A Guide to Choosing the Right Small Business Loan

Credit: Duncan Andison/Shutterstock

Launching and running a small business is not a cheap endeavor. Whether it's money to get up and running or cash to invest in inventory or buy new equipment, it's likely you're going to need more capital than you have in the bank at one point or another to keep your business moving in the right direction. 

The question is, when you need money and don't have it, where do you turn? Small businesses today have a variety of options when it comes to finding a lender. There are government-backed loans and loans from banks, merchant service providers and alternative lenders, which include an assortment of online lending services that don't come with those same guarantees as those backed by the government. 

Before you start applying for loans, you first need to answer several critical questions that will push you in the right direction, including:

• What do you need the money for?
• How much money do you need?
• How long will it take you to pay it back?
• How long have you been in business?
• What is the current financial shape of your business?
• How much collateral, if any, do you have to put up for the loan?
• How quickly do you need the money?

Answering these questions will help determine if you should pursue a government-backed SBA loan, a loan or line of credit through a bank or other financial institution, a cash advance from a merchant services provider, or a loan from an online alternative lender. All offer types of loans that you can use for an array of purposes, such as smaller working capital loans for day-to-day expenses, or larger loans to buy new equipment or real estate. Each type of loan varies greatly in how much interest is required, how much money you can get and how quickly it needs to be paid back.

Once you know how much money you need and how it will be used, you have to figure out the best place to get it from. 

Small Business Administration

One of the first places small businesses often turn to for capital is the government for a Small Business Administration (SBA) loan. The SBA offers several loan programs designed to meet key financing needs for a wide range of business types.

The most important thing to understand with these loans is that the government isn't directly lending small businesses money. Instead, the SBA sets guidelines for loans that are made by its partners, which include banks, community development organizations and microlending institutions. Businesses have a variety of loan types to choose from when pursuing an SBA loan, each of which comes with its own parameters and stipulations on how the money can be used and when it must be repaid.

Javier Marin, a consultant with the Florida Small Business Development Center at the University of South Florida, said the biggest positive of SBA loans are the government guarantees that come with them.

"The SBA provides a guarantee that enables the bank to extend credit it would have otherwise declined," Marin told Business News Daily. "This is true for startups, companies with a tight cash flow stream, and business owners with borderline, not bad, credit scores."

That government guarantee, which typically covers between 75 and 90 percent of the loan, eliminates much of the risk for the lender, said Lynette Newman, president of Newman Business Loan Consultants Inc. 

"The business works with the [lender] and then the [lender] asks the government to guarantee or co-sign with the business for the loan," Newman said. "If the business fails to repay the loan, the lender handles [it] like any other type of defaulted loan."

It's only after unsuccessful attempts to recover the amount owed, either by collecting on collateral or personal guaranties, that the lender will ask the government to honor the guaranty. 

"The [lender] will then take a loss on the unguaranteed portion," Newman said. "The U.S. government, of which SBA is a part, can then attempt further recovery, generally by a tax refund offset."

The terms of an SBA loan also tend be more favorable to borrowers, Newman said.

"If the SBA guarantee is applied, the bank/lenders can lend more, or perhaps with less collateral," Newman said. "It may also not need as much cash injection, or may have longer repayment terms than it could without a guaranty in place."

Marin said another positive of SBA loans is that the repayment terms are longer than non-government-backed loans. SBA loans are extended to 10 years for certain types of loans and 20 years for others, giving the business more time to pay if needed. Additionally, there is no prepayment penalty on loan terms under 15 years.

SBA loans aren't without any downsides, however. Since the government is involved, you can expect the process of applying for an SBA loan to be much more complex than when applying for a conventional loan through a bank or an alternative lender.

Newman said there is additional paperwork to be filed and there are extra fees that need to be paid. The length of time it takes to get approved, or denied, is also lengthier, she said.

"It takes longer to have a guaranty placed on a business loan than a non-guaranteed loan would take," Newman said.

When applying for an SBA loan, small business owners are required to fill out forms and documents for the specific loan they are trying to get. In addition, the SBA encourages borrowers to gather some basic information that all lenders will ask for, regardless of the loan type. Among the required items are:

• Personal background and financial statements
• Business financial statements
• Profit and loss statement
• Projected financial statements
• Ownership and affiliations
• Business certificate/license
• Loan application history
• Income tax returns
• Résumés
• Business overview and history
• Business lease

The SBA also advises small businesses applying for a loan to be prepared to answer several questions, including:

• Why are you applying for this loan?
• How will the loan proceeds be used?
• What assets need to be purchased, and who are your suppliers?
• What other business debt do you have, and who are your creditors?
• Who are the members of your management team?

Small business owners can find SBA loan applications on the SBA website.

Banks

While banks are often the sources of SBA loans, they also are lenders of conventional loans. The biggest difference between SBA bank loans and non-SBA conventional loans is that the government isn't guaranteeing that the bank will get its money back. 

Conventional bank loans also give you a little more freedom on what you can do with the money. While a specific plan is still needed to get approval, bank loans don't come with such stringent use terms that each of the SBA loans do.  

Rohit Arora, CEO and co-founder of Biz2Credit, said there are a number of reasons a conventional non-SBA bank loan is a good choice for small businesses in need of funding. 

"Conventional bank loans come at good interest rates, and because a federal agency is not involved, the approval process can be a little faster," Arora said.

Just like the other lending sources, there are some negatives to pursuing a conventional bank loan. Marin said bank loans typically include shorter repayment times than SBA loans and often include balloon payments. This can force small business borrowers to refinance the loan in 3 or 5 years because the money is due.

Additionally, Arora said it's often difficult to get approved for a conventional bank loan. 

"Even though approval rates have increased, big banks approve [only] slightly more than 20 percent of the loan requests they receive," Arora said. "Smaller banks approve a little less than half of the loan applications they receive."

When applying for a bank loan, you'll be required to share all of your financial details. You'll need to provide your lender with all the financial background on your company, future growth plans and often your personal financial information. This allows a bank to gain an understanding of your complete financial situation.  

The more information you have to illustrate that you've run your business well gives banks the confidence they need to invest in you for the future. The more information you provide, the easier it will be for your loan officer to get your loan approved.

In addition to proving that you won't have trouble paying back the loan, you will also need to show details on how you plan to spend the money. Don't skimp on specifics with banks. Show exactly how you will use the requested funds and how much you need to accomplish your goals.  

Lenders appreciate attention to detail and preparedness when it comes to the facts.  For example, if you are looking to purchase a new piece of equipment, provide quotes on the exact costs, how much capital you need to facilitate this purchase, and specifically how the new equipment will help grow your business. 

Credit: Anita Rahman

 

Alternative lenders

If you don't want to deal with a bank, for either an SBA-backed loan or a conventional loan, there are a large number of alternative lenders you can turn to for money. Examples of alternative lenders include the online sites Lendio, Kabbage, OnDeck Capital and Biz2Credit.

Alternative lenders are particularly attractive to small businesses that don't have a stellar financial history.

"Many businesses do not qualify for bank financing," said Darren Schulman, chief operating officer of business financing provider AmeriMerchant. "Either their credit scores are too low, the business is new, or there is no collateral that banks would want."

Even if a business owner does qualify for a bank loan, the process may move too slowly for their liking. For this reason, alternative lenders are becoming a popular choice for startups and established businesses alike. 

"Small business owners have an entrepreneurial mentality, which means when they see an opportunity, they want to move fast," said Scott Brandt, vice president of marketing at online payroll services provider SurePayroll. "So if a traditional venue for seeking capital is slow or difficult, nonbank alternative lenders are an attractive option. In most cases, what used to take weeks or months can now be done almost instantly online. "

The downside of using an alternative lender is that interest rates can be significantly higher than what's charged by a bank. Arora said alternative lenders sometimes charge between 30 and 40 percent interest on their loans. 

"While a borrower is able to get money quickly, he or she pays a premium for that in the form of higher interest rates," Arora said. "Alternative lenders are more willing to provide money to companies that might not have great credit ratings. The increased risk the lenders take is reflected in the interest rate charged."

When considering an alternative lender for your financing, experts recommend taking several factors into consideration.

• Interest rates: Small business owners should know that they can pay off the loan relatively quickly to avoid hefty interest charges.
• Fees and policies: Be sure to speak with each lender's representative about any fees that may apply when the loan is funded, and how the payback will affect your cash flows, to make sure that you can run your business while paying back the loan.
• The lender's ratings and review: There are many companies today who say they are an alternative lender, but Schulman advised finding a company that has an A+ rating with the Better Business Bureau. Additionally, you can research online reviews from other customers and speak with small business owners who have used that particular lender, Brandt said.

Even though it can be easier to obtain a loan from an alternative lender, you still have to provide them with an array of personal, business and financial information. Each lender, however, varies in what it asks for. Some pieces of information that could be requested include a plan for how the money will be used, your credit history and a verification of your income and assets. 

Types of loans

In addition to knowing the sources for loans, it is also critical to better understand the types of loans each offers.  Here is a rundown of the various types of loans each lender offers.

Currently, the SBA offers four separate types of small business loans:

• 7(a) Loan Program: This is the SBA's primary lending program to help startups and existing small businesses obtain financing. 7(a) loans are the most basic and most common type of loan, as well as the most flexible. The money can be used for a variety of general business purposes, including working capital, machinery and equipment, furniture and fixtures, purchasing or renovating land and buildings, leasehold improvements and debt refinancing. 7(a) loans have a maximum loan amount of $5 million. Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets. Borrowers can apply through a participating lender institution.
• Microloan program: The SBA offers very small loans to newly established or growing small businesses. The loans can be used for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery or equipment. The loan cannot be used to pay existing debts or purchase real estate. The SBA makes funds available to specially designated intermediary lenders, which are nonprofit organizations with experience in lending and technical assistance. Those intermediaries then make loans up to $50,000, with the average loan being about $13,000. The loan repayment terms vary based on several factors, including loan amount, planned use of funds, requirements determined by the intermediary lender and the needs of the small business borrower. The maximum repayment term allowed for an SBA microloan is six years.
• Real estate and equipment loans: The CDC/504 Loan Program provides businesses with long-term fixed-rate financing for major assets, such as land and buildings. The loans are typically structured with the SBA providing 40 percent of the total project costs, a participating lender covering up to 50 percent and the borrower putting up the remaining 10 percent. Funds from a 504 loan can be used to purchase existing buildings, land or long-term machinery, construct or renovate facilities, or refinance debt in connection with an expansion of the business. These loans cannot be used for working capital or inventory. Under the 504 program, a business qualifies if it has a tangible net worth of less than $15 million and an average net income of $5 million or less after federal income taxes for the preceding two years before the application. The maximum amount of a 504 loan is $5 million. Generally, the project assets being financed are used as collateral and personal guarantees of the principal owners are required. CDC/504 loans are available with 10- and 20-year maturity terms. 
• Disaster loans: The SBA provides low-interest disaster loans to businesses of all sizes. SBA disaster loans can be used to repair or replace real estate, machinery and equipment, and inventory and business assets that were damaged or destroyed in a declared disaster. The SBA makes disaster loans of up to $2 million to qualified businesses.

In addition to the SBA loans, banks and alternative lenders also offer some similar loans, as well as funding options that the SBA doesn't offer, including:

• Working capital loans: Working capital loans are designed as short-term solutions for businesses in need of money to help run their operation. These finds can be used to pay bills, make payroll, purchase inventory, etc. Working capital loans are not designed to make large equipment or capital purchases that would require a lengthy payback term. Working capital loans are available from both banks and alternative lenders. The advantage of a working capital loan is that it gives small businesses the ability to keep their operations running while they search for other ways to increase revenue. Some downsides of a working capital loan are that they often come with higher interest rates and have short repayment terms. 
• Equipment loans: In addition to the SBA, both banks and alternative lenders offer their own types of equipment loans. Equipment loans and leases provide money to small businesses for office equipment, like copy machines and computers, or things such as machinery and tools. Instead of paying for the large purchases up front and all at once, equipment loans allow business owners to make monthly payments on the items. One benefit of equipment loans is that they are often easier to obtain than some other types of loans because the equipment you're purchasing with the loan serves as collateral. That means that if you fail to make your loan payments, lenders can seize your equipment to satisfy repayment. Another positive of equipment loans is that they don't require a large down payment, so they preserve cash flow. In addition, they offer some tax advantages, like write-offs. The biggest disadvantage of using equipment loans to finance a business is that these loans can be used only to purchase equipment. Even if you end up not using the equipment you purchased, you'll still have to pay for it.
• Merchant cash advance: A merchant cash advance (MCA) is a loan made to a business based on the volume of its monthly credit card transactions. Businesses can typically receive an advance of up to 125 percent of their monthly transaction volume. The terms for repaying a merchant cash advance vary by lender. Some take a fixed amount of money out of a business's merchant account every day until the advance is repaid with the agreed-upon interest, while others take a percentage of the daily credit card sales. The best candidates for merchant cash advances are businesses with strong credit card sales, such as retail merchants, restaurants and service businesses. The advantages of merchant cash advances are that they are relatively easy to obtain, funding can be received as quickly as in a few days and the loan is paid back directly from credit card sales. The biggest downside of a merchant cash advance is that it is expensive. Interest on these loans can run as high as 30 percent a month, depending on the lender and how much money is being borrowed. 
• Lines of credit: Lines of credit are similar to working capital loans in that they provide small businesses money for day-to-day cash flow needs.  Not recommended for larger purchases, lines of credit are available for as short as 90 days to as long as several years. Typically, traditional banks and financial institutions offer lines of credit. One benefit of a small business line of credit is that you only have to pay interest on the amount you use. Lines of credit are comparable to credit cards, in that the bank will let you borrow up to a certain amount of money. This gives you the ability to take only what you need and pay interest only on what you use and not the entire amount.  Other advantages are that these loans are usually unsecured and don't require any collateral, have longer repayment terms and give you the ability to build up your credit rating if you make the interest payments on time. The downsides of lines of credit are the additional fees that are charged and that they put small businesses in jeopardy of building up a large amount of debt. 
• Professional practice loans: Professional practice loans are specifically designed for providers  of professional services, such as businesses in the health care, accounting, legal, insurance, engineering, architecture and veterinary fields. These types of loans are typically used for purchasing a practice, buying real estate, renovating office space, buying new equipment and refinancing debt.
• Franchise startup loans: Franchise startup loans are designed for entrepreneurs who need financing to help open their own franchise business. These loans, offered by both banks and alternative lenders, can be used for both working capital and to pay franchise fees, buy equipment and build stores or restaurants. They are usually only offered when the entrepreneur is interested in opening a franchise from an approved franchisor.

Once you understand the lender and the type of loan that best fits your needs, the next step is making sure you can get approved for it. The loan approval process can be a difficult situation for many small businesses owners. To give you the best chance of getting the money you need, Visa Small Business and America's Small Business Development Centers offer 10 tips to help guide small business owners through the process of obtaining funding.

1. Credit score: Since it's one of the first things a lender looks at when reviewing a loan application, it is important to know what your credit score is. FICO scores range from 300 to 850. It's challenging for a business with a score of less than 600 to secure business credit from a financial institution.
2. Understand your options: It's important to identify why you're borrowing money and to account for any product or marketplace changes. Review and revise your budget and make sure to borrow only what you know you can pay back.
3. Financial statements: Have a professional analyze your financial statements before asking for a loan. They can help you clean up simple mistakes and eliminate unnecessary red flags for potential lenders.
4. Have a repayment plan: It is critical to have a plan to pay back your loan. Business owners should prepare projections with expenses and earnings and incorporate the new loan payments into their plan. Additionally, including a safety plan in case projections fall short will show lenders you're committed to repaying the debt.
5. Provide collateral: Since collateral is essential to business lending in today's market, small businesses owners should be willing to provide a collateral package to their lender. Without collateral, a lender relies solely on future performance or existing cash flow to repay the debt. That often translates into higher risk and interest rates for borrowers.
6. Know your industry: It is critical to make sure your business is not grouped into industry trends that fail to adequately reflect your company's future. Explain to lenders what's happening within your industry and how you're approaching future opportunities.
7. Personal guarantees: In order to send a clear message that you stand behind your business and its performance, provide your lender with a personal guarantee. It raises a red flag to lenders when questions arise about the development of a corporation to protect personal assets.
8. Increase cash flow: A recent survey revealed that nearly half of small business owners say cash flow would be the most beneficial process improvement. This indicates owners are struggling with cash flow more than any other business process. Turn to reliable and convenient ways to pay and be paid, such as electronic payments, which don't require cash or checks to be handled, counted or deposited.
9. Be on time: Paying bills on time will help improve credit ratings and increase credit capacity. As a result, you may get better interest rates, loan terms and e-payment acceptance costs.
10. Business credit cards: While small business owners may be tempted to use personal credit cards, the best bet is to use a business credit card to limit personal liability and make it easier to track business expenses.

In addition to obtaining loans through an SBA partner or your local bank, there are an assortment of alternative lenders that offer loan programs or loan-matching services to small businesses. Here is a full list of alternative lenders and a summary of what each company claims to offer.

Accion: Accion is a small business microloan lender. The company provides two types of loans — one for established businesses and the other for startups. Loans up to $50,000 are available to established and profitable businesses and $200,000 loans are available for start-up businesses. Both loan options feature fixed interest rates. us.accion.org

American Express: American Express offers merchant financing to small businesses. The service is only available to businesses that accept the American Express card. The financing offered is a commercial loan, not a purchase of receivables or a cash advance. A business must repay the loan in full, together with the loan fee, regardless of its future credit/debit card charge volume. americanexpress.com

Balboa Capital: Balboa Capital offers several small business loan products. These include working capital loans, merchant cash advances and flexible small business loans. The company makes quick credit decisions, offers loans up to $250,000, has fast processing and no restrictions on how you can use your loan. balboacapital.com

Biz2Credit: Biz2Credit is an online marketplace for small business funding. The company connects small businesses in need of funding with lenders. Biz2Credit can help small businesses obtain a variety of loans, including SBA loans, equipment financing, business acquisition loans, commercial loans, lines of credit, franchise loans, real estate financing, disaster loans and merchant cash advances. biz2credit.com

BoeFly: BoeFly is an online marketplace for small business loans. The site is a loan exchange that connects small business owners with more than 4,000 business lenders. BoeFly is a subscription service that does not charge any transaction fees. boefly.com

Business Financial Services: Business Financial Services offers both small business loans and merchant cash advances. The company provides small business loans to a wide range of industries, including but not limited to restaurants, retail stores, service providers, manufacturers and wholesalers. Business Financial Services offers loans ranging from $4,000 to $2 million. businessfinancialservices.com

Can Capital: Can Capital offers small businesses loans and merchant cash advances. Loans through Can Capital vary anywhere from $2,500 to $150,000, with a range of four to 24 months in maturity. No personal collateral is needed and funds can be transferred in as little as two business days. cancapital.com

Dealstruck: Dealstruck provides a variety of small business funding options, including business term loans, revenue-secured term loans and asset-based lines of credit. The company offers loans between $50,000 and $250,000. Businesses approved by Dealstruck need to be profitable, with annual sales of at least $250,000 and more than one year of operating history. dealstruck.com

FastUpFront: FastUpFront provides completely unsecured business cash advances up to $250,000. All businesses that accept credit cards are eligible for a cash advance from FastUpFront. The company's unsecured cash advances are based on future sales, not credit. www.fastupfront.com

Fundera: Fundera gives small businesses access to multiple loan offers through one application. Fundera does not loan money directly to small businesses, but rather connects small businesses with different financing options. Types of loans the company helps set up for small businesses include small business loans of up to $1 million, merchant cash advances, equipment loans, factoring, 401(k) rollover funding and lines of credit. fundera.com

Headway Capital: Headway Capital offers $5,000 to $30,000 lines of credit to small businesses. Once they are approved, businesses can borrow as much money as needed, whenever it’s needed, up to the available credit limit. With each draw, a business can select the repayment schedule that best suits its needs. In order to be eligible to apply, your business must have been in operation for at least one year, and it must be located in one of the following states: Florida, Illinois, Missouri, North Carolina, Pennsylvania, Virginia, Washington or Wisconsin. headwaycapital.com

Kabbage: Kabbage is a provider of working capital loans to small businesses. Kabbage leverages data generated by dozens of business operations to understand performance and deliver fast, flexible funding in real time. Kabbage can support any small business by analyzing various data sources that you use every day to run your business. kabbage.com

Lending Club: The Lending Club offers loans to most types of businesses in 45 states, including professional and personal services, retailers, contractors, health and wellness providers, automotive, wholesalers, manufacturers and restaurants. Its loans can be used for a variety of purposes, including business expansions, buying inventory or equipment, working capital and refinancing. lendingclub.com

LendingTree: LendingTree connects consumers to lenders who compete for their business. LendingTree lenders offer an array of loan types, including business loans. The loan amount a business is approved to borrow is based on several key factors, such as how long it's been in business, the company's annual revenue and credit score. www.lendingtree.com

Lendio: Lendio is an online service that helps small businesses quickly find the right business loan. Lendio makes business loans by matching qualified small business owners with active banks, credit unions and other lending sources. lendio.com

Merchant Advisors: Merchant Advisors offers an assortment of loan types, including small business loans, working capital loans, restaurant loans, bad credit loans, cash advances, SBA loans, restaurant equipment leasing, lines of credit, franchise financing, 401(k) business funding and home-based business loans. onlinecheck.com

National Funding: National Funding serves small businesses by offering a range of financial services and products, including working capital loans and merchant cash advances. The company's small business working capital loans require no pledge of personal assets. nationalfunding.com

OnDeck: OnDeck is a lender of loans to small- and medium-size businesses. The company uses data aggregation and electronic payment technology to evaluate the financial health of small- and medium-size businesses when determining whether or not to approve a loan request. The company's proprietary credit models look deeper into the health of a business, focusing on overall business performance rather than the owner's personal credit history. ondeck.com

PayPal: PayPal offers working capital loans to small businesses that already process payments through PayPal. In most cases, the maximum loan amount is up to 8 percent of the sales a business has processed through PayPal in the past 12 months. When applying for a PayPal Working Capital loan, businesses select the daily repayment percentage, which is the portion of future sales that will go toward repaying the loan balance. The loan balance is repaid automatically as businesses make sales through PayPal. paypal.com

Prosper: Prosper loans are not traditional small business loans. Its personal loans are based on applicants' credit scores and they are issued to individuals, not businesses. These loans are desirable in a variety of cases, such as when a business doesn't yet have a proven track record. Prosper loans are unsecured and don't require any collateral. prosper.com

SBL Group: SBL Group offers loans ranging from $5,000 to $1 million. Funds are typically available within 24 hours, with repayment terms varying from between three and 24 months. To qualify, businesses must have been in operation for more than three months, have income of more than $100,000 over the past 12 months and have a credit score of more than 500. www.smallbusinessloansgroup.com

SmartBiz: SmartBiz offers SBA loans up to $350,000 with interest rates between 6 and 8 percent. After completing the application, businesses can receive funds in as fast as seven days. Loans between $151,000 and $350,000 typically take longer: from four to six weeks. SmartBiz is a joint effort of Golden Pacific Bancorp and Better Finance. Golden Pacific is a member of the SBA’s Preferred Lenders Program and Better Finance is a financial technology company that provides leasing and credit solutions. smartbizloans.com

Small Business Loans Depot: Small Business Loans Depot offers an assortment of loan types, including Bank statement loans, small business loans, working capital loans, equipment loans and equipment refinance loans. Loans are available from $5,000 to $150,000. The amount for which a business can qualify depends on things such as business and personal credit, time in business, the amount of equipment owned and the business’s gross sales. smallbusinessloansdepot.com

Square: Square offers small business funding to its customers that have an active credit card processing account with them. Square capital can be used to increase inventory, buy equipment or open a new location. Businesses make loan repayments to Square automatically as a fixed percentage of their daily card sales. The payments are tied directly to card sales. Businesses pay more when sales are strong and less if things slow down. squareup.com

Are you an alternative lender that would like to be added to this list? Please feel free to contact Chad Brooks at cbrooks@purch.com.

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