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 business will be funded. While venture capital and equity financing is an option for some startup businesses, most new businesses need debt financing to fund their endeavors. Debt financing is where startup business loans come into the picture. With this guide, we’ll answer many of the common questions small business owners have about this method of business funding.
What is a startup business loan?
A startup business loan isn’t a specific type of business financing; it’s a term used to describe the funding used to launch or grow a new business. A small business loan can be used for this purpose.
What are the most popular types of business funding?
Term loans are structured the way most people are familiar with when it comes to loans — a borrower receives money from a lender up front and repays it (plus interest and sometimes fees) in installments over an established “term” (period of time). Other popular types of business funding include:
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, the business can draw funds to be used for any business expense when needed. The business then repays their funds (with interest and sometimes fees) according to their agreed-upon repayment schedule. As the funds are repaid, they become available to draw from again — without needing to re-apply.
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 personal credit cards do, with many even offering rewards. Business credit cards also allow a business and the small business owner from keeping their finances too intertwined. Therefore, they can 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. The appeal and upside is understandable, however. With an SBA loan, small businesses can receive a term loan or microloan from a bank with very favorable rates and terms. That is because the loan will be guaranteed/backed by the 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, however, the favorable rates can be worth the effort and time it requires.
Equipment Financing: Equipment financing refers to a specific type of business funding in which the funding is used specifically for equipment, and the equipment acts as collateral to secure the loan. This can be a worthwhile form of funding to pursue if in fact your business’s financing needs are for a one-time purchase of equipment.
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 have a difficult time 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. Microloans 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. Similar to the merchant cash advance, it is more like a cash advance. But 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 such a relationship, 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. This type of business funding isn’t for every business, but it fills a need for some.
What are startup business loans used for?
Some of the common uses for startup business loans include purchasing equipment or inventory, working capital to cover payroll and regular/everyday expenses, remodeling and renovation, or the acquisition of real estate. What the loan is needed for generally helps to determine the type of funding that would be best for your business.
What is required to get a small business loan?
In order to qualify for small business loans, lenders will 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 the 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 that a business have been operating for at least one year, have a minimum credit score of at least 600, and have financial statements that show the business is capable of repaying its debt obligations.
How should I determine how much funding I need?
In order to determine how much business funding, you’d first want to identify exactly what you need the money for. It may be tempting to apply for more than the loan amount you need, but you’ll only want to receive as much as you need — and can comfortably repay. On the flip side, make sure that the loan amount you receive can cover the extent of your business’s need, 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, while replenishing the amount you have available to borrow again 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 essentially come 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 “4 Cs:”2
Capital: Lenders like to see business assets that can be used to make a profit, which can then be used to make payments on your loan.
Collateral: There are sometimes opportunities to secure your loan with collateral such as equipment, or personal assets of yours or a co-signer.
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 application.
Can I get a startup business loan with bad credit and no collateral?
Receiving approval for a startup business loan with bad 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 revenue, or for the business owner to have great credit and high personal income. Additionally, the funding may be more expensive than if the applicant had good credit or collateral. Businesses with poor credit who aren’t a good fit for these business lenders should probably consider a non-traditional funding option.
What are some non-traditional funding options for my business?
Of course, newer businesses won’t always meet the criteria or have what a bank or traditional lender looks for in making a lending decision. Those small business owners have some alternative funding options.
Crowdfunding: A newer concept for small businesses is crowdfunding. Crowdfunding is the process of raising money through the internet for a business or idea to come to life.
Alternative Lenders: Non-bank 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 a valid 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 Small Business Administration is not the lender. They 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 an SBA loan, businesses typically must meet the following requirements:1
- 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
Keep in mind, SBA loans are known for being difficult to receive approval for. 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, you can search the small business pages of your government websites, and look for grants that are specific to your location and industry.
Private grants are provided by corporations and generally have less stringent eligibility requirements than government grants do. Due to the relatively relaxed qualifications required, these grants are more likely to have a greater number of applicants however. Therefore, they can be very competitive and difficult to receive.
1SBA. (n.d.). Terms, conditions and eligibility.
2Murray, J. (2018). Why Do Banks Say No to Business Startup Loans?.
The information in this article is provided for educational and informational purposes only, without any express or implied warranty of any kind, including warranties of accuracy, completeness or fitness for any particular purpose. The information in this article is not intended to be and does not constitute financial, legal or any other advice. The information in this article is general in nature and is not specific to you the user or anyone else.