For many entrepreneurs, one of the biggest obstacles to success is funding. Your imagination is soaring with new ideas, but almost everything you want to do — from investing in startup technology to developing a new product to take your small business to the next level — requires money. You may find yourself wondering how to get a small business loan.
No doubt it can be challenging, especially for a first-timer, to navigate the process of applying for a small business loan. But once you understand the lending landscape and lay the groundwork, you’ll have a huge leg up in the competition for these scarce resources.
Editor’s note: The following content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Your blueprint to success lies ahead. In this article we’re going to cover how to get a small business loan in seven steps:
- Solidify your business plan, including financial projections.
- Make your business official.
- Take an inventory of your startup costs (expense sheet).
- Understand your small business loan options.
- Boost your chances of qualifying for the right loan.
- Avoid common mistakes.
- Apply for a small business loan.
Let’s get started!
1. Solidify your business plan, including financial projections
Maybe your business idea is little more than a gleam in your eye. Or maybe you’ve established your business and are looking to expand. Either way, you’ll need to have a sturdy business plan in hand before you apply for a small business loan.
This is your chance to lay out your vision, identify key milestones in your growth, and provide a road map of how to get there.
What to include in your business plan
To help you secure a small business loan, your business plan should be robust. Make sure it details things like:
- Why you’re in business. What problem or market gap does your product or service address?
- What sets your business apart from the competition.
- Your strategy. This is where you outline specific goals and how you will achieve them. Do you want to boost revenue, attract more clients, or expand your line of products or services? Maybe all of the above?
Whatever your goal, it’s important to choose a target that you can measure. Also, make sure it’s relevant and attainable.
The business plan should also identify the people who will help bring your business idea to life. Who will you be working with? Also, who are your customers? Who’s going to buy your product or service?
Creating a buyer persona is crucial to your branding and marketing efforts.
Focus on your financial projections
This is where you itemize what each of the plan’s components will cost and project your revenue.
Crunching these numbers can be one of the trickier elements of your plan, but it’s arguably the most important in knowing how to get a small business loan. These financial projections should show any historical information for your business as well as a three- to five-year forecast.
One key piece of information a potential lender will want to see is your break-even analysis. In other words, when will your business begin to turn a profit.
Provide sales and revenue estimates that reflect what is happening with the brand now.
Make the information easier for a small business loan lender to evaluate by including visual representations of your data such as graphs and charts.
Put your business plan on paper
When it comes to writing your business plan, there’s no need to reinvent the wheel.
Free, online templates help make the process relatively fast and easy. Some templates even have features designed to tailor your plan to your state’s lending requirements. They come in a variety of formats, from simple Word documents to flashy PowerPoints. Most can be easily updated as you refine your plan.
Related: 5 best business plan templates
Another good resource to help you sketch out your business plan is Lean Canvas.
This one-page template represents a Cliff’s Notes version of your business plan. You’ll need a more detailed business plan to get a small business loan. But, as this article explains, a one-pager that can be created in 20 minutes and updated on the fly is a good tool to help entrepreneurs stay nimble when faced with enormous uncertainty.
Already have a business plan? Great. You’re ready to move on to step two.
2. Make your business official
If you’re just starting out, there are a few important things you need to do to make your business official — both in the eyes of the government and your customers.
From filing the necessary paperwork to creating initial branding, the seeds you plant now will determine how your business develops and grows over time.
To help make sure you don’t forget anything amid the flurry of startup activity, here’s a checklist that includes the myriad tasks involved with getting a new venture off the ground.
Have you decided what kind of business entity to set up? Many freelancers and small businesses choose to structure as a sole proprietorship because it’s simple and easy to establish. But for reasons such as maximizing your tax benefits and minimizing your legal liability, you may want to go through the trouble of creating an LLC or S-Corp for your small business.
Permits and licenses
Do you know what permits or licenses your new venture needs to have? Requirements vary widely, depending on where you live and what type of business you’re running.
Consider hiring professionals
Be especially mindful on the legal front. A lack of attention to detail here could wind up costing you more time and money in the long run. You may want to consult a lawyer and/or an accountant.
Related: Legal issues for startups
Jumpstart your brand with a domain name and website
Once you’ve established your legal entity, you can focus on the creative part — building a brand for your small business.
In today’s digital economy, you’ll want to stake out your web presence early on by choosing a domain name that’s short, easy to recall and doesn’t conflict with any existing businesses out there.
Your web presence is your digital calling card, no matter what kind of business you’re running. You can use it to sell products or services, show off your expertise in your field, nurture new potential clients, engage with customers, and give your brand the profile it deserves.
Luckily, building a website has never been easier.
As you begin to position yourself in the marketplace, keep in mind the competitive research you completed for your business plan.
Make it easy for them to understand your unique selling proposition at a glance by aligning your website with those values. Here’s how.
3. Take an inventory of your startup costs (expense sheet)
Now it’s time to get down to the nitty-gritty. Learning how to get a small business loan means getting a line on all the expenses that you plan to cover with your loan.
Standard startup expenses
Even if you’re still in startup mode, you probably have a good estimate of the basics — phone, internet, utilities, supplies and inventory.
Digital startup expenses
Next, consider all of the digital expenses that may catch you off guard. There’s that snazzy new website, along with email and other costs related to marketing. If you’re an eCommerce enterprise, add onto that the expenses of packaging and shipping your products.
For a deep-dive on any website expenses that you might have overlooked, here are four website costs to consider when sitting a budget for your business site.
You don’t want to risk an outage that hurts your bottom line. To help you consider your staffing needs along with hardware and software, consult this IT budgeting template for small businesses. The post also recommends some handy spreadsheets to keep you organized.
Expense budgeting basics
Even if you’re an established entrepreneur who wants to know how to get a small business loan in order to expand an existing business, you’ll still need to budget carefully.
At each stage of the development cycle — from conception and development to promotion — it’s essential to be very clear about your goals and how you’re going to get there.
Make sure your budget includes money for market research and a promotion plan. You don’t necessarily have to spend a lot of money if you plan well and follow these cost-savings tips.
It helps to have a basic knowledge of accounting principles when learning how to get a small business loan.
You don’t have to be an accounting whiz. But even if you outsource your record-keeping, you’ll want to brush up on the basics. If you can’t tell your P&L from your A/P, or you need some help translating those and other common accounting acronyms such as COGS, check out “Accounting 101 for entrepreneurs.”
4. Understand your small business loan options
Now that you have a solid business plan in place, and have a good sense of how much money you’ll need to start or grow your business, it’s time to take a look at where you’ll get the needed cash.
Whether you plan to seek a personal loan for business or apply for a small business loan, it’s a good idea to review all your choices before deciding the best path for your situation.
Taking out a personal loan for business seems like a no-brainer: If you can bootstrap your new business from the start, you’ll avoid going into expensive debt. Plus, a personal loan can be obtained using your personal credit history, making it easier to get.
But it isn’t the best choice for every business owner. To decide if a personal loan for business is a smart choice, answer these questions.
Can you qualify for a personal loan for business?
To qualify for a personal loan for business, you’ll need to have a good credit score and proof of stable income.
If your credit score is below 670, you’d be considered a subprime borrower by many lenders — and could have difficulty getting a loan.
If you have a good credit score but no income, financial institutions might also be wary of lending to you. That is, unless you can provide proof that you can afford your loan payments.
Asking a cosigner to take joint responsibility for a personal loan could help you get past these hurdles. However, since the cosigner would be responsible for paying back the loan if you can’t, you’d need to have a clear plan for repayment. You should also have a serious discussion with your cosigner about the risk they’re taking on.
To find out if a personal loan for business is a possibility, consider getting prequalified.
When you do, you’ll get an idea of the loan repayment terms and the interest rate you’ll be offered. You’ll need this information to decide if financing your company with a personal loan is affordable.
Can you borrow enough to make your company a success?
If you can take out a personal loan to grow your company, you’ll need to think about whether you should.
To help make this decision, refer to your detailed business plan. Make sure it includes projections on costs and when you expect to become profitable.
When you’re deciding on the size of your personal loan for business, be realistic about how long you might need funding before you turn a profit.
According to a 2018 study by CB Insights, running out of money is the second most common reason startups fail. If you can’t borrow enough (or you need to borrow way too much) to keep your doors open long enough to become profitable, you might need to explore other financing options.
What are the advantages of using a personal loan for business?
Assuming you can borrow enough to fund your company’s growth, is a personal loan for business the best choice?
When compared with other popular financing options for businesses, there are some advantages in a personal loan.
The Consumer Financial Protection Bureau reported many startups aren’t able to get financing when applying for loans within their first few years of operations. If you have good credit and a reliable source of income, a personal loan for business could be easier to qualify for if your company doesn’t have an established credit history.
You also get to maintain control over the company and keep all the profits yourself. That’s typically not an option with some other types of funding, such as using outside investors or crowdfunding sites.
What’re the disadvantages of using a personal loan for business?
A personal loan for business isn’t the perfect solution. It can have some disadvantages, too, including:
- Strict qualification requirements. If you don’t meet the criteria to get approved, you won’t have access to this funding source.
- Your personal wealth could be jeopardized. If you can’t repay the loan, creditors could get a judgment against you. This could lead to wage garnishment, a lien on your house, or bankruptcy.
- You’re taking on all the risk. If you were able to find investors, it wouldn’t just be your funds at stake. By using a personal loan for business, only your finances are at risk.
Ultimately, whether a personal loan is the best choice will depend upon how you balance risk versus reward.
The level of risk is greater when using a personal loan for business — you’re putting your credit on the line. Of course, if your company becomes successful, you reap all the benefits.
Let’s explore some of the other options for startup funding.
Crowdfunding through sites such as Kickstarter
Crowdfunding will allow you to fund your company through contributions from anonymous investors. However, it can be time-consuming and difficult to publicize your campaign to raise funds. Plus, there’s no guarantee you’ll raise enough money.
Depending on the platform you use, you might also need to give up a small stake in your company to contributors.
Related: Top 20 crowdfunding platforms
Short-term business loans
Entrepreneurs often shy away from short-term loans, put off by the high-interest rates and other charges. On the other hand, if you have an immediate need for a cash infusion and can repay the loan quickly, it’s a good option to explore.
Here are three types of short-term loans to consider.
If you’re a small business owner, you’ve probably heard of the Small Business Administration — an arm of the government that helps out entrepreneurs in a few important ways.
An SBA loan— or a loan partially guaranteed by the SBA in order to lower the risk for lenders — is the holy grail for small business owners.
With low rates, long terms and large loan amounts, they’re hard to beat for up-and-coming entrepreneurs searching for financing.
Important stuff to know about SBA loans
Need money right away? If so, an SBA loan probably isn’t the choice for you.
The SBA loan process generally takes 60 to 90 days. This includes writing your thorough business plan and gathering all your financials, as well as waiting on the lender and SBA to process everything.
If you’re looking for quick financing to help you make payroll next week, then you’re better off finding a faster — and more expensive — loan.
But if you can stand to wait, an SBA loan may be worth your while. SBA loans come with large loan amounts, long terms and low-interest rates.
With the SBA’s most popular financing program, a 7(a) loan, you can qualify for up to $5 million, with monthly payments between seven and 25 years, paying interest rates of six to 13 percent.
All in all, that’s a better deal than you’ll find almost anywhere else — especially if you’re new or too small to qualify for a bank loan.
Unlike some other types of financing, SBA loans don’t require your business to be operational for two years or to be bringing in a lot of annual revenue for one simple reason — even brand new businesses could potentially qualify.
However, strong revenue and a robust business history will improve your chances of getting an SBA loan, along with a detailed business plan and the other things outlined in this post.
Keep in mind that SBA loans do require high credit scores. You also have to qualify as a “small business.”
This one often surprises people who are exploring how to get an SBA loan. According to the SBA, a small business is one that falls under a certain number of employees or average annual receipts, depending on its industry. Check the SBA website to see where your business fits in.
Beyond business size, you also need to:
- Be for-profit
- Operate in the U.S.
- Be independently owned
- Not hold a monopoly in your industry
Although they might be annoying to apply for and hard to qualify for, SBA loans are well worth the work for small business owners who need financing.
Once you’ve looked at all the options and zeroed in on what type of loan you want, you’re almost ready to apply for a small business loan.
5. Boost your chances of qualifying for the right loan
Before submitting a loan application, it’s a good idea to make moves that will position your business to qualify. This might include: improving your credit score, building a customer base, earning revenue, and refining financial projections.
Organize your paperwork
Lenders, especially for an SBA loan, will need to see a mountain of paperwork related to your borrowing history and business financials.
Here are just a few of the documents you might need to collect, organize, and pass along:
- Driver’s license
- Voided business check
- Personal background information
- Bank statements (one year)
- Balance sheet
- Profit and loss statements
- Personal credit score
- Business credit score
- Business tax returns
- Personal tax returns (past three years)
- Business plan
- Business licenses and registrations
- Articles of incorporation
- Third-party contracts
- Franchise agreements
- Business debt schedule
- Collateral documentation (depending on your lender)
- Use of loan proceeds
- Landlord subordination agreement
While not every lender will ask for each document, make the process of getting a small business loan smoother by ensuring that you have everything in order from the get-go.
Check your credit scores
Based on Fundera’s data, business owners need personal credit scores of at least 650 — and often 700 — to be eligible for an SBA loan.
Your credit score is a measure of how reliable you are as a borrower, and it’s especially important if your business is small or new.
Lenders will also look at your business credit score. Or more specifically, the SBA will take into account your liquid credit score — also known as your FICO SBSS (Small Business Scoring Service) score.
It’s designed to reflect the variations and changes that small businesses go through and to accommodate for the fact that a small business can have five employees — or 500.
The SBA’s minimum FICO SBSS score for its 7(a) loan program is 140, which is not-so-coincidentally also the maximum score you can achieve with no time in business or business credit history.
So if you’re figuring out how to get an SBA loan, make sure to build up your business credit with business credit cards, smaller loans and on-time payments to vendors who report your transactions.
Understand your debt-service coverage ratio
Keep in mind that out of all the things that go into applying for a loan, one of the most important deciding factors is a number that lenders call your debt-service coverage ratio.
The debt-service coverage ratio (DSCR), which is sometimes referred to as the debt coverage ratio, is the ratio of cash a business has available for servicing its debt. It’s the mathematical equation that allows lenders to know whether or not you can actually afford to repay your potential loan.
As an entrepreneur searching for a business loan, your debt-service coverage ratio is one of the bottom-line factors that will determine whether or not you’ll qualify for a small business loan — so it’s something you should understand completely and track regularly.
If you approach your financing search with DSCR in mind, it will help you better understand the responses you receive from lenders.
Why is the DSCR important?
The debt-service coverage ratio is important because it’s the financial scale a lender uses to determine whether or not your business produces enough cash flow to cover the cost of your loan, including payments on principal, interest and fees. But that’s not all lenders look for when calculating your DSCR.
In business, unexpected expenses can arise. That’s why lenders want to see that you have some extra padding in your bank account.
If, for example, a piece of equipment breaks and you need to replace it, lenders want to make sure you will be able to cover the unexpected cost without defaulting on your loan payments.
Generally, lenders will probably want to see a minimum DSCR of 1.25 — but that number can vary. Some lenders may accept a lower DSCR, others might want to see something even higher than 1.25.
How to calculate debt-service coverage ratio
Now that you understand exactly what the debt-service coverage ratio is and why it matters, how exactly do you determine what yours is?
To calculate the debt-service coverage ratio of your business, divide your cash flow by your loan payment. Here’s the formula you’ll need:
Annual Net Operating Income + Depreciation & Other Non-Cash Charges /
Interest + Current Maturities of Long-Term Debt
For example, if your company has a total annual net operating income of $20,000 and your debt service will be $16,000 for the year, your debt-service coverage ratio will be 1.25. Also, if you are currently financing a different loan, lenders will also include your other debt in their DSCR calculations.
By maintaining a respectable DSCR, you’ll put your business in a good position to be approved for a small business loan or line of credit to grow your business in the future.
Build your customer base
Finally, it’s important to have a strong customer base. This will help ensure that money will continue to flow in and pay off the loan.
If you need ideas on how to attract customers to your business, check out:
- How to get your first customer
- How to attract customers
- 25 ways freelancers can generate qualified leads
- How to turn contacts into referral sources
- 5 ways to get more local customers
6. Avoid common mistakes
Before you apply for a small business loan, consider some of the reasons that loans are denied.
Lenders often reject applications if they need more information or require you to change a few key portions. Aside from omissions, other common rejection causes include poor credit scores (both personal and business), cash flow concerns, inadequate collateral and applying for types of loans (e.g. a line of credit) that aren’t a good fit for your needs.
Get all of the information
Be sure to keep careful records of all of the documentation relating to your loan application(s). In the event of a dispute, you’ll definitely want to have those documents on hand.
Some lenders might provide you with the reason for your rejection straight away, but others might come back with a simple “No.” If that’s the case, don’t fret. The Equal Credit Opportunity Act (ECOA) requires lenders to tell you why your application was rejected.
Pro tip: If you’re not immediately informed as to why your application was rejected, you can request more information within 60 days of the rejection notice.
Understand how to re-submit a loan application
Lenders’ re-submission practices and preferences vary. Be sure to check with your particular lender to ensure you’re following their protocol.
Protect yourself from credit discrimination
The ECOA also protects you against credit discrimination. If you feel you’ve been discriminated against in any way, don’t keep it to yourself.
The Federal Trade Commission (FTC) has a more rigorous overview of ECOA protections on their website (and lots of other useful tools), but here are a few key factors that lenders cannot take into account when evaluating your application:
- National origin
- Sex (Gender)
- Marital status
- Receipt of income from any public assistance program
Visit the FTC’s site here for more information on how to protect yourself against credit discrimination.
Adjust your expectations
It’s true that some rejections can be reversed quickly if you’ve merely left out some important required information. With that said, addressing deeper concerns that arise in a rejected loan application can take months or years.
If it’s an issue with your cash flow, for example, you might need to work to reduce expenses or increase your revenue in order to make your application more attractive. If there’s an unprofitable area that you’ve kept afloat, now might be the time to shut down that avenue and focus your resources on what’s really working.
Check your credit score
Although it’s rare, lenders might have received a faulty report after running your credit. So if you notice any discrepancies between the score you expect and what they have on file, let them know immediately.
But did you know that often lower credit scores are the result of inaccurate information on your credit report? Check all of your credit reports, both business and personal, frequently to make sure that all of the entries are accurate reflections of your credit history.
Many lenders recommend checking your credit reports every six months to ensure reporting accuracy.
If you find inconsistencies on your credit report, reach out to the reporting agency to fix the error right away.
If you are organized and have maintained good debt payment records, you should be able to prove the mistake and get it fixed, which will, in turn, improve your credit score. Communicating with credit agencies to fix a reporting error can involve a lot of time and legwork, but it’s worth the effort to increase your chances of being approved for your loan.
Think like a lender
While you might have dozens of reasons why you think your business will flourish in the coming months and years, lenders tend to be more pragmatic.
For example, you might be betting on a huge influx in customers when a new housing development or public transportation station opens. But if your cash flow shows that you’ll have trouble making your payments in the short-term, lenders will likely turn you down.
Knowing what a lender is looking at will help you focus on the most important factors of your business loan application, and give you a better chance at success.
Revisit your business plan
Being approved for a small business loan starts with a great business plan.
You need to approach lenders with a strong, well-thought-out business idea — knowing what your intentions are for your business and how you intend to get there.
Include any evidence you can provide that approving your application will be a great investment in a successful company — successful enough to pay back that loan!
Improve your company cash flow
Ultimately, your lender wants to know that you’ll have the ability to pay back your entire loan, on time. To determine this, they might look into your cash flow history to confirm that you have enough money coming in on a regular basis to make your regular loan payments.
One way to improve your cash flow without increasing sales or prices is by offering clients a slight discount for making on-time or early payments.
Even a discount as low as 3 to 5 percent might be enough to encourage clients who have the cash available, but weren’t previously in a hurry, to pay your bill. Sending regular payment reminders and offering easier ways for your customers to pay will also improve your likelihood of being paid early or on time.
Maintain a strong bank balance
If your business is seasonal or has an irregular sales pattern, it might be more difficult to maintain a strong, regular cash flow.
To offset your irregular receivables and avoid being turned down by lenders, you’ll want to maintain a sizeable bank balance.
Ideally, you’ll have more than enough money in your business bank account to cover a future loan payment after all of your expenses (including the current month’s loan payment) are taken out. This will show lenders that you’ll always be able to make your loan payment, even if sales are slow for a month or two.
Plan to offer collateral
Even though you have a great business idea, a strong business plan, money in the bank and a strong cash flow, many lenders will require some type of collateral to secure your loan. By offering expensive business equipment, business real estate, or even your personal home or other property as collateral, you’ll assure the lender that you have an alternate source of debt repayment in the event that, in spite of your best efforts, your business is less successful than you hope.
7. Apply for a small business loan
Congratulations! You’re ready to apply for a small business loan.
The harsh reality is that not everyone who applies for a small business loan gets approved. To give yourself a fighting chance, you’re going to want to dot your i’s and cross your t’s. This, of course, means giving attention to everything that could be a potential threat to your business loan application.
Make sure you’re straight with the IRS
If you don’t pay your business taxes on time, the IRS will come after you, sending you a Demand for Payment Notice. And if you’re unable to pay off your debt or can’t come up with a payment plan, the IRS can slap a tax lien on to your business’s property.
This will make it difficult for you when you’re ready to apply for a small business loan. The best way to get rid of a lien on your business is to pay it off.
Once the debt is paid, it takes 30 days to be removed from your credit report. If you’re unable to pay the debt, working out a payment plan with the IRS is your next best solution.
Make sure your landlord is on board
It’s common for a commercial real estate lease form to give the landlord the rights to your collateral if you fail to pay your rent. Unfortunately for you, lenders aren’t interested in playing second fiddle when it comes to recovering their losses.
If you’re applying for an SBA loan, plan on having your landlord sign a Landlord Subordination Agreement or Landlord’s Waiver. If the landlord signs this agreement it gives the lender first rights to seize collateral if you fail to make your payments. Unfortunately, your landlord may not be so eager to sign, and if they don’t you may have to kiss that loan goodbye.
Build business credit
Your business credit history is a huge factor in determining whether or not you will get a small business loan.
For brand new businesses who are looking for funds early, lack of general business history can be a huge deterrent for lenders. Even some of the most lenient lenders require you to have been in business for at least a year.
If your business is less than a year old, try building up a business credit score before you apply for a loan by applying for a credit card or leasing equipment as opposed to buying it.
Keep seasonality in mind
If you’re applying for a short-term loan, lenders will ask to see your bank statements from the last three months. Just remember, if you’re a seasonal business, you don’t want to apply for a loan during your offseason. Your statements would not accurately represent your yearly revenue.
To increase your chances of getting approved, only apply for a loan during your company’s busy season.
The application process for a small business loan can be time-consuming and frustrating. The last thing you want to happen is to go through all that trouble and come out empty-handed.
But if you follow the steps outlined here — including shaping up your business plan, making your business official with a domain name and website, gathering together all the necessary documents, researching and choosing the best loan option for your winning idea, and keeping in mind where the pitfalls are — you’ll be well positioned to apply for a small business loan.
You can take these suggestions to the bank. Good luck!