How To Get A Small Business Loan: The Step-By-Step Guide
The lending process can be confusing. If your small business needs a loan and you are feeling overwhelmed, use our guide to walk through how to get a loan from start to finish.
You need money for your business, and you’re considering a small business loan. But like many small business owners, you may not even know how to get a business loan or where to begin. We’ve made this comprehensive guide to help you through the process.
Taking on debt without knowing the facts can be dangerous, with irresponsible borrowing leading to unpaid debt, collections, or even bankruptcy. That’s why it is important to understand small business loans before applying with a lender.
Keep reading to learn more about how to get a small business loan and determine if this is the right financial decision for your business.
Table of Contents
- Step 1: Determine How You Will Use Your Small Business Loan
- Step 2: Calculate The Amount Of Your Small Business Loan
- Step 3: Calculate How Much Money You Can Afford To Borrow
- Step 4: Check Your Credit Score & Report
- Step 5: Decide What Type Of Small Business Loan You Need
- Step 6: Research Small Business Lenders
- Step 7: Prepare Loan Application Documents
- Step 8: Apply For Business Loans & Compare Loan Offers
- Ways To Improve Your Business Loan Application
- The Bottom Line On How To Get A Business Loan
- FAQs About How To Get A Business Loan
Step 1: Determine How You Will Use Your Small Business Loan
Before even filling out a loan application, you should determine how the business loan proceeds will be used. A small business loan should only be used to benefit the business over the long term. You may need a small business loan for:
- Purchasing new equipment
- Buying land, office space, or buildings
- Refinancing high-interest debt
- Hiring new employees
- Covering payroll expenses
- Purchasing inventory or supplies
- Working capital
- Starting or acquiring a new business
- Funding startup projects
- Purchasing a franchise
Step 2: Calculate The Amount Of Your Small Business Loan
Once you’ve determined why you need a small business loan, the next step is to figure out exactly how much you need. Taking out a loan for an excessive amount of money that’s not needed could result in unnecessary extra fees and interest payments.
Run through calculations of your potential expenditures. Consider all scenarios when making these calculations. Do your research. For example, if you’re looking to expand your facilities with the purchase of commercial real estate, look at comparable properties online to get an idea of how much you will need to borrow. If you plan to purchase new equipment, compile a list or spreadsheet of related costs to give you an overview of how much money you need.
Not only will this help you save on interest by not over-borrowing, but it is also necessary for the application process. Lenders will want to know why you want to borrow the money. Doing your research ahead of time and having a logical response for how much you need and why you need it is a critical step in applying for a business loan.
Step 3: Calculate How Much Money You Can Afford To Borrow
Understanding the lending process and whether you can afford a business loan is a critical step to take before applying for a loan.
To understand how to get a small business loan from a bank or other lender, you need to know the various calculations used throughout the loan process to determine how much you can afford to borrow.
What Is Debt Service Coverage Ratio?
Debt Service Coverage Ratio (DSCR) is determined by dividing your annual net operating income by the annual debt payments of your business. The resulting score is used as a metric for determining loan amounts and terms.
Debt Service Coverage Ratio = Annual Net Operating Income / Annual Debt Payments
The DSCR of your business should be higher than 1. This shows lenders that you will be able to make your loan payment even with other debts.
For example, if the annual net income of a business is $150,000 and annual debt payments are $100,000, the DSCR would be 1.5, showing the lender that the business can afford to pay the principal and interest on a loan because income exceeds debt payments.
What Is Debt-To-Income Ratio?
Debt-To-Income Ratio (DTI) is used to show the relationship between the debt of the business owner and the owner’s monthly income. To calculate DTI, total monthly debt is divided by gross monthly income.
Debt-To-Income Ratio = Total Monthly Debt / Gross Monthly Income
Let’s say the business owner brings in $5,000 per month in income. The business owner’s monthly debt payments total $2,000. Plugging this into the formula shows that the DTI is 0.4 (or 40%).
In this example, the DTI is a bit high. Ideally, DTI should be around 36% or lower. While some lenders will still finance business owners with higher DTIs, approval may be more difficult and terms may not be as favorable.
What Is Return On Investment?
Return on investment (ROI) shows that the total cost of the loan, including interest and fees, is less than the profits that will come in as a result of getting the loan. For example, let’s say you need a loan to hire more employees. With more employees, you will be able to complete more work for your customers and make more money. Over time, this increased productivity will more than pay for the loan.
Step 4: Check Your Credit Score & Report
A small business loan requires you to have a strong credit score in order to receive the best rates and terms. Before applying for a loan, you need to have an understanding of your credit score and know what’s on your report.
Start by getting a free credit report and score online. Check your report for any errors that need to be disputed. Take note of negative items, such as collections, charge-offs, or late payments, as you’ll need to explain these to your lender.
How Do I Improve My Credit Score?
If your credit score isn’t high enough to secure the loan you need, look at this as an opportunity to boost your credit and understand your finances while putting you on the path to responsible borrowing.
There are several easy ways to improve your business credit score:
- Identify errors in your credit report
- Dispute errors with the credit bureaus
- Pay your bills on time
- If you’re unable to pay on time, contact your creditors
- Keep your credit utilization at 30% or lower
- Pay off debt as quickly as possible to lower credit utilization
Finally, don’t fall victim to companies that offer to boost your credit score. These services often come at a high price and don’t do anything to your credit report that you can’t do yourself.
Can I Get A Small Business Loan With Bad Credit?
It’s generally recommended to have a score at least in the high 600s to qualify for a business loan. Other options may be available for anyone with scores in the lower 600s or even the 500s, but these are often short-term loans with higher interest rates and lower maximum amounts.
While bad credit small business loans are available, we recommend raising your credit score to secure the best rates and terms.
Step 5: Decide What Type Of Small Business Loan You Need
The next step in the process is to determine the type of loan that best fits your needs. Understanding borrower requirements and knowing how you plan to spend funds can help you narrow down your options.
Step 6: Research Small Business Lenders
Since interest rates, repayment terms, and requirements vary by lender, it’s important to take the time to research your options in order to find the most affordable loan for your business. Here are some of the options available to your business.
Step 7: Prepare Loan Application Documents
Depending on the type of loan you’re applying for, paperwork requirements vary. At the bare minimum, you will be required to show the lender that you have the means to pay back the loan. Some loans, such as term loans from the bank or SBA loans, require additional documentation.
In general, you should expect to provide the following documents:
- Balance sheets
- Profit and loss statements
- Personal and business credit reports
- Personal and business income tax returns
- Bank statements
- Business licenses
- Franchise agreements
- Quotes from contractors and vendors
A personal guarantee from each owner may be required. This holds business owners personally liable if the loan goes into default.
Startup businesses may be required to submit other paperwork, including a business plan, resumes for all owners to prove industry experience, and financial projections.
Can I Get A Business Loan Without Collateral?
For certain types of business loans, collateral is not required. However, larger loans and some types of business loans often require collateral, typically in the form of business assets. Some lenders will also use personal real estate or assets as collateral for a loan.
Step 8: Apply For Business Loans & Compare Loan Offers
If you’re still interested in receiving a small business loan, the final step is to submit an application to a lender. Depending on the lender and the type of loan you’ve selected, you may have to visit a financial institution, call the lender, or apply online.
During the application process, you will need to provide some information to your lender. This includes:
- The reason you’re applying for the loan
- The amount you wish to borrow
- All documentation required to complete your application
- Explanations for any negative items on your credit reports
During the application process, personal and business credit reports will be evaluated by the lender. All documentation will be evaluated to determine whether you qualify for the loan, including creditworthiness and ability to pay back the borrowed amount.
After documentation has been submitted and the application completed, the approval process begins. For business credit cards or lines of credit, this could be almost immediate. For long-term loans, this process could take several weeks.
Once approved, the loan will need to go through underwriting, closing, and funding. Depending on the loan selected, the entire process could potentially take several months. This is especially true for SBA and long-term business loans from banks and credit unions.
If you’ve applied for multiple loans, such as through an online loan marketplace, compare the offers you’ve received to determine which has the most favorable rates and terms.
Ways To Improve Your Business Loan Application
Before you apply with a lender, here’s how to improve your business loan application to increase your odds of securing the funding you need.
- Check Borrowing Requirements: You should have a general understanding of the lender’s borrowing requirements, including personal and business credit scores, before submitting an application.
- Avoid Credit Inquiries: Avoid submitting numerous applications, especially if you don’t meet the requirements. This can result in unnecessary credit inquiries that impact your credit score.
- Research Rates & Terms: Research lenders to find the lowest rates and best repayment terms.
- Choose The Right Amount: Take the time to do the calculations to ensure you can afford the loan.
- Pay Off Existing Debt: Paying off existing debt shows your lender you take debt responsibly, lowers your DTI, increases your DSCR, and leaves you more money to pay your new loan.
- Offer Collateral: Even if collateral isn’t required, putting up property can increase your chances for loan approval and help you secure a higher borrowing amount.
- Ask A Professional: Your accountant or a business resource like SCORE or Small Business Development Centers can offer advice on how to improve your loan application and any potential red flags that lenders may spot.
The Bottom Line On How To Get A Business Loan
Once your loan has been funded, it’s time to use the money for your intended business purpose. With careful planning, these funds have the potential to take your business to the next level. The final step is to remember to always pay your loan as agreed like any responsible borrower. This proves that you are a trustworthy business and opens up more lending opportunities for the future.