How to Qualify for a Small Business Loan

If you’re considering starting a business or are already a small business owner, you should understand what business loan requirements apply and how to get a business loan to transform your ideas into a viable business opportunity. A whopping 99.9% of companies are small businesses. Still, many of them face challenges when it comes to access to funding. Knowing how to qualify for a business loan can be a critical factor that makes or breaks a small business as around 82% of them fail due to the cash flow problem. To assist your business fall under the remaining 18%, start here by understanding how to qualify for a new business loan and get access to much-needed cash.

In this article

    What is a small business loan?

    Small business loans are loans intended specifically for small businesses use to help them reach their goals and pay for costs and expenses incurred in the running of the company.

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    In order to get a small business loan, you’ll need to apply for one at a traditional lender such as a bank and a credit union or an alternative lender such as online loan providers. As not all businesses are capable of returning the borrowed money, lenders will set minimum requirements a loan applicant needs to meet to get funding. Make sure you understand their requirements to increase the odds of loan approval.

    What are the business loan requirements and how do they work?

    A small business will typically be a company with up to 50 or even 500 employees. The Small Business Association has a bit more complex classification with the number of employees and the industry-specific total gross income determining the size of the business.

    Business loan requirements include factors that relate both to you and your business, such as your personal credit score, years in business, the purpose of the loan, annual revenue, amount of debt that you already have and assets that can serve as collateral.

    The requirements differ between lenders, with a general rule that traditional lenders have stricter criteria compared to alternative or online lenders. For this reason, they often have lower financing costs. However, online lenders have lower overhead due to their digital business model and sometimes will pass on a part of these savings to their customers in the form of lower interest rates they charge, so make sure to consider carefully all your potential lenders. Also, business loans will have stricter rules compared to lines of credit or business credit cards, leading to lower financing costs, which is something to keep in mind when choosing a suitable financial product.

    A small business loan can be short term and long term. Short-term loans are intended to satisfy short term funding needs, such as inventory and payroll financing. On the other hand, long-term loans are designed to fund more expensive projects that span over longer periods, such as constructing a building or buying expensive equipment. It’s generally not a good idea to fund long-term projects with short-term loans or to finance working capital with long-term loans.

    [ Read: A Loan to Build a Dream On: Where to Find Small Business Funding ]

    How to apply for a small business loan

    Before you apply for a small business loan, make sure you carefully consider the purpose of the funds that you want to borrow and how much external financing you really need and can afford.

    Apply at lenders where you are confident that you meet minimum credit requirements, otherwise, your application will probably get rejected. According to score.org, most traditional lenders will want to see a credit score above 700. In contrast, online lenders may work with borrowers with scores below 650 if the borrower can demonstrate they run an otherwise healthy business. The SBA loans are the most desirable as they come at the most favorable financing terms, but they usually require a score above 650.

    Shop around to secure the best financing terms, including the lowest APR and lowest fees. Once you finally choose a loan provider, you will usually need to submit business and personal bank statements and tax returns as well as financial statements and legal documents such as articles of incorporation.

    Pros and cons of small business loans

    A small business loan is a great way to secure funding for starting or growing your business, but make sure you consider all the pros and cons before applying for one.

    Pros:

    • Cheapest option: These loans come at lower financing costs, especially when offered by traditional lenders such as banks and credit unions.
    • Builds credit: If you stay current on your payments, a business loan can help you build a strong business credit profile which will help you get financing easier in the future.
    • Business insights: When you apply for a loan, the lender will ask for information that will also help you understand your business better.

    Cons:

    • Strict criteria: Minimum requirements are higher compared to other financing options.
    • Limited use of funds: You can use the funds only for the purpose you stated when you applied.
    • Long approval procedures: It takes a longer time to get a loan as the lender needs to check whether an applicant meets higher eligibility criteria.

    [Related: Small Business Guide to Home Tax Deductions]

    Check Your Business Loan Rates

    View our top-rated lenders and find the best rates today. It’s quick and easy.

    Alternative financing options

    Despite being the least expensive financing option, small business loans come with stricter eligibility requirements that may prevent many owners from getting one. In this case, you may want to consider alternative financing options. Which one you’ll choose will depend on your financing needs.

    • Business line of credit: This product is a revolving type of credit, convenient for working capital financing such as inventory and payroll.
    • Business credit card: A business credit card is suitable for a quick smoothing of seasonal ups and downs in revenue.
    • Merchant cash advance: This is a type of financing convenient for small businesses with high credit card sales in which the borrowed money is paid back as a fixed percentage of future sales or revenue. However, it is one of the most expensive financing options.
    • Invoice financing/factoring: This involves selling your invoice to the factoring company help you get access to money quickly without waiting for customers to pay for the product or service that you sold them. Keep in mind that you will receive lower amounts than the invoice amount in return for this convenience.
    • Equipment financing: If you need to buy equipment, this type of financing is easier to qualify for compared to term loans.

    We welcome your feedback on this article. Contact us at inquiries@thesimpledollar.com with comments or questions.

    Aleksandra Deric

    Contributing Writer

    Alex Deric is a freelance finance and technology writer that brings in-depth investment knowledge and experience to her writing. Originally from Serbia, Alex has spent more than a decade working in the finance industry around the world, including London and New York. After having studied at Oxford and the London School of Economics, she is now working towards her Ph.D. degree. You will find her published work on sites such as The Simple Dollar, Interest.com, NetworkNewsWire, CQNet, FundingHQ, and CS Strategies. She’s an avid runner and a firm believer that financial education can make the world a better place.

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    • Courtney Mihocik
      Courtney Mihocik
      Editor

      Courtney Mihocik is an editor at The Simple Dollar who specializes in insurance, personal finance, and loans. Previously, she wrote and edited for Interest.com, PersonalLoans.org, Ballantyne Magazine, Thread Magazine, The Post, ACRN, The New Political, Columbus Alive and the Institute for International Journalism.