Business Loan Guide: All About Small Business Loans
At Fora Financial we want to ensure that you understand how accessible business loans can be. Small business financing doesn’t need to be scary, and can take your business to new heights. In this small business loan guide, we’ll thoroughly explain how small business loans work and how to assess your financing options.
Different Types of Small Business Lenders
The three main types of financing providers in the United States are standard bank loans, SBA loans, and alternative financing options.
Standard Bank Financing
Business loans guaranteed by large banks and credit unions can provide competitive terms and rates. Interest rates for standard bank loans will be in the middle-to-upper single-digit range.
Typically, the loan term will range from 1-10 years, dependent on numerous factors. In this vein, for commercial real estate mortgaging, standard bank loans will offer amortization periods of up to 25 years, similar to a conventional home mortgage.
Despite long terms, bank financing comes with strict credit checks, collateral requirements, and cash flow prerequisites. In addition, banks require extensive financial documentation. Typically, this includes:
- Three years of financial statements and business tax returns
- Accounts receivable and accounts payable aging schedules
- A debt schedule
Small Business Administration (SBA) Loans
Small Business Administration (SBA) business loans, are provided by banks, community banks, credit unions, and nonprofit financing institutions.
SBA lenders don’t provide financing opportunities directly to the business owner. Instead, the bank provides the loan, and the SBA covers a percentage of the financing. By doing this, the SBA hopes to improve small business lending practices while also mitigating risk to the lenders.
Because the SBA is a federal government entity that partners with financial institutions, there are stringent documentation requirements. This includes, but isn’t limited to:
- Three years of financial statements and business tax returns
- Accounts receivable and accounts payable aging schedules
- Debt schedules
- Personal financial statements
- Tax returns
Alternative Financing Options
Alternative small business funding can be a happy medium between bank financing and very-high interest opportunities.
These business financing options provide affordable short-term loans and medium-term funding to small businesses that may not have the documentation and credit requirements necessary for bank loans. In addition, the funding process is typically faster, with most being completed in one to two weeks.
Generally, the required documentation to obtain alternative financing will include:
- Credit report
- 3+ months of business bank statements
- Two years of business tax returns
- The previous year’s profit and loss statement
- A debt schedule
- A year of personal tax returns and financial statements
Different Business Financing Options
There are ample business financing options that fall into one or more of the buckets mentioned above. The first is the SBA financing types, almost all of which fall into one of four categories.
In addition to SBA loans, there are various funding methods that utilize both conventional and alternative options. These include:
- Lines of credit
- Working capital loans
- Equipment loans
- Professional practice loans
- Invoice factoring
- Franchise startup loans
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Small Business Administration (SBA) Financing Types
Four main SBA loan types comprise the vast majority of SBA funding options: the 7(a) loan, 504/CDC loan, Disaster loan, and various types of microloans.
Each of these types of loans has its own set of rules, limitations, interest rates, and different uses, which we’ll examine in the sections below.
Real Estate and Equipment Loans
Most real estate and equipment loans are channeled through the SBA’s CDC/504 loan program. This is similar to the 7(a) program in that it’s guaranteed up to $5 million. However, the funds from a real estate and equipment loan will typically be used for just that: concrete capital like operational facilities, land, and machinery.
Many SBA 504 loans are processed through specialized lenders and nonprofits. Technically, it’s two loans, one from a bank source of funding, which represents 50 percent. The other piece comes from a Certified Development Corporation (or CDC). The CDC funds another 40 percent, and the remaining 10 percent is the small business’ down payment.
Every month, CDCs submit their closed loans to the SBA. Then, the SBA pools them together to sell to investors, who in turn provide the capital necessary to fund loans.
The rates for these loans are subject to SBA rulemaking, in which interest rates are based on 5- and 10-year Treasury bonds, plus investor return and fees charged by both the CDC and SBA.
These rates are generally fixed, meaning a small business’ loan payment isn’t going to change for the CDC piece. However, the interest rates on the lender’s side are negotiated between the lender and the business requesting the loan. The SBA holds no bearing here, but still, almost all rates fall under 10 percent.
For more on the SBA 504/CDC loan program, view our article What is an SBA 504 Loan and How Can You Apply?
The SBA’s microloan program provides small-time loans that’ll usually cap out at $50,000. These loans are meant to be used for investments like:
- Initial business funding
- Working capital
However, unlike the 504 loan that’s processed by private-sector lenders, and 7(a) loans that are typically run through banks or equivalent financial institutions, microloans are processed through community-side businesses and local nonprofits.
The SBA takes a more hands-off position regarding microloan rates when compared to alternative lending options. The SBA’s role is to limit the intermediary markup that lenders can charge above standard SBA rates. This covers the lender’s costs to borrow the funding directly from the SBA.
These loans can range anywhere from $500 to $50,000 and can be utilized for a variety of different usages, including:
However, SBA microloans can’t be used to pay off debt or purchase real estate assets.
For more information about the SBA microloan program, read our article What Is an SBA Microloan?
The SBA’s 7(a) loan program is their closest thing to a flagship lending option. These are an excellent choice for small businesses, are incredibly flexible, and have a federal guarantee of up to $5 million borrowed.
Funds for 7(a) loans are used mainly for:
- Working capital
- Expansion projects
- Startup Costs
- Seasonal financing
- Debt refinancing
In many cases, SBA 7(a) loans are processed through banks, specialized lenders, and credit unions.
7(a) loans should never be used to pay creditors who lack adequate securitization. In addition, they can’t be used for speculative or general investing, lending to third parties, rental properties, gambling, and nonprofits.
For more information on the SBA 7(a) loan, check out our article on What You Should Know About SBA 7(a) Loans.
Small Business Disaster Loans
An SBA disaster loan can be used by business owners (or individuals) affected by a disaster such as tornadoes, hurricanes, or droughts.
The Small Business Disaster Loan is the only program the SBA offers in which they’ll lend directly to borrowers in almost every case. Alternatively, the SBA guarantees the loans provided by other lenders.
There are many types of SBA disaster loans, which we’ll summarize below:
- Business Physical Disaster Loans: With business physical disaster loans, small business owners can replace or repair assets like machinery, equipment, or property, as well as inventory, fixtures, or improvements to leased property and assets. They are meant to offset losses that insurance doesn’t fully cover.
- EIDL: With this type of loan, the recipient will receive financing that works very much like a standard working capital loan. They’re meant to assist small businesses in meeting financial obligations that would’ve been achieved if not for a natural disaster. These are relegated to small businesses, private nonprofits, and smaller agricultural co-ops.
- Home and Personal Property Disaster Loans: With home and personal property disaster loans, most opportunities will apply to homeowners and not small businesses. However, these loan types apply to those who own and operate rental properties. These loans are used to replace or repair the value of these properties.
- MREIDLs : This financing can be used for meeting operating expenses that would otherwise have been met if a key employee wasn’t called to active duty by the US military. While not technically a “disaster,” this loan type falls under the disaster loan category.
For more information about SBA disaster loans, check out our guide Everything You Need to Know About SBA Disaster Loans.
Conventional and Alternative Loan Types
There are an extensive number of both traditional and alternative types of business loans. These are typically methods of funding that aren’t guaranteed by the SBA or provided by major banks.
Lines of Credit
Business lines of credit work similar to business credit cards.
A small business is provided a number that acts as a maximum credit limit. The small business can then spend up to the limit provided, and make multiple draws against this as needed. Interest is applied to borrowed funds, and the interest is paid back with the principal via scheduled payments.
Both secured and unsecured credit lines are available for small businesses. Typically, secured lines are provided to applicants with lower credit scores and startups. Because they’re backed by assets utilized as collateral, if the small business defaults, the lenders can use collateral to pay the debt.
Unsecured lines don’t require collateral and are available to borrowers with strong credit histories.
Business lines of credit are great options for unexpected expenses or to resolve cash flow shortages. In addition, they can be used to buy inventory or supplies to handle seasonality.
Much like credit cards, it’s crucial to use business lines of credit only as needed and to pay back borrowed funds quickly. This will help you avoid having to pay interest.
Working Capital Loan
Typically, small business financing options are categorized by their usage. For example, business mortgages act as longer-term loans for properties. In comparison, working capital loans are used to fund everyday, standard business operations.
Small businesses can use working capital loans for multiple costs, such as:
- Debt repayments
- Seasonal expenses
Working capital loans are also an incredibly flexible loan option for small businesses that need quick cash to cover expenses. However, these loan types should never be considered a long term funding option for investments like property purchases or business expansions.
The advantage to an equipment loan is that you can utilize it to purchase equipment immediately, but you aren’t required to pay the full cost upfront. Instead, you’ll spend less on monthly, smaller payments, or on some other schedule for loan repayment, and low interest to the lender.
Equipment loans are an excellent option for individuals interested in more affordable options to own expensive equipment or machinery. This funding option also works well for business owners with less than stellar credit scores. Typically, there’s no collateral requirement either, as the equipment serves as collateral and can be repossessed upon default.
While some credit unions and banks offer different types of equipment loans, online lenders have extensive options available as well. In addition, equipment manufacturers sometimes have their own credit programs for borrowers.
Professional Practice Loan
This type of loan is a fantastic option if you want to increase cash flow to afford costs, such as:
- Office renovations
- New buildings
- Existing loan refinancing
- Buying into (or buying out) an existing practice
Professional practice lenders exist to make things far more straightforward for this process. In equipment loans and practice renovations, licensed practice lenders have a deep understanding of the industry, and know the benefits that new equipment or building remodels have for practices.
A professional practice loan is similar to other types of conventional lending but geared towards those specifically in the medical, legal, or other service industry.
Invoice factoring is financial transactions that act as a type of debtor financing for small businesses. In invoice factoring, small business owners sell their accounts receivable balances (in the form of outstanding invoices) to third parties (referred to as “factors”) at a discount from the total cost of incoming revenues.
Companies will, at times, factor receivable assets to meet immediate and present needs for cash. A small business may also factor invoices to mitigate credit risk properly.
When using invoice financing, a small business owner will provide services or products to their customers and submit proper invoicing for payment. Then, the business sells those unpaid invoices to invoice factoring entities.
Once completed, an invoice factoring provider will verify invoices and fund the business quickly with payments. Up to 90 percent of the value of receivables will be received on the same day.
Finally, customers will make their payments directly to the invoice factoring company under the terms of the original invoice. The invoice factoring company will then return the paid invoice balance, minus a small fee.
Frequently Asked Questions About Small Business Financing
The small business lending process can be confusing, especially if you haven’t applied before. Below are some of the most common questions that our team is asked regarding the business funding process.
If you’re a potential or existing customer, please see our main FAQ page. Or, if you’d like to start the funding process now, click the link below for your free quote from Fora Financial.
Frequently Asked Questions
What does a bank require when you apply for an SBA loan?
As seen above, the SBA provides several loan types. Regardless of this, many share the same standard application requirements.
One of the essential metrics for lending institutions before providing an SBA loan is time in business. The SBA wants to ensure that you already have a positive track record of company ownership, typically at least two to three years in business.
Also, you’ll be asked about your personal and your business credit history. You can’t mask your potential personal credit issues when applying for SBA loans, as most applications will require you to input your social security number.
However, business credit scores are just as important as personal credit scores. These are built up over time with on-time payments to suppliers, vendors, and creditors.
In addition, other documents are required, including debt schedules, profit and loss statements, official business financial statements, bank records, and more.
In addition, you should bring the following documents and information:
- Your business plan
- Working capital requirements
- Expected financials
- Potential collateral and a personal guarantee
What questions will be asked?
Typically, you’ll first be asked if your organization is a non-profit, because the SBA only provides loans to companies that are considered “for profit.” Due to this, charities usually aren’t eligible for such funds.
Another question that you’ll be asked is whether your business is U.S. based because the SBA only words with businesses in the U.S.
In addition, you’ll also be asked about your level of owner investment because the SBA wants to ensure that you’re personally invested in your business’s success.
Lastly, you’ll need to prove to the SBA that you weren’t approved for other financing options. This rule exists because the SBA aims to work with businesses that can’t access traditional financing.
What is needed to apply for conventional bank loans?
When applying for a conventional bank loan, you’ll find that the requirements are strict. Although the number of business loans have grown year over year for a while now, they still only sit at about 27 percent. This makes it a very challenging process.
Remember, the dream gets you into the bank, and a good credit rating ensures the door remains open. Making sure you have good business and personal credit will go far in the conventional bank loan process.
In addition, making payments on-time is crucial to build and maintain good business credit. However, it isn’t the only factor that matters; credit utilization is also essential.
Cash flow is also important, because a bank isn’t going to provide you with a loan if you can repay it. Aside from secure credit, stable cash flow is a great way to show that your small business is a worthy candidate.
In addition to cash flow and credit, you also need some form of capital and collateral. However, it’s worth noting that collateral isn’t as common of a requirement as it once was. In fact, many banks offer unsecured business funding to companies with a track record of continuous success.
What requirements do alternative lenders typically have?
Depending on the loan that you’re applying for, there will be different prerequisites. For example, with invoice factoring, the process won’t be as in-depth into your past business finances, as much of the payment steps are determined by physical returns (invoices and credit card receivables).
Remember, it’s far better to over-prepare than to come lacking documentation and scramble to put things together.
What fees are included when applying for small business financing?
The loan application process usually comes with fees, regardless of the small business financing option you apply for. This includes:
- Application fees: Some financing providers will attempt to charge an upfront fee to review an application.
- Origination fees: This is an upfront fee that’s charged for the evaluation and origination of a loan. It’s typically a percentage of the principal, but in some cases it can be a flat fee.
- Loan Guaranty Fees (SBA): If you’ve received an SBA loan, they’ll guarantee up to 85 percent of the loan amount for 7(a) loans. The guaranty fee is due within three months of the loan approval date. These fees are usually between two and four percent for these SBA 7(a) loans of over $150,000, dependent on repayment terms and loan amounts.
In addition, there are other fees such as monthly administrative fees, annual fees, late payment fees, and prepayment fees. Keep an eye on the charges associated with the small business financing that you’re approved for, because they can add up fast!
Editor’s Note: This post was updated for accuracy and comprehensiveness in July 2021.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.