How to Get a Small Business Loan (Simple Funding Guide)

Sometimes you have to invest if you want to take your small business to the next level, and a small business loan can be a good way to achieve that.

But how do you go about getting a loan? What different types of loans are available, and how do you decide which one’s right for you? How do you figure out whether you qualify and then make a successful application?

I’ll answer all those questions in this tutorial, so read on to discover what you need to know to secure small business funding successfully.

How to Get a Small Business Loan — How to get a small business loan. (graphic)

1. Understand the Different Types of Small Business Funding

Let’s start by covering the landscape of small business funding. What kind of loans can you get, and what are their characteristics?

Traditional Bank Loans

This is the plain vanilla type of loan: You go to your bank, ask for the amount you need, and if you meet their criteria, you get the cash. Then you make regular payments to pay off the balance, plus interest, over an agreed amount of time.

These loans are ideal for funding a particular new project, premises, equipment, or product development. The main downside is that they can be very difficult to qualify for, and you’ll often need to show a long track record of profitability before the bank will take a risk on your company. Banks often aren’t interested in lending small amounts to very small companies either; many of them have a different definition of what a small business is.

Government-Backed Loans

Some governments offer special loan programs to help small businesses. In the U.S., for example, the Small Business Administration (SBA) runs several different loan programs. You’re not actually borrowing from the government—you’re still borrowing from a bank, but the SBA will guarantee a proportion of your loan, making it easier to qualify and to achieve a lower interest rate. It’s a way of encouraging banks to lend to small businesses.

This is a good option if it’s available in your country, and if you meet the requirements (as an example, here are the requirements for the SBA’s general small business loan program). You will have to wade through the government’s sometimes complex requirements and put together a comprehensive application, and then wait for it to be processed, so it can take some extra time.

Lines of Credit

A line of credit is a good option for covering day-to-day expenses. It’s a bit like having a credit card: you have access to a certain amount of money, and you can borrow up to that limit. You only pay interest on the money you borrow, not the whole amount of the line of credit. But, as with credit cards, the rates can often be higher than for traditional loans, and it can be easy to get in over your head.

Alternative Lenders

Because it’s difficult for many small businesses to get traditional bank loans, alternative lenders have entered the market. Often these loans are processed purely online, and the eligibility requirements can be less strict. But the downside is that interest rates are often much higher.

Peer-to-peer lending is also an option. In this case, you go to a website and borrow from other people who’ve signed up on the site. Often your loan will be split between many different people—for example, if you borrow $1,000, you might actually be borrowing $10 from 100 different people, so that the default risk for each individual lender is lower.

Merchant Cash Advances or Factoring

With these options, you can cover short-term cash shortfalls by getting up-front cash payments based on your future sales. So if you have a $1,000 payment due from a client in three months, you can get that money immediately—minus interest and fees, of course.

2. Why Do You Want to Borrow?

Once you understand the types of loans out there, the first step is to get clear on what you will use the loan for. Is it for a specific project? Do you want to expand your premises, or buy more equipment or inventory? Maybe you want to hire new staff, or just have extra funds on hand to cover possible shortfalls in cash flow.

Being clear about exactly what you need the money for will help you decide how much you need and what type of loan is right for you.

As we’ve mentioned in previous tutorials, you should have some kind of business plan, even if it’s just an informal one, so that you can stay on track with your objectives. So refer back to it now, and make sure that the loan you’re taking on is helping you to achieve one of your core objectives. Debt can be expensive and risky to take on, so really make sure that you’re doing it for something essential to your business strategy.

We have lots more tutorials on business planning that you can read, such as How to Write a Business Plan and How to Create a Financial Model for Your Business.

3. How Much Do You Need?

Now it’s time to figure out how much you need to borrow.

If you’re borrowing money for a particular project or to work on a new product, you’ll need to come up with a comprehensive budget plan that figures in all the different costs, both direct and indirect, that will be involved. Our tutorial 6 Budget Planning Steps to Professional Project Estimates is aimed at freelancers, but the steps apply to small businesses too.

The estimating process for buying new equipment or inventory should be easier: just research the cost of what you need to buy. For hiring staff, it’s quite simple too, but don’t forget that on top of the new employee’s salary, you’ll need to take account of extras like payroll taxes and employee benefits.

Of course, you may not be able to get as much as you need. Later on, we’ll see if you can afford to borrow that much, and whether you’ll qualify. But to do that, we need to understand the interest rates available.

4. Research the Market

To get an idea of what we can afford, we’ll need to know what terms we can expect. Interest rates vary a lot in different countries, and also within the same country over different time periods, so it’s best to do your own research to get the most up-to-date figures.

Price-comparison websites are a good place to start. In the U.S., for example, you can go to NerdWallet’s page for small business loans. You enter a few details about your business and your finances, and it gives you some sample interest rates from different providers. Similar sites are available in different countries—in the U.K., for example, you could use MoneySupermarket, and in Australia, you could try InfoChoice.

Sometimes the rates provided by these sites may only be estimates, and often the range will be quite broad, so it’s also worth contacting individual lenders to get an idea of the more exact rates you can expect in your particular situation.

Alternative lenders often aren’t included in the price-comparison sites either, so go to their websites separately. For peer-to-peer lending, try Prosper or Lending Club; for alternative online lenders, Kabbage and Fundation are a couple of examples. For merchant cash advances, try RapidAdvance. For factoring companies, see the list at the bottom of this article.

The goal here is to get an idea of what kind of interest rate you can expect to pay for the type of loan you want. The final rate may be different once you’ve completed the application and provided all your information, but this stage should at least give you an idea.

5. How Much Can You Afford?

Now that you know how much you want to borrow and what your interest rate might be, you can work out how much you can actually afford to borrow.

There are plenty of free loan calculators available online, so you can choose any you want. The one provided by Shopify is a good, simple option. You just enter your loan amount, the interest rate, and the length of the loan term in years, and it tells you what your monthly payments will be and how much you’ll pay in interest.

For example, if you borrow $10,000 for five years at 8% interest, your monthly payments will be $202.76, and you’ll pay a total of $2,165.84.

Now you’ll need to go back to your company’s finances and see what the impact of both of those numbers will be. First of all, will you be able to afford the monthly payments? How much of a dent will those $202.76 monthly payments make in your cash flow? And looking further ahead, how will the overall interest cost of $2,165.84 affect your longer-term forecasts? Will the new project or growth you’re investing in generate enough profit to offset that cost?

Be realistic here, and be conservative in your forecasts. Debt can be a useful way of funding a business, but it can also be crippling if you take on more than you can comfortably afford. So make sure that the loan is affordable, in the worst case as well as the best case scenario.

6. Will You Qualify?

The next step is to see whether you qualify for the loan. Lenders often won’t put their specific eligibility requirements online for you to check, because they like to assess each loan application individually and take multiple factors into account. So it can be tough to know whether you’ll qualify until you make the application.

But here are some general guidelines on what you’ll need to qualify for a bank loan:

A very good personal credit score, and ideally strong business credit as well.
An established business track record showing financial stability for several years at least.
A detailed business plan.
Some form of collateral—property with real, tangible value that the bank can lay claim to if you don’t keep up the payments.

Government loan requirements will usually be similar but not quite so stringent. Alternative lenders often have much looser requirements so it’s much easier to qualify—that’s why they typically charge higher interest rates.

7. Get Organised, and Make Your Pitch

Applying for a loan will often require a lot of documentation. Alternative lenders make it easier, but they’ll still need to see some financial track record. And banks or government agencies will need the full works: financial statements, a detailed business plan, tax returns, personal and business credit reports, and often legal documents such as your articles of incorporation or copies of the licenses you need in order to do business.

If you need help with any of that, see the following tutorials:

Then, if you’re dealing with an alternative lender, you’ll usually be able to complete the whole process online. But with a bank, credit union, or other traditional lender, you’ll have to meet face to face and convince them to lend to you.

It’s important to strike the right balance here between being passionate about your business and realistic about the prospects, the risks, and your responsibilities.

Most important of all, don’t approach the process as if you’re asking for a favour. Banks generally don’t like doing favours. Instead, present it to them as a good business opportunity. Show them that making this loan will be a good business deal for them. You’re reliable, you’re well organized, and you’ll pay their money back with interest and be a good customer for years to come.

For more presentation tips, see the following tutorials:

And looking professional is important, too, so you’ll want some professional presentation templates like those on Envato Market.

With all the research you’ve done up to this point, you’ll be well prepared to succeed, so approach the application process with confidence.

Conclusion

In this tutorial, you learned how to get a small business loan.

You’ve seen the different options available to you, and gone through the process of figuring out how the loan will fit in with your business strategy, what kind of terms you can expect from different providers, and how much you can afford to borrow. And you've also seen some tips on making an effective presentation to your chosen lender. You’re now ready to apply for and secure a small business loan.

Debt can be risky, as we all know, but risks are everywhere when you’re running a small business; the important thing is to manage them effectively.

If you apply the lessons you’ve learned here and go through the full process of deciding which loan is right for you and how much you can realistically afford, you’ll be well positioned—not only to qualify for the loan you want, but also to stay well on top of the repayments and keep your business healthy and growing.