Acquiring a small business loan approval enables entrepreneurs to secure additional financing to launch your startup or make your business thrive further. To qualify for a business loan, demonstrate proof that you can return the loan with interest on time. Completing the application for a small business loan may seem like a daunting process due to the volume of documentation and transparency required by the lender.
Various funding options qualify as small business loans, but the most common types are credit or bank union, and term loans from a financial institution. Trusted lending institutions provide low-interest rates through a term loan. This type of loan is considered one of the most preferred funding options for entrepreneurs due to its affordability despite the substantial paperwork and good financial standing required.
Small business loans could be issued as microloans that can range from a few thousand dollars to a more substantial amount that can exceed a million dollars, with a term of one to five years or more, depending on the case. The small business loan interest rates can amount to 2% up to 8% in general. The interest rate is based on the credit rating of the borrower, as well as the requirements of the lender.
The level of difficulty in obtaining the approval of a small business loan not only lies in the financial institution’s required documentation but also in your current financial standing. The following guidelines will enable your application towards a smoother process on how to get a small business loan approved.
Identify the type of loan you need
Understanding the reasons why you need a loan and how much should ensure that you accept the type of funding most suitable to your business’ needs. Defining the core reasons and loan usages also help entrepreneurs apply strategic management in handling it to avoid financial burden. Aside from that, lenders review the justification for outside financing applications.
Generally, there are four categories that the common applications fall on. These are: launching a business, managing the daily operating expenses, expanding the business, and building a safety net.
Your justification determines the type of small business loan you can apply for. For instance, if the reasoning falls on the category of launching a business, then it is quite impossible to obtain loan approval from an online lender or bank in your company’s first year.
Startups are normally disqualified from financing because lenders oblige the borrowers a steady cash flow for completing the loan repayment along with the interest charges. In this case, startup company owners can rely instead on personal loans, business credit cards, and borrowing from family and friends, among other types of startup financing.
For businesses that have operated profitably for more than a year, there are several other financing options. Repayment terms, however, can affect the long-term viability of your business.
This is why choosing the type of loan is critical; it should work for you and your company’s goals.
The following items are the most common types of business loans, together with their standard requirements:
- Bank Loans (US Small Business Administration or SBA Loans)
Requirements and considerations:
- Good credit standing
- The government provides a fixed Annual Percentage Rate (APR)
- The longer turnaround time to secure funding approval
Before checking alternative lending sources, companies tend to prefer traditional loans funded through the SBA due to their highly competitive interest rates. Small businesses also prefer this because the SBA guarantees the loan instead of having the borrower present a personal guarantee. Loan rates range from 2.25% to 4.85% with a loan amount of up to $5 million.
- Online Lenders
Requirements and considerations:
- The shorter turnaround time to secure funding approval
- Lower maximum loan amounts
- Variable APR
- More flexible credit prerequisites
Companies turn to this option when traditional banks decline the request for funding or the need for external funding is required sooner. Online lenders provide a solution for businesses in dire need of immediate loan approval and processing to quickly improve their cash flow, as well as those without good credit histories. These loan companies issue approvals faster with higher APRs and the need for collateral is no longer required.
Requirements and considerations:
- Good credit standing
- Short-term repayment schedule
- Competitive APR
Microloans are part of the lending programs funded through the SBA. The loan amount averages around $13,000, with programs specific to funding working capital, equipment or furniture purchases, inventory replenishment, and rentals, among others. Microloans also offer low-interest rates, however, presenting collateral and having a solid credit history is required.
- Alternative Loans
Requirements and considerations:
- The quick turnaround time to secure loan processing
- Short repayment timelines
- More stringent loan terms
- Flexible credit prerequisites
Alternative loan options cover merchant cash advances, P2P loans, and invoice factoring. These have gained popularity among companies requiring additional funds over the past 15 years or so.
Merchant cash advances are the most suitable lending programs for businesses with a high volume of credit card transactions. These are quite a short term in nature, with a repayment schedule spanning shorter than three months.
The loan payment process entails having the lender take a percentage of the daily sales based on the lending terms. Meanwhile, P2P loans are lending opportunities with a fixed interest rate that provides repayment schedules completed between two to four years.
Compare small-business lenders
Online lenders, nonprofit microlenders, and banks are the three types of loan providers. They offer loan options such as credit lines, accounts receivable financing, and term loans.
Online lenders are most suitable for funding when you quickly need the funding yet lack collateral. They provide small-business loans amounting from $1,000 to $5 million with average annual percentage rates that range from 6% to 99%.
The APR depends on the amount and type of loan, lender, repayment term schedule, the borrower’s credit standing, and if there is required collateral. Online lenders typically have much higher APRs than traditional banks. However, they have higher approval rates and offer much faster funding, some in as fast as 12 hours.
Banks are the preferred small-business lenders if you can guarantee collateral, prove good credit history, and have a sufficient timeframe to wait for the funding. These traditional bank options offer commercial mortgages for refinancing or buying properties, lines of credit, and term loans.
The SBA provides general small-business loans through disaster loans and short-term microloans, and it is a popular 7(a) loan program with loan amounts ranging from $500 to $5.5 million. Obtaining funding from banks takes the longest time compared with other lenders. Nevertheless, they provide loan options with the lowest APRs. Low revenues, cash reserves, and poor credit standing are the leading factors affecting the loan approval rate from banks.
Microlenders are there to assist in providing traditional loans for small companies. They are nonprofit organizations that offer short-term funding of less than $50,000. The loan size is considered as “micro” in amount, yet startups or smaller companies with a limited number of years in operations, and lack of collateral can apply from these lenders. The application involves submitting financial statements, loan justification, and a detailed business plan.
Qualify for small business loan approval
This step is the most crucial on how to get a small business loan approved. Securing funding from lenders means you have proven that you can repay the loan with interest on time.
Demonstrating this ability is the primary interest of the lenders to proceed with the approval of the small business loan. Here are four guide questions to check if you can qualify for a small business loan.
- How long has your company been operating?
If your company has been in business for at least one year, then you can qualify for most online small business loans. Meanwhile, companies with at least two years of business operations are granted most bank loans.
- Do you have enough cash flow generated through revenues?
Lenders have a minimum annual revenue requirement ranging from $50,000 to $250,000. Calculate your yearly cash flow from revenues to check if you comply with the needed threshold before submitting your application.
- How is your credit standing?
Review your credit report free of charge from among these three major credit bureaus: TransUnion, Equifax, and Experian, or obtain your credit score for free from personal finance websites or other credit card issuers. Banks favor borrowers with credit scores above 680.
- Can you comply with the required repayment schedule?
Carefully assess your financial standing, specifically your company’s cash flow, to check if you can fulfill the repayment timeline. It also enables you to plan and prepare your finances to strategically manage the repayment schedule and maximize the loan amount.
Complete the required documentation
It is crucial to demonstrate your business’ commercial standing, credit history, and financials through corroborating documents. Preparing this early on enables ease of accessibility to streamline the process of your business loan application.
Standard small business loan programs require sharing of all the company’s financial details, along with your financial standing, as well as the business’ growth plans stating how the requested capital will enable the company’s expansion.
Depending on the loan provider, submit each or a combination of the following documents:
- Business plan.
- Business permits and licenses
- Business and personal tax returns.
- Business financial statements.
- Business and personal bank statement.
- Business legal documents like permits, licenses, commercial lease, franchise agreement, and so on
- Business and personal credit scores
Submit your small business loan application
Select the loan type with the lowest APR and most suitable payment schedule among the loans you qualify for. Prepare the documents you have gathered, submit your loan application, and patiently await the approval of the funding for your business.
Meanwhile, here are the DON’Ts to help you avoid mistakes in obtaining the funding approval you need for your business.
- Showing limited cash flow
Cash flow evaluation is crucial for loan providers because it helps gauge the commercial health of your business. Essentially, it is the main consideration in proving that you can afford a loan. To check the loan amount that you can afford, you can calculate the debt service coverage ratio by dividing your net operating income by your total annual debt. Having a ratio of 1 means that your monthly loan payments are equal to your cash flow, showing a healthy financial capacity for your business. Lenders prefer selecting borrowers that can prove a ratio of 1.35 to show that the business has a buffer in their cash flow for handling debt coverages.
- Presenting poor personal and business credit histories
Lenders refer to credit reports as their tool in determining a borrower’s credibility. Showing a lack of due diligence in completing the repayment of past loans is a huge factor in being rejected for your new loan application.
- Not having an established and solid business plan
A comprehensive business plan is crucial for showing your financial projections to maximize the terms and amount of the funding you are applying for. A sound, documented justification with proof of business growth and expansion will help you build your case for a smoother loan application approval.
- Not seeking the advice of financial experts
Small business owners can rely on their accountants as an important source of advice, especially in assessing the required working capital for the business. Plenty of resources are available for detailed information on the types of capital funding and preparing for loan applications. Financial counseling from experts in your market and industry will also help you gain more insights into your business plan and strategic funding management.
- Not allocating the time and effort to shop for the best lender and loan type
Business owners must take the time to research and explore each option that best fits your business requirements. Ensure that you understand each term and condition of the loan type and lender you can shortlist as top choices for the funding you need. Review and compare the real annual cost of your loan options through evaluating the APRs plus additional charges side-by-side, making sure that you can carry out an apples-to-apples comparison to choose the best funding for you and your business.
Determining your needs and proceeding with a small business loan application are challenging. Keeping in mind these guidelines will help you ensure a more streamlined and less daunting loan application approval.
Always remember that lenders want to get their money back on time, which is why they will approve only applicants whom they deem worthy of getting their money.
If you can show them that you are capable of paying back your loan with interest in the agreed-upon timeframe, then you will likely get approved for that loan.