Decide what type of business loan you need
Before you apply for a business loan, you need to know your current budget, the amount of money you can realistically put up as capital and how you plan to use the loan funds.
Here are a few common business costs that could determine the type of business loan you need:
- Startup expenses: If you’re just getting your business off the ground, you might consider applying for a startup loan to cover the initial costs. You may alternatively use short-term loans or a business credit card with a low introductory interest rate.
- Equipment needs: If you need to purchase large equipment for your company, many lenders offer equipment loans. These loans are secured by your equipment, meaning if you default, your lender can seize the equipment. That said, equipment loans oftentimes offer longer terms and lower interest rates than other business loans.
- Operational expenses: If you need help covering payroll or other daily operational expenses, you might consider a working capital loan. These short-term loans help you cover immediate expenses until your business generates revenue.
- Miscellaneous business expenses: If you want access to funding to make purchases or cover expenses on an as-needed basis, you might consider a business line of credit. This form of revolving credit allows you to only borrow the amount you need when you need it.
» MORE: Business loan types
Check your eligibility
Once you know which type of business loan you want, you’ll need to find out how much money you qualify for. When assessing your application, lenders will consider your credit score, business revenue and collateral, among other factors.
Credit score
One of the most important factors when qualifying for a business loan is your business credit score. Your score helps lenders determine the risk of loaning your business money, and a higher score can give you more favorable loan terms.
There are three major business credit reporting bureaus: Dun & Bradstreet, Equifax and Experian. While personal credit scores range from 300 to 850, business credit score ranges vary depending on the credit bureau:
- Equifax assigns businesses credit scores from 101 to 992.
- Experian assigns businesses credit scores from 300 to 850.
- Dun & Bradstreet assigns businesses credit scores from 1 to 100.
There’s also the FICO Small Business Scoring Service, which assigns scores from 0 to 300.
If you run a small business that doesn’t have an established business credit profile, lenders will often evaluate your personal credit score instead. They’re looking for FICO scores in the good-to-excellent range (above 670). Some lenders may offer business loans to borrowers with poor credit scores, but the loan terms and rates they’ll offer these subprime borrowers will likely be unattractive.
Age of business
Lender requirements vary regarding how long a business needs to have been operating to qualify for a loan. Some lenders may lend to businesses that have been open for only six months. However, establishing your business over a long period of time will open more doors to business credit.
Business revenue
Most lenders require a business to demonstrate a minimum amount of revenue in order to be approved for a loan. This minimum amount can vary by lender and may depend on the requested loan amount and credit profile of the loan applicant. Lenders want to know if your business has enough cash flow to repay the loan.
Loan affordability
Business lenders look at a business’s debt service coverage ratio (DSCR) to determine whether it can afford loan payments. This number is determined by taking the business’s annual revenue and dividing it by its annual debt payments.
For example, if your business has annual revenue of $500,000 and annual debt payments of $200,000, you would have a DSCR of 2.5.
The higher your DSCR, the better you look to lenders. A high DSCR indicates that you have enough cash flow to cover future loan payments.
Compare business loan lenders
Before applying for a business loan, you’ll want to compare several lenders and review their loan offerings. Interest rates, loan fees and loan term lengths can vary quite a bit between lenders, so comparing a few top options can help you find the best lender for your needs (and save you money, too).
Here are a few types of lenders to consider:
Online lenders
Banks and credit unions
SBA loans offer repayment terms of up to 25 years, which is much longer than most private business loans. SBA loan amounts can go up to $5.5 million (or more) as well, making them good options for businesses needing significant funding.
Microlenders
These loans may work well for new businesses that can’t qualify for a traditional business loan.
Community programs
Gather your documents
To apply for a business loan, you’ll need to supply both personal and business financial documentation. This may include your:
- Personal credit score
- Personal bank statements
- Business credit score
- Business financial statements (profit and loss, balance sheets, etc.)
- Business tax documents
- Business legal documents
- Business plan
Each lender will have specific documentation requirements, so make sure to check with your lender before applying to ensure you have all the documents needed to complete the loan application.
“The documents needed really depend on the type of business,” said Tina Grant, a finance manager at Aerospheres who has direct experience compiling documentation for a business loan in the aviation industry.
“You’ll need to provide a business plan, a financial statement, tax returns and possibly collateral. The credit score of the business, financial statements, forecasts and projections — these are a couple of things that banks will consider. The better collateral you can offer, the higher the chance of approval.”
Apply for your business loan
Applying for a business loan follows a process similar to any other type of loan application. Your initial application will most likely be online; you can typically submit your personal and business information and upload the required documentation on a lender’s website.
Once your application is submitted, the lender will contact you about the next steps, including submitting any additional documentation needed and answering questions about your business and the loan.
The better collateral you can offer, the higher the chance of approval.”
If you need help submitting your application or simply want a small business professional to review your materials, consider connecting with a local Small Business Development Center. Employees of these SBA-administered offices can look over your loan application to ensure you haven’t missed anything and help you maximize your chances of approval.
Business loan approval can take a while, as lenders will need to review your financial information, tax documents and eligibility. Depending on your loan needs, SBA loans can take 30 days or more to be processed.
Manage your business loan
Once the lender approves you for a business loan and you receive the funds, it’s important to set up your account for repayment and pay the loan on time every month. Setting up automatic payments is the best way to ensure you don’t miss any payments or end up in default.
If you default on your business loan, your lender can seize any collateral secured by the loan, such as business equipment. Ultimately, most lenders require a personal guarantee for their small business loans, so most small business owners are personally responsible for their business debt. When you personally guarantee a business loan, you become liable for any default.
While some business loans provide lenders with unlimited recourse to pursue your personal assets in order to pay the loan balance (plus fees), others may offer a limited personal guarantee that restricts a lender’s ability to seize personal assets. To ensure that you fully understand your degree of liability, you and a lawyer should carefully review any business loan that requires a personal guarantee.
FAQ
Do lenders use your personal credit score for a business loan?
If your business doesn’t have a sufficient credit history of its own to qualify for a business loan, lenders will use your personal credit score and history to assess your eligibility for a business loan.
Is it hard to get a startup business loan?
Startup business loans are harder to come by than conventional loans, though many lenders offer them (including SBA-affiliated lenders). Since new businesses typically don’t have an established credit history or much revenue, they’re capped on the amount they can borrow, and the interest rates they receive may be relatively high.
Is a business loan considered income?
No, taking out a business loan isn’t considered income. You’ll only have to report income on your business loan if your lender decides to forgive all or a portion of the loan amount. The forgiven amount is considered taxable income.
Can you use a personal loan for business purposes?
Yes, you can use some personal loans for business purposes, but it’s not a great idea. Not only will you be personally liable for paying it back if the business defaults on the loan, but it can also cause tax issues if you use the personal loan funds for both personal and business expenses. Also, some lenders restrict personal loans and don’t allow them to be taken out for business expenses.
Bottom line
Getting a business loan can be a great way to boost your business, from funding new equipment to helping cover operating expenses as you expand. There are many different types of business loans available, making it easy to find one that fits your specific needs.
But make sure you have established business credit and the revenue needed to demonstrate your repayment capability. Otherwise, you might not qualify for a large enough loan, and you could end up paying a high interest rate.
Article sources
- Score, “ Understanding the Three Major Business Credit Bureaus .” Accessed July 27, 2023.
- Equifax, “ Small Business Sample Credit Report .” Accessed July 27, 2023.
- Dun & Bradstreet, “ Business Credit Scores & Ratings .” Accessed July 27, 2023.
- U.S. Small Business Administration, “ Loans .”
- U.S. Small Business Administration, “ Terms, conditions, and eligibility .” Accessed July 27, 2023.
- U.S. Small Business Administration, “ 504 loans .” Accessed July 27, 2023.
- U.S. Small Business Administration, “ Microloans .” Accessed July 30, 2023.
- Community Development Financial Institutions Fund, " About Us ." Accessed July 17, 2023.
- Business News Daily, “ Personal Guarantees and Business Loans .”
- Intuit, “ How to Get a Small Business Loan and Navigate the Tax Implications .” Accessed July 27, 2023.
- IRS, “ Topic No. 431, Canceled Debt – Is It Taxable or Not? ” Accessed July 27, 2023.
