How to get a startup business loan in 5 steps

Obtaining a business loan is more challenging for startups than for established businesses, but it’s still possible. New business owners can improve their chances of approval by choosing the right type of financing, familiarizing themselves with their credit scores, and identifying the most competitive loan options available. Here’s how to get a startup business loan.

1. Evaluate what type of loan you need

Many small business owners opt for financing through traditional banks and credit unions. However, there are several types of business financing that can help startups get off the ground. Common types of business loans for startups include:

  • Online term loans. Term loans are generally issued by online and traditional lenders, and involve a bank extending a lump sum of cash, paid over a set period of time, at a set interest rate. Annual percentage rates (APRs) on the best small business loans start around 9% and maximum limits generally range from $250,000 to $500,000. That said, start-up business owners may not qualify for higher loan amounts and more competitive interest rates.
  • Commercial lines of credit. With a commercial line of credit, a lender extends funds up to a certain amount and the business owner can access the financing as needed. Interest only accrues on the portion of the line of credit that is accessed from month to month. In addition, the borrower can access the funds repeatedly after making payments during the draw period.
  • SBA 7(a) loans. The 7(a) loan program is offered through the U.S. Small Business Administration (SBA) and provides business loans of up to $5 million to eligible applicants. Funds can be used for working capital, equipment purchases, and business expansion expenses, and interest rates range from 2.25% to 4.75% plus a prime rate.
  • SBA Microloans. SBA microloans are available to eligible business owners for up to $50,000. Loans are generally offered to new businesses in disadvantaged areas and those owned by minorities and women. Repayment terms can be up to six years, with interest rates ranging from 8% to 13%, depending on the lender.
  • Asset-Based Financing. Asset-based financing is a form of secured commercial financing that allows emerging business owners to borrow against valuable assets such as inventory, machinery and equipment, accounts receivable, and real estate. This type of financing is less risky for lenders, so the terms are often more competitive than other types of loans. However, secured financing means that the bank can repossess the collateral if the borrower defaults.

2. Check your business and personal credit scores.

Lenders evaluate an applicant’s credit score to gauge the amount of risk they pose. Applicants with higher credit scores are more likely to make payments on time and, therefore, are more likely to be approved. Business credit scores are generally available after six months to a year of operations, so new businesses may not have one, especially if the start-up is new.

That said, loans are often personally guaranteed, meaning that the borrower legally agrees to repay the debt with his or her personal funds if the company defaults, so lenders also look at the applicant/business owner’s personal credit score.

Prepare for the application process and gauge your chances of approval by requesting copies of your business credit reports and checking your personal credit score before applying for a loan.

3. Gather and prepare the required documents

The exact documents needed to obtain a business loan vary from lender to lender. However, there are a few documents that most lenders use to evaluate and verify an applicant’s identity and the existence of a business. For example, lenders often request tax returns for at least two years, as well as financial records such as bank statements, accounts receivable, credit card sales, and outstanding invoices for at least the last four months.

As a startup founder, you can also improve your chances of approval by writing a comprehensive business plan. This can demonstrate to lenders that the business is financially stable enough to pay its debts based on future revenue and expense projections. Lenders may also request copies of business licenses and registrations applicable to your business or industry, as well as bank information for direct deposit.

4. Research and compare lenders

Depending on your personal and business qualifications, you may qualify for a start-up loan through multiple lenders. To identify the best business start-up loans for your needs, consider these factors when comparing lenders:

Annual Percentage Rates. In general, commercial loan APRs start around 9%, but rates can be higher for starter business loans and may even be lower for more qualified applicants. Visit each lender’s website or contact a customer service representative to determine available APRs.
Fees and other costs. Commercial lenders often charge origination fees ranging from 3% to 5% of the total loan amount to cover the costs of handling paperwork and verifying application information. Others also charge prepayment penalties for borrowers who pay off their loans early or late fees for those who miss their due date. These fees can increase the overall cost of borrowing and some lenders eliminate them to remain competitive.
Lender reputation. Even if a lender looks good on paper, take the time to read online reviews to assess its reputation among current and former borrowers. Similarly, reach out to other members of your business community to learn about others’ experiences with the financial institution. Consider choosing another lender if your research reveals red flags, such as negative customer service experiences.

5. Submit your application

Once you choose a lender, familiarize yourself with their application process and be sure to compile the correct documentation. Application and underwriting processes tend to vary by lender, so find out if you can apply online or over the phone, or if you need to visit a branch. After submitting your application, a lender representative may contact you to request additional documentation, such as proof of collateral or other financial records.

What happens if I am turned down for a commercial start-up loan?

If you are turned down for a commercial start-up loan, there are a number of things you can do to finance your new business. Start by contacting the lender directly to find out why your application was rejected. This information can give you an idea of what changes you can make to improve your credit profile and future chances of approval. Then, continue to build your business finances until you are established enough to qualify for a start-up business loan or another financing.

If you don’t have time to improve your credit score or build your business before reapplying for a business loan, consider an alternative form of financing.

Startup Business Loan Alternatives

Start-up business loans can help cover the costs of getting a new business off the ground or growing it into a larger operation. However, strict qualification requirements can make it difficult to obtain a traditional business loan. Here are some popular loan alternatives for startups.

Business credit cards

Business credit cards allow business owners to access financing on a revolving basis, as needed. Funds can be used for a wide range of purposes, including everything from purchasing furniture and other office supplies to larger purchases such as equipment, and the application process is simpler than for business loans. Because lending decisions are based solely on the borrower’s personal credit score, it is often easier to qualify for a commercial card than for a loan.

APRs range from 13% to 25%, but some cards offer 0% introductory APRs that allow business owners to make interest-free purchases for up to two years. In addition, cardholders only pay interest on unpaid balances that carry over to the next billing cycle. Therefore, credit cards can help emerging businesses cover monthly operating costs and avoid interest.

Personal loans for businesses

Startup founders who cannot qualify for a business loan may have better luck applying for a personal loan. Not only is the application process often less rigorous than for commercial loans, but the qualification requirements for personal loans are also generally less robust.

And, while loan amounts may be lower than those available through commercial lenders, qualified applicants can qualify for lower APRs with a personal loan than with a commercial loan, as low as 3% for the most creditworthy applicants.

These features make personal loans an excellent option for startups with no established income or financial projections. However, some personal loan lenders do not allow borrowers to use the funds for business purposes, and borrowers are personally responsible for repaying personal loans, although this is also the case with many commercial loans. Finally, the combination of business and personal loan funds can complicate accounting, tax, and legal issues.

Personal Savings

For some, borrowing is not the only way to finance a new business. Business owners who have sufficient personal savings can use those funds to start or grow their businesses. Not only do personal savings eliminate the need to pay origination fees and interest, but using cash to fund a startup can help a business owner avoid giving equity to investors.

That said, investing personal money can be a risky move and can result in a business owner losing his or her savings if the business fails. Many startup founders also lack the extra money to invest in their businesses, let alone start or grow a business without additional funding.

Friends and family

Alternatively, startup owners may consider borrowing money from friends or family to get their business off the ground. Borrowing cash from family eliminates the need to meet traditional qualification requirements, but the approach presents its own challenges. Before borrowing from anyone, a business owner should consider whether he or she is comfortable entering into that type of relationship.

Borrowing money from friends and family can complicate existing relationships, so it is important to make sure that all parties understand the terms of the loan. To reduce future conflicts, startup founders should get the loan agreement in writing, including the loan amount, interest rate, repayment terms, and other factors.

Fundraising

Crowdfunding offers startup founders a way to raise funds for their businesses without having to borrow from a traditional financial institution or from friends and family. Business owners can start a crowdfunding campaign using an online fundraising platform such as Kickstarter or Indiegogo.

Once the campaign is set up, users can donate funds that will be available to the business at the close of the crowdfunding round. The business owner does not need to meet any traditional qualification requirements, and donors do not receive business capital in exchange for their generosity.