How to Get a Startup Business Loan
Being a startup business owner may limit your financing options, but it doesn’t mean you don’t have options.
If you’re the owner of a new business and are thinking about applying for a loan, there are a few things you need to consider from the start, said P. Simon Mahler, a mentor with SCORE, a nonprofit association that helps small businesses grow and meet their goals through education and mentorship.
“The first thing you have to ask is, ‘Do I really need that money?’” Mahler said. “You want to figure out how you can really get going with this business with the least amount of overhead and the most amount of exposure.”
This is important because the cost of running a business, comes with, well, a cost. You should know how much it takes to operate your business before you apply for a loan so that you can ask for the right amount. You can fill out a startup costs worksheet to get a good idea of your expenses. Here are some common startup costs:
- Rent and utilities
- Inventory/upcoming orders
- Licensing, permits and taxes
- Advertising and marketing
- Expert help
Along with your expenses, you’ll also want a good handle on your revenue projections and any assets you have, Mahler said. Many traditional lenders will require collateral, so you should make a list of all the assets you could potentially use for collateral.
How to get a startup business loan in 4 steps
Here are four steps you can take to give yourself the best shot at getting a small business loan and a head start on the process.
1. Create a business plan.
If you haven’t already, write out a business plan. Your business plan should be a professional, living document with updated projections and financial information that you can present to a bank, financial institution or investor. You should also include your business goals and clearly express knowledge of your industry and how you plan to market your company. For Mahler, it’s important when it comes to your company’s financials that you show your work and “go in-depth” in providing details.
“Have an asterisk after each number and put an index in the back with how you came up with each number,” he said. The U.S. Small Business Administration (SBA) has an in-depth guide to writing a business plan here.
2. Know your credit score and boost it if you can.
If your startup is too new to have a credit history, then your personal credit score is the score traditional lending institutions will use when determining your credit risk. Before you approach a lender, boost your score as much as you can. Understanding the 5 C’s of credit — character, capacity, capital, collateral and conditions — may help you know where you stand with a lender.
To boost your credit score, make sure you’re current on all accounts, don’t open any new lines of credit (unless you don’t have one already) and make sure your credit card balances, both individual and combined, are less than 30 percent of your credit limit.
3. Register your business.
Make sure your business is registered and you have all the right licenses and permits. First, register your business as a legal entity (for example, an LLC or a corporation).
If you’re a sole proprietorship (a company owned and run by one person), you won’t have to register as an entity. If your business has employees, you’ll need to register with the IRS and get an Employer Identification Number (EIN). If you don’t have employees, you can use your Social Security number.
4. Get your documents in order.
The paperwork and documents each lender requires will vary, but there are some common ones. You can jump-start the process by making sure you have the following documents ready:
- Profit and loss statements
- A balance sheet
- Cash flow statements
- Bank statements (usually from the last three months)
- Loan and lease statements
- Personal and business tax returns
- Business license
- Proof of collateral
- Articles of incorporation
Now that you’ve assembled all this information, what looks like a viable path to securing a loan? Do your financial projections look promising enough to get a traditional business loan? After looking through your expenses, does it seem you may need only a small amount of money that the SBA may be able to help you with? Would a credit card suffice? Below, we will look at all available funding options for startup businesses.
Startup loans to consider
While some options may be limited for startups in need of a loan, there certainly is more than one type of financing available. Although many lenders want to see at least two years of time in business, newer companies can improve their chances by offering collateral or showing strong sales. Many online lenders don’t require collateral and will have lower requirements for time in business, sometimes as little as six months. However, online lenders will almost always have higher interest rates.
Commercial bank loan
For a commercial bank, a startup company may look very risky, Mahler said. For starters, you will need to put up collateral to secure a bank loan, which could mean using a personal asset — such as your house — if you don’t have much inventory or receivables. Your personal finances will have to be in good shape and you’ll need a solid business plan. It’s important to note, however, that having collateral, good financial history and a solid business plan still might not be enough for a traditional bank loan, even if you have good credit.
“Acquire funds and show growth,” Mahler said. “A lot more banks will be interested in knowing you bootstrapped it.”
Revolving line of credit
A revolving line of credit is a loan that provides a fixed amount of capital that can be accessed when needed. All or part of a line of credit can be accessed at any given time up to your credit limit and the borrower only pays interest on the amount they use. Oftentimes, a revolving line of credit can offer lower annual percentage rates (APRs) than credit cards, and is typically used for short-term needs.
However, similar to a commercial bank loan, it can be challenging for a startup to secure a line of credit through a traditional bank. There may also be an annual fee attached to a business line of credit.
SBA 7(a) loans
The SBA helps provide loans for small businesses. It doesn’t issue the loans itself, but rather works with financial institutions including banks and credit unions to offer loans to businesses. The SBA then guarantees a portion of the loan, usually between 50 and 90 percent. If the borrower defaults and the lender can’t recoup the funds from the borrower, the SBA would repay the guaranteed portion of the loan. This can increase your chances of approval through a traditional bank, since the SBA guaranty lessens the lender’s risk.
However, this doesn’t mean all startups will get approved for an SBA loan. There are similar hurdles to securing a loan with the SBA that you would experience with a traditional lender. Mahler recommends visiting the SCORE site and going through its programs and certifications to help improve your loan application. “You still have to prove this business can sell itself,” he said.
SBA 7(a) loan features:
- The SBA 7(a) loan is the most popular of the SBA loan types and gives a borrower access to capital for a variety of different uses, including working capital to run your business.
- These loans can be fixed-rate or variable and have different rates of maturity based on the borrowers needs. Maximum maturity for real estate is 25 years, 10 years for equipment and seven years for working capital.
- Fees for the loan vary based on the guaranteed dollar amount and the maturity of the loan.
- To be granted an SBA 7(a) loan, you must be a for-profit entity that is located and does business within the United States. You must have a good FICO Small Business Scoring Service (SBSS) score and present a solid business plan.
- Business that are granted an SBA 7(a) loan can’t have access to alternative funds from other sources.
- The maximum loan amount is $5 million.
The SBA’s Microloan program provides short-term loans of up to $50,000 to small businesses for working capital or to buy inventory, supplies, furniture, fixtures, machinery and equipment.
These microloans are financed through nonprofit organizations that are intermediary lenders. They have a fixed rate of no more than six years. Borrowers may have to pay an annual contribution, but it can’t exceed $100.
SBA 504 loans
The SBA 504 loan program is specifically for facilities. This loan can be used for the purchase of land, buildings, improvements, new equipment, construction or commercial real estate.
The maximum SBA 504 loan amount is capped at $5 million. Rates are fixed, with a maturity of 10 or 20 years. To qualify for this government-backed loan program, you must be located and doing business within the U.S. You must present a solid business plan and also not have access to funds from other sources.
Microlenders will give loans to startups and small businesses in amounts that are typically less than $50,000. They may be found through a variety of institutions including nonprofits. Proving that you have customers and interest could be crucial for this kind of lending.
“Everybody wants customer traction. It doesn’t matter if it’s 20 people or 1,000 people; they want to see something,” Mahler said.
Microlenders will also want to see a solid business plan, as well as financial statements.
There are other ways to receive funding for your business, such as investors looking to fund startup businesses. They may have higher interest rates than traditional lending institutions, but you may find they are on par with banks and just as willing to assume more risk than a traditional lender.
“Telling a story is really important when approaching investors,” Mahler said. “If you are talking to investors or alternative lenders, put together a pitch deck of no more than 13 slides.”
Mahler also suggests getting plugged into the entrepreneurial community and joining your local SCORE chapter. Networking is a great way to find alternative types of investment funds, he added.
Is a business credit card an option?
A business credit card can be a good source of funding, especially for smaller, everyday expenses or short-term needs. Newer businesses are also more likely to be approved for a business credit card than a traditional loan because their personal and business income will be considered (and sometimes their spouse’s income will be as well).
Credit cards typically have higher interest rates, so unless you can find a credit card offering a zero percent APR for an introductory period, it can be expensive to carry a balance on the card for a long time, Mahler said. Credit cards also have lower borrowing limits than many loans. A 2016 Experian report showed business owners had an average credit limit of about $56,000.
Be wary of using a personal credit card for your business. “If you fail in your business and you can’t afford those monthly payments after the business goes away, your credit is tanked,” Mahler said. “You also won’t get the benefit of building up your business credit. If you are willing to assume personal responsibility for your business, a personal credit card could be a feasible short-term option.”
3 alternative forms of financing
1. Invoice factoring and invoice financing. Invoice factoring is when a business sells their outstanding invoices to a factoring company in exchange for a cash advance. New businesses that have outstanding invoices for existing customers may be able to sell those invoices in exchange for a percentage of up-front cash.
This may be a good option for a startup, as approval is not dependent on the company’s credit; instead, it’s dependent on credit of their customers. Typically, the business receives 50 to 80 percent of the invoice value based on the risk profiles of the company’s customers. Then you receive the remainder of the amount, minus a factoring fee, when the factoring company collects on the invoice. The fee is typically about 3 to 5 percent of the invoice value.
Invoice financing is similar, except you don’t sell your invoices — instead, you use your invoices as collateral for the cash advance. However, if your customer doesn’t pay the invoice, you’ll still be responsible for repaying the money you were advanced, with an average fee of 2 to 4 percent of your monthly invoice value.
2. Crowdfunding. With crowdfunding, someone uses a website, such as Kickstarter, to seek donations or secure advanced sales to fund a product or service. Crowdfunding has exploded in popularity, but it’s a lot more work than it looks like. Mahler said the most successful crowdfunding campaigns will clearly display the business owner’s passion and their value in the community. “You have to put in the time and the effort and the energy to make that happen,” Mahler said. “You have to constantly update.”
3. Borrowing from friends or family. Family and friends are, of course, likely going to want to help you in your endeavors, but it’s possible to ruin relationships over business. So what is the best way to ensure a good relationship when mixing business with personal relationships?
“You need to treat them as if they are an investor you just met for the first time,” Mahler said. “The family or friend should receive equity in the business, or you should pay them interest on their investment, and there should be a payment plan. Don’t do anything on assumption or just a handshake.”
The bottom line
Finding financing for a startup may feel like an uphill battle, and you may not be ready for a big bank or lender. But showing growth, progress and customer satisfaction is a start to getting the type of financing you need. Understanding your options and maintaining good credit is key to securing financing for your business.