, having a strong business credit report is one of the most important aspects a lender will use to evaluate your loan application.

Can I Get a Startup Business Loan With Bad Credit and No Collateral?

Receiving approval for a startup business loan with lower credit and nothing to put down as collateral can be a big challenge for a new business. That said, there are a few business lenders in this space. These lenders may not be a great fit for every startup in this situation, however. They may require your business to have high annual revenue, or for the business owner to have a great FICO score and high personal income. Additionally, the funding may be more expensive than if the applicant had good credit or collateral. Businesses with lower credit who aren’t a good fit for these business lenders should probably consider a non-traditional financing option.

What Are Some Non-Traditional Loan Options for My Business?

Of course, newer businesses won’t always meet the criteria or have what a bank or traditional financial institution looks for in making a lending decision. But those small business owners might be able to pursue alternative funding options.

Crowdfunding platforms. A newer concept for entrepreneurs is crowdfunding. Crowdfunding is the process of raising money through the internet for a business or idea to come to life. Websites like Kickstarter have made this possible for several years.

Online lenders. Non-bank online lenders such as OnDeck are able to make lending decisions with technology that allows them to approve businesses for funding that traditional lenders do not. 

Friends and family. While not an option for everyone, many businesses get started with money from friends and family of the small business owner. Be careful if you go this route to avoid letting money get in the way of your relationships.

How Do You Qualify for an SBA Loan?

SBA loans are widely known to be a great opportunity for newer businesses — that is, if they can qualify and receive approval for one. With SBA loans, it’s important to note that the U.S. Small Business Administration is not the lender. Rather, SBA loans are just guaranteed by the SBA, which makes it incredibly easy for a bank or lender to provide a small business loan at favorable rates. To qualify for the SBA 7(a) loan program, businesses typically must meet the following requirements:

  • Operate for profit.
  • Be engaged in, or propose to do business in, the U.S. or its territories.
  • Have reasonable owner equity to invest.
  • Use alternative financial resources, including personal assets, before seeking financial assistance.

The SBA also has a microloan program that could be a fit for some business owners. Keep in mind, qualifying for SBA loans can be difficult. There is certainly no guarantee of approval even if you meet all of the eligibility requirements.

How Do I Get Free Money to Start a Business?

While free money sounds like it may be too good to be true, there are grant opportunities available that can make such a situation a reality. Grants can be an amazing opportunity for startup businesses because they don’t need to be repaid. Essentially, they are free money designated for the specific use of growing your business.

There are two main kinds of business grants: government and private. Government grants are generally given at a federal or state level. To find government grants, search online for grants that are specific to your industry and geographic location.

Private grants are provided by corporations and generally have less stringent eligibility requirements than government grants do. However, due to the relatively relaxed qualifications required, these grants are more likely to have a greater number of applicants. Because of this they can be very competitive and difficult to receive.

This content is for educational and informational purposes only, and is not intended as financial, investment or legal advice.