How Do Small Business Loans Work?
Regardless of your financing situation, we wrote this guide to help you familiarize yourself with the small business loan process. We’ll start by overviewing the typical steps you’ll have to go through during the loan application process. Then, we’ll detail what each of the steps within the process looks like so you can be better prepared.
Small Business Loan Process Overview
The loan process may vary depending on the business lender that you’re applying for financing from. However, most lenders require certain steps, such as a credit report review and the completion of an application.
According to the Small Business Administration, the typical steps involved in a small business loan approval flow like this:
- Create a Business Plan: The small business owner will likely be asked to prepare a business plan that details how their business works. They may also meets with the business lender to discuss their financing needs.
- Submit Application: The owner must complete and submit the lender’s loan application.
- Lender Completes Application and Credit Review: The lender will review the application, check the business’s credit report, and approve the loan. If you don’t meet the lender’s business or personal credit score requirements, you may be disqualified.
- Lender Prepares Loan Offer: The loan provider will prepare the loan documents.
- Loan Offer Finalized: Once any terms and conditions of the loan authorization are satisfied, the loan will be closed.
- Loan Given to Borrower: The loan proceeds will be disbursed based on agreed-upon terms and conditions.
- Borrower Pays Off the Loan: Throughout the life of the loan, the borrower will make payments as agreed.
- Once Balance Is Paid Off, The Loan Process Is Complete: When the loan is paid back in full, the liens of collateral will be released, and the note will be marked as paid.
To be clear, these are the steps usually involved with a traditional small business loan from a bank or SBA loans. Depending on what you’re getting the loan for, you may need to provide additional documentation. Other financial institutions
Also, if you’re putting up collateral or providing a personal guarantee, there will be additional steps to take. However, generally this is how you can expect your business loan process will go.
In the next few sections, we’ll explore these business loan steps in more detail:
Steps #1 – #3: Business Plan and Application Review
With a traditional term loan, business lenders will require that you submit a business plan and a loan application.
While loan applications differ from lender to lender, you’ll generally be asked for personal and financial information. This could include:
- Your contact details
- Social security number
- The nature of your business
- Your business structure
- Cash flow projections
- How you plan to use the loan
You’ll also be asked for financial statements such as your profit and loss statements, tax returns, and more.
With this application, as mentioned, you’ll also be asked to submit your business plan. The idea behind the business plan is to help the financial lender determine the viability of your business. At minimum, your business plan must:
- Provide background on the business and yourself.
- Describe the experience of your management team.
- Summarize your business’s current activity and results.
- Identify and explain your industry, your customers, and your market.
- State how much money you need, how you determined how much you need, and what the loan will be used for. Most business loan providers will require that loans are used for business expenses, such as real estate, inventory, or equipment, to name a few common examples.
Once you’ve submitted all this information, your lender will decide whether to approve your business loan application.
Keep in mind that, depending on the lender and your business structure, other people may also be required to submit an application. For example, if your business is structured as a partnership, your other partners may be required to complete the application process as well.
Steps #4 – #6: Loan Documentation and Disbursement
Once your business loan is approved and underwriting is complete, your financing lender will assemble a package of loan documents. This package is your loan agreement.
While different types of loans require different documents, the loan agreement essentially lays out the terms of your loan. Your agreement will include information about various loan costs, how and when the loan is repaid, and any additional terms and conditions.
Once you and the business lender sign these documents, the next step is for the lender to release the funds. In what amount and when the lender releases these funds depends on what’s stated in your loan agreement. You should ask questions about funding timeline prior to applying so that you’re aware of how long this typically takes.
Steps #7 – #8: Repaying the Small Business Loan
After you’ve received your loan funds, the repayment period will start. The amount and timing of your payments will be documented in your loan agreement.
Usually though, you’ll repay your loan with periodic payments. Each of these periodic payments will include principal and interest rates. If you have any questions about your repayment terms or how much you’ll pay in interest, be sure to ask your lender prior to taking out the loan.
You may be allowed to make larger payments than you’re required to pay the loan off early. However, some lenders will assess fees for early repayment. You can ask your lender, or review your agreement, to determine if you can pay your loan back early without a fee.
Once you’ve completed repayments, the lender will remove any liens on your collateral. When the liens are removed, the business lender no longer has a claim against you. Then, to mark the end of your loan agreement, the lender will mark your note as paid.
Conclusion: Take Time to Prepare for the Small Business Loan Process
It’s completely normal—perhaps even expected—to feel overwhelmed by the small business loan process. Fortunately, by familiarizing yourself with the application process, you can quickly overcome that feeling.
Just remember to be prepared for the different nuances in individual online lenders’ loan approval processes. In addition, the loan process may change depending on the type of business loan that you’re applying for.
Also, keep in mind that the process we’ve outlined above applies to traditional term loans. Other types of financing such as merchant cash advances, equipment financing, or business lines of credit follow slightly different processes.
Finally, if you’d like to learn about typical loan requirements and documentation, check out the following resources:
Editor’s Note: This post was updated for accuracy and comprehensiveness in December 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.