Looking to expand your business or bridge cash flow? Then you've probably been reading up on small-business loans and you're probably realizing that the loan approval process can be more daunting than you thought.
Worse, a lack of knowledge may mean that you'll either be rejected outright or sucked into a contract that's not in your best interest. While small-business loan approvals from banks do seem to be on the rise, according to a 2016 study by Biz2Credit, only about 23 percent of small-business bank loan requests were accepted in the month of March.
That's why it pays to be prepared. Business loans can be complicated, but they don't have to be. Here's everything you need to know about the small business loan application process.
What Type of Loan Is Right for You?
Before we even get into the loan application, let's figure out which type of loan is right for you:
Business line of credit
A business line of credit is flexible "revolving" capital that works almost like a credit card, except you get access to cash and, in some cases, lower APRs. What's convenient about a business line of credit is that you can get approved in as little as one day. On top of that, there are no strict credit requirements, and it's a great way to build your credit score (as long as you pay back your balance on time!). Even better, with a business line of credit, you only have to pay back the balance and interest on the funds you draw.
There are some cons to business lines of credit. You may need to provide updated documents each time you draw, and the lender might also ask for collateral. Also, if your credit score is low, you may have to deal with higher interest rates. This can make using a business line of credit riskier and/or more expensive.
A business term loan is a lump sum that is paid back over a specific period of time with a preset or floating interest rate. One of the more competitive loan products, you'll need to be in business for at least two years, with a 620+ credit score and at least $100,000 in annual revenue.
Term loans are traditionally a bank product, but there are many online lenders that offer longer-term loans at an affordable rate. Because term loans generally have lower monthly payments and longer payment terms than short-term loans, you have the flexibility and breathing room to grow your business sustainably.
Short-term loans operate somewhat like a traditional term loan but need to be paid back within a shorter timeframe and usually with daily or weekly payments. As a result, loan amounts tend to be smaller and interest rates are higher.
The advantage is that you can get approved quickly (sometimes in just one day) and can set up your own payment structure. For those with bad credit, a short-term loan is a funding option worth considering, as even those with low scores may be approved.
The downside to short-term loans is that they can be very expensive. Because of the higher cost, payments could be hard to meet if cash flow is slow during a week, month, or quarter. So, you definitely want to analyze your actual ability to service the loan first.
SBA 7 (a) Loans
SBA 7 (a) loans are long-term, low-interest-rate small-business loans partially guaranteed by the government -- meaning the government will cover a portion of the loan if the borrower defaults. SBA loans are coveted by small-business owners who might not qualify for traditional bank loans because of the low cost and excellent repayment terms.
While SBA loans typically have the lowest down payments, longest payment terms, and reasonable interest rates, the process takes lengthy paperwork which leads to longer approval time. SBA loans may also require collateral.
Merchant cash advances
Merchant cash advances provide you with a lump sum of capital that you repay with a portion of your daily credit card sales.
The advantages of merchant cash advances are that the approval process is easy, you enjoy quick access to funding, and bad credit is often OK. Getting cash fast and easily can be the jumpstart your business needs to start booming.
Be warned, though: While a merchant cash advance may give you access to fast cash, the daily payments can be a strain on your cash flow and they are absolutely the most expensive loan product on the market. You might want to consider another short-term loan before applying for a merchant cash advance.
Invoice financing lets you get paid for your outstanding invoices right away -- for a fee. The approval process is short and simple -- you just need invoices (of course), 3+ months in business, and at least $50,000 in annual revenue. Approval can take as little as one day, and credit score isn't always a factor (but, in most cases, it is).
For businesses that already have solid cash flow, invoice financing may be a sensible choice.
It allows you to finance 50 to 90-plus percent of the invoice amount and then repay it when the client pays you (just be aware of the fees).
There are some cons, though. Fees are higher than those of traditional financing. Also, you owe more the longer it takes a client to pay, which can make using invoice financing risky and expensive.
When you need to purchase new business equipment right away, you can use the equipment itself as collateral. You can borrow up to 100 percent of the equipment value, and the loan term is roughly the length of the equipment's expected life.
Main pros to equipment financing include quick approval and very limited paperwork. Also, the equipment serves as collateral. The only real risk is that the equipment may become obsolete before you pay off the loan.
What Lender Should You Look For?
Once you've decided what type of loan makes the most sense for you, you'll want to look at and compare different lenders. Banks aren't the only way to go. There's also the SBA and a number of alternative lenders that may make sense for your needs.
Generally speaking, there are five types of lenders:
Alternative online financing companies: Peer-to-peer lending platforms, short-term lenders, MCAs, crowdfunding sites, purchase order financiers, etc. Many of these financing companies offer speedy loan approval times, but interest rates are higher than those of traditional lenders.
Big banks: Big banks are "the lender you know." While the interest rates and payment terms for a bank loan are typically more favorable, you might not get approved.
Community banks and credit unions: These financial institutions are often very willing to work with small businesses, and tend to have higher approval rates than big banks.
Nonprofit microlenders: These lenders typically offer terms and interest rates that are very favorable for small loan amounts.
The Small Business Administration: See above. SBA loans are easier to secure than traditional bank loans, but still have tough eligibility requirements and long applications.
You can never be too prepared
Many people approach business loans when they're desperate, leaving them no time to prepare or research. But fast loans are expensive, and you might miss out on the best loan for your business if you don't give yourself enough time to research and prepare.
Now that you have this small business loan cheat sheet, make sure you do your homework. Compare different loans from the same lender and across different lenders. Go out of your way to see what's available for your exact financial situation and credit score.
Do yourself justice and find a business loan that works for you (not the other way around). After all, you're getting a loan so you can sustainably grow your business, not so you can stress even more about the future.