Trying to decide if your small business needs a business loan? Check out this guide to discover your funding options.
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While not every business owner is going to need a loan, it is very common for small business owners to seek additional financing for their business, and loans can be a good option. But how does a business loan work? And how do you get business loans for a new business?
A first-time business loan can be daunting and confusing, but it doesn’t have to be!
Read on to learn more about everything you need to know before applying for a first-time business loan.
Do you know your way around a business loan and just need a refresher? Head over to our step-by-step guide on applying for a business loan.
Before You Apply For A Business Loan: 5 Easy Steps
Getting a business loan doesn’t start with filling out the loan application. Instead, the process should begin before you even talk to a lender. Before you hop online to fill out your application or head to your local bank branch, prepare by taking the following steps.
1. Check Your Credit Score
Lenders want to make sure they’re working with low-risk borrowers who will pay their loans as scheduled. To assess risk, lenders look at several factors, including credit scores. Your credit score is one of the most important factors lenders consider when deciding whether to approve your loan application.
A low credit score indicates that a borrower is high-risk. A lender may deny the loan application if your credit score is too low. In other cases, loan options may be available but at a higher price for the borrower — think higher APRs, down payment requirements, and the need for collateral.
To receive the best loan offers, a score that is at least in the high 600s is required for many business loans, including loans from the Small Business Administration and banks. However, some alternative lenders will give loans to borrowers with scores as low as 500. A lower score may result in fewer options and higher costs over the life of the loan in most cases.
You can take steps to raise your credit score before applying for a business loan to score better rates and have access to more funding options.
Learn more about the importance of your credit score in our article about the 5 Cs of Credit.
2. Decide How You'll Use A Loan
Before taking on the debt of a loan, it’s important to establish why you need the loan and how you will use it. It’s easy to just grab for the money right in front of you, but you need to determine whether your reasons for taking the loan are sound.
Before applying for a loan, consider your return on investment. In other words, will taking out a loan and paying fees and interest be worth it? If the loan will benefit your business and outweigh the costs, proceed with the loan process. If there is no real benefit to receiving a loan, reconsider taking on this extra debt.
You’ll also need to decide how much money you need. Once you’ve determined how you’re going to spend the loan proceeds, this step shouldn’t be too difficult. If you’re buying a new piece of equipment, shop around to get price estimates. If you’re updating your facilities, get bids from vendors and contractors. If your goal is to purchase commercial real estate, look at comparable commercial properties in your area to get an idea of what you’ll spend.
Lenders will want to know exactly how much money you need and exactly what you’re going to use it for. You’ll need to make a business plan designed for the business loan application process.
3. Calculate How Much You Can Borrow
You know how much you need to borrow. Now, you need to calculate how much you can afford to borrow.
Before applying for a loan and taking on debt, you’ll want to calculate your debt service coverage ratio or DSCR. This shows the relationship between the income and debt of your business.
Debt Service Coverage Ratio = Net Operating Income / Debt Obligations
To calculate DSCR, divide your net operating income by your debt obligations for the current year. Your net operating income will include all revenue minus operating expenses. Your debt obligations will include all debt, including interest and fees, for the next year.
After plugging your numbers into the formula, your DSCR should be at least 1.25. This shows you (and your lender) that you are bringing in enough income to cover your current debts and can take on additional debt, such as a business loan.
Learn more about how to calculate this ratio in our article about improving your DSCR.
4. Improve Your Online Presence
Lenders want to loan money to borrowers who are low-risk and will pay their loans back as agreed. This is why the loan process can be so tedious. Lenders evaluate your credit score, your business revenues, and even your social media.
Believe it or not, many lenders are now turning to the internet to learn more about loan applicants, especially small business owners. It has been reported in the past that FICO is considering using social media as one of the factors to measure creditworthiness.
Before applying for a loan, consider bolstering your online presence. Make sure that any online resumes are completed and updated. Reach out to your clients and customers and encourage them to review and rank your business through social media and review sites like Yelp For Business. You want to show lenders that you are a trusted, well-established business.
It’s also important to never complain about work or discuss financial challenges online. This doesn’t just look negative to lenders, but it’s a general best practice that will help you maintain a veneer of professionalism to your customers, clients, and anyone who searches for you or your business online.
5. Prepare Loan Application Documents
There’s one thing that can never be avoided when applying for a loan: submitting your paperwork. Although requirements vary by lender, the amount of money you’re requesting, and the type of loan you’re applying for, there are a few basic documents you will need to prepare ahead of time to submit with your application.
- Income Tax Returns: Prepare a minimum of 2 years’ worth of returns to submit with your application.
- Bank Statements: You’ll need as few as 3, but we recommend having at least the last 6 or 12 months’ worth of business bank statements.
- Profit & Loss Statements: Additional documentation proving income and revenue may also be required, including balance sheets.
- Proof Of Ownership: For many loans, you’ll need to also prove that you’re the owner of your business. This can be done with business licenses, certifications, and other official documents.
- Purchase Agreement: This will only be required if you are purchasing real estate.
- Debt Information: This will be required if you plan to use the loan to refinance existing debt. You’ll need information about your debt like your account numbers and statements.
If you’re a new business or startup, you may not have access to many of these documents. Instead, you’ll need to have the following:
- Business Plan: This will need to be solid and detailed and also include future income projections.
- Industry Experience: You may need to submit your resume to prove that you have experience in the industry your new business will be a part of.
You should also know that going into the loan, collateral may be required. Collateral requirements vary by lender, and in some cases, specific collateral is not needed.
However, most loans do require a personal guarantee to be signed by every owner of the business. This guarantee holds business owners personally liable for the loan and allows the lender to pursue legal action and even seize personal property if the loan goes into default.
How To Find the Right Lender
The lender you use depends on various factors.
You’ll want to consider:
- The loan amount
- The type of loan
- Your creditworthiness
- Your time in business
Most business owners turn to three main types of lenders for their business loan needs: traditional or online banks, the Small Business Administration, and alternative lenders.
Check out the best small business loans for reputable lenders we recommend.
When You Should Apply For A Bank Loan
When they need a business loan, many business owners turn to a source they already use for other financial purposes: the bank. Bank loans are popular with business owners because they offer some of the most affordable loan options on the market.
You should apply for a traditional business loan from a bank if:
- You need a high loan amount
- You want low interest rates and great repayment terms
- You have a strong credit history (score of 600-700+)
- You can provide collateral
- You have time to wait for the application process
When You Should Apply For A SBA Loan
Small Business Administration loans are extremely competitive because of their low rates and flexible terms. Because these loans are backed by the government, lenders known as intermediaries have more incentive to loan to small businesses that have trouble qualifying for conventional loans.
SBA loans have similar documentation requirements as banks, as well as similar timelines for approval and funding.
You should apply for a SBA loan if:
- You have a strong credit history (score of 600+)
- You’ve never defaulted on government loans
- You can provide collateral for higher loan amounts
- You fall under the SBA definition of a small business
You can do a deep dive into SBA loans to learn everything you need to know about the specifics of the different programs, but here are the main ones:
- 7(a) Program: The 7(a) program provides up to $5 million for almost any purpose.
- 504 Programs: 504 programs are best for the purchase or improvements of real estate.
- Microloans: Microloans are smaller loans of $50,000 or less.
- Veterans Advantage Program: The Veterans Advantage Program is exclusively available to military veterans and service members.
- Community Advantage Program: The Community Advantage Program is exclusively for businesses in underserved areas.
Qualified business owners can apply for these loans through SBA-approved banks, credit unions, non-profit organizations, and Certified Development Companies.
When You Should Apply For An Alternative Loan
More businesses are turning to alternative loans for several reasons. Difficulties qualifying for conventional loans and the need for fast financing are two of the biggest reasons alternative lenders are becoming more popular in the small business world.
You should apply for an alternative loan if:
- You have difficulty qualifying for conventional loans
- You need fast financing
- You have a lower credit score (500+)
- You own a startup/new business
- Your business hasn’t generated a lot of revenue
- You want a faster application process
- You can provide collateral for larger loan amounts
It is important to note that these loans often come with higher interest rates. Because alternative loans are more expensive, qualified business owners with high credit scores should consider more affordable options.
First-Time Business Loan Application Best Practices
You’re almost ready to apply for your loan, but before you do, it’s important to understand a few best practices. While it’s easy to focus solely on the money, it’s also critical to present yourself as a professional, trustworthy business owner to lenders.
- Be Thorough: This will help expedite the entire loan process. Shop around to make sure you’re getting the most affordable financing deal, know what you want to say to potential lenders and how you want to present your business, and have all of the paperwork to back it up.
- Be Honest: Be upfront with your lender about how you plan to use the money and your current financial situation. Lying will get your application rejected. Be honest with yourself as well when you’re determining how much of a loan your business can handle.
- Be Available: After a potential lender receives your application, they’re most likely going to have follow-up questions. Answer phone calls and/or emails from your future lender whenever you are available to avoid delays in your application process.
Additional First-Time Business Loan Resources
Have more questions? We’re here to help! Click on the options below to learn more about the different aspects of business loans.
Fixed Amount Loans
Are you in need of a fast $5K for your business? These smaller loans are usually easier to qualify for and don’t have lengthy application processes. Many of them can dispense funds within 24 hours of approval. Check out our top picks for $5K business loans.
If you need a little more than $5K to help alleviate your business woes, $10K loans offer the same conveniences as $5K loans but with more cash flow. Whether you want short-term loans or flexible lines of credit, our favorite lenders for $10K loans will have what you need.
Read our article on the best small business loans to learn more.
Final Thoughts
Applying for a business loan can be intimidating, but with careful planning and a little knowledge, you can move through the loan process like a pro. Be prepared, know your numbers, keep in contact with your lender, stay professional, and you’ll soon be on your way to securing your first business loan!
Keep on reading our other loan content if you have more questions on average business loan interest rates or how to calculate a monthly business loan payment
First-Time Business Loan FAQs
How hard is it to get a first time business loan?
First time business loans aren’t always hard to get. The difficulty of getting a first time business loan will depend on the strength of your loan application, the type of lender you are applying for, and other factors.
What are best options for first time small business loans?
The best option for a first time loan will depend on why your business needs a business loan, the types of loans you’re qualified for, and other factors. Learn about business loan types, and what businesses benefit from each, in our types of business loans guide.
Is personal credit considered for first time business loans?
Yes, personal credit is almost always considered for first time business loans.
How to get a first time business loan?
To get a first-time business loan, you’ll need to do your research, find a potential lender, prepare your documents, and apply.
What do you need for a first-time business loan?
For a first time business loan, each lender will have different application requirements. At the very least, you’ll need to provide financial documents (taxes, etc.), proof of ownership, and proof of revenue. Click here to see a full list of documents you might need to provide.