Small Business Loans – 9 Options for 2023

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by Chamber of Commerce Team
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Every major business today started out as a small business. Microsoft, Apple, and Tesla – these titans weren’t always household names and needed business financing to grow. While most businesses strive to sell their stock or equity to the public, most should inquire about small business loans first. However, this process can be very complex due to its many moving parts.

Fundamental Concepts

Before requesting financing, it’s imperative to understand basic terms like APR, debt coverage ratio, FICO, and what financial data to show a lender.

APR is simply the interest rate that is assessed to a loan. So, an APR of 3% on a $1,000 loan would actually cost the borrower a total of $1,030. Conversely, APY takes compounding interest into effect. This simply means that interest will accumulate on prior interest charged. Banks use methods to make APY seem like a better deal, but it actually results in paying extra fractions of a percent extra per year. This figure doesn’t seem like much, but it can add thousands of dollars in payments over the long term.

Another fundamental ratio to understand is the debt service coverage ratio, which can be found by this formula: Cash Flow/Loan Payment. There are many different debt service coverage ratio benchmarks per industry, but it’s wise to aim for a ratio above one. For example, a business with a monthly cash flow of $2,500 and a payment of $2,000 would have a DSCR of 1.25. Constantly monitoring the ratio will allow the business to remain profitable and afford its payments.

Per financial guru Robert Kiyosaki, a credit score is like an adult version of a report card. He stresses the importance of financial education and knowing the fundamentals of credit. FICO score is extremely important and determines whether the small business owner will get favorable terms or a loan at all. This figure is derived from many components like amounts owed, payment history, types of credit, new credit and credit history. The biggest two factors behind this score are the amounts owed as well as payment history at 30% and 35% respectively. Therefore, it’s wise to pay loans and credit cards on time. This alone will help the business owner have a reasonable FICO score prior to applying for financing. Lenders also look at income, amounts owed and if the borrower can pay expenses with their current income. They also look at available credit used, which includes the credit card limits.

What to bring

Most lenders would like to see important financial documents like a balance sheet, income statement, personal tax returns, and bank statements. They analyze these statements to see if the business is profitable and can sustain a potential monthly payment.

In addition, lenders analyze personal tax data to understand possible business deductions and be aware of any shady tax strategies. For example, many lenders shy away from business owners who have high deductions, little profit and haven’t been in business for at least 2 years. Instead, it’s preferable to see businesses that have been around for at least 2 years, have reasonable tax deductions and are profitable.

Fees and things to look out for

Most lenders are ethical partners that want to help businesses grow. Yet, others are unethical and want to assess unnecessary fees to ignorant business owners. Some fees to know include:

  • Origination Fee: This reflects the lender’s cost to create the loan like admin fees, employee salaries, and supplies. Look for loans that have low or no origination fees.
  • Application Fee: Many lenders run credit and background checks prior to closing a loan. These services cost money, which is passed to the borrower as an application fee.
  • Guaranty Fee: This fee mainly applies to SBA loans through the US government. Outside lenders issue these loans, with the government guaranteeing parts of the loan to reduce risk to the lender. The lender has to pay the government for this security, which is passed on as an additional fee to the borrower.
  • Late Payment Fees: It’s important to pay debts on time to keep a good credit score and avoid late payments. Business loan lenders assess late payment fees for tardy borrowers, which can add up over time. Therefore, consider having an automated payment system to pay the monthly amount on time to avoid these.
  • Pre Payment Fees: It might seem like a good thing to pay off debt early. However, prepaying a loan can leave the borrower on the hook for underwriting fees. Thus, they charge this fee to recover these costs.

In addition to inquiring about these fees, prudent business owners should request everything in writing. Many unethical lenders promise “too good to be true” terms only to change them once the paperwork is signed (i.e bait and switch). Look for lenders with good reviews, transparent terms and excellent customer service.

SBA Loan

Small Business Administration or SBA loans are different from conventional loans as they’re backed by the US government. The government offers these loans to business owners that they believe are trustworthy and reliable. The rates are usually lower than other types of loans and have terms ranging from 5 to 25 years. Also, these loans are usually approved for smaller balances like $5,000 and have an APR around 7%. Luckily, they can be approved in as little as two weeks and have less red tape than traditional banks.

Why it’s needed

These loans are good for multiple purposes including working capital, purchasing inventory, buying real estate, refinancing debts and more. Also, confirm that the lender is an SBA approved resource. This will make it more likely that they’re a reputable lender and that the loans will be guaranteed. SBA loans also have the lowest down payments, longest payment terms, and reasonable interest rates out of many loan types.

How to qualify 

SBA loans are guaranteed by the government and are offered through reliable lenders. They also have favorable terms, which make them relatively difficult to obtain. However, these are still easier to obtain than standard bank loans as lenders have less risk. Yet, both new and established businesses can obtain this financing if they have good credit.

Generally, lenders like to see businesses that have FICO scores of at least 700 and have been in business for 4 years. Lenders could also analyze the business’s industry and compare their financials to standard industry benchmarks. 

How to apply

Many large and smaller banks offer SBA loans. Regardless of the bank size, each one will look at the small business owner’s credit score, tax returns, business financials, and will take at least a few weeks to process the paperwork.

Some important documents to bring include the owner’s driver’s license, two years of business bank statements, business plans, business tax returns, personal tax returns, balance sheet, and income statement. It’s also wise to bring any partner’s financial documents if they will be cosigning the loan. Therefore, consider each partner’s financial background prior to including them as consigners.

Check out our guide on the Most Common Types of SBA Loans

Business Term Loan

Unlike SBA loans, these are more traditional financing products that have higher loan amounts along with varying interest rates. Loan amounts typically range from $25K-$100K, have terms up to 5 years and interest rates ranging from 7-30%.

Be careful when dealing with any loan that has an interest rate above 20% as a credit card could be a better choice. Credit cards could be a better alternative if the loan amount is relatively small.

Also, these loans can be processed fairly quickly, which could be as little as two days. This depends on the lender’s organization, the business owner’s financial data and credit score. And, this of course varies depending on whether you’re looking within the US or, for example, for small business loans in the UK.

These loans are very standard and are usually a lump sum that is paid back over regular payments at a fixed rate. The fixed rate is very useful as it ensures the payment will be the same every month.

Why it’s needed

Business term loans can be used for a variety of business purposes, but they’re generally short term in nature. These aren’t the best products for larger purchases like complex machinery, office space or real estate. Conversely, they can be very useful for one-off purchases like small equipment, computers or a small batch of inventory.

Watch out for potential prepayment fees that will make this loan more expensive. The best ways to avoid this are paying the loan until its term is finished and asking for everything in writing. 

How to qualify 

Fortunately, most businesses qualify for this type of loan, but the terms will vary based on its financials and credit score. Established businesses with better credit scores will receive favorable rates, terms, and payments.

Usually, lenders give optimal terms to businesses that have been around for at least 3 years and have a credit score of at least 680. These terms are similar to SBA loans, but these lenders prefer businesses that have revenue of at least $300k per year. This figure is roughly double the revenue requirements of an SBA loan and makes sense as these aren’t guaranteed by the government.

How to apply

Like most loans, small business owners need to bring tax returns, balance sheet, income statement, credit score, and bank statements.

It can be easier to apply for these loans via online lenders like Lending Club which has a quicker application process.

Also, some lenders will require the small business to put a piece of collateral like equipment to secure the loan. This is usually done with those that have low credit and weaker track records. Collateral will make it easier to obtain the loan with better terms compared to one without collateral.

Business Line of Credit (LOC)

Lines of credit or LOCs can be used by both businesses and individuals. In fact, some individuals use Home Equity Lines of Credit or HELOCs to borrow against their home equity. Business lines of credit are similar to this as they give the small business owner access to a credit account. So, if a business owner has a LOC with a $10,000 limit and only uses $3,000, he or she will have to pay back the $3,000 with interest.

Why it’s needed

LOCs can be great for businesses that desire flexibility, speed, and higher loan amounts. In theory, a business could be approved for a $1 Million LOC and only pay the amounts withdrawn. Similar to credit cards, lenders will only raise the maximum amounts if the business owner has a good track record of paying debts on time. The loan terms range from as little as 6 months to 5 years with interest rates generally falling between 7-25%. These loans are suitable for many business purposes and can be accessed by those with poor credit. 

How to qualify 

They’re easier to obtain compared to bank loans as the borrower isn’t given a lump sum immediately. However, keep in mind that some lenders require borrowers to show updated financial paperwork each time they want to withdraw money.

Usually, younger startup businesses are approved for lower balances and shorter terms. More established businesses would be able to access higher balances and longer terms. LOC lenders like to approve businesses that have been in business for at least a year, with $180K in annual revenue, and a credit score above 600

How to apply

Every business owner must bring fundamental documents including personal and business tax returns, income statements, balance sheet, as well as credit score. Like term loans, they can also be backed by collateral. This can be useful if the small business owner has mediocre credit or wants better terms. Also, he or she should pay the amounts on time as interest rates will greatly increase for missed payments. 

This is one of the major factors to pay attention to with LOCs. Since these loans have more flexibility, lenders use this to justify much higher interest rates for non-compliance. On the other hand, these loans are easy to renew if the business owner has been in good graces with their lender.

Lastly, online financing websites provide shorter-term LOCs with quicker turnaround times. This is due to their streamlined, technology backed underwriting processes.

Check out our roundup of Best Business Lines of Credit Providers

Invoice Financing

Invoice financing is a different type of financing that involves selling a business’s unpaid Accounts Receivable or AR to a lender. The lender would supply the small business owner with a portion of the invoice amount. This is also known as Invoice Factoring or Accounts Receivable Financing. It can be great for those that have large, outstanding and unpaid invoices. Businesses that use this type of financing can expect to obtain an advance for 85% of the unpaid invoice with the remainder being paid back later.

Why it’s needed

Invoice Financing can be great for small business owners that are in a pinch and can’t collect on unpaid invoices. These loan products can be approved in just a few days and they can be more efficient than trying to sue past clients or other legal proceedings. The maximum amount businesses can receive is usually 100% of the invoice value and fees range from 8 to 30% of the unpaid invoices. Also, the business owner would be required to make payments once they’ve received completed invoices from their clients.

How to qualify 

Most businesses that are B2B qualify for this financing style. However, they MUST have outstanding AR, which will be used as loan collateral. Due to this, lenders have looser standards with this financing type compared to others.

Some factors that impact approval include the amount of AR outstanding, AR quality, and credit score. In the long run, lenders just want to see if the AR makes sense for them to finance. Since lenders have looser standards, businesses that have been around for at least a year, have $130K in annual revenue, and credit scores above 600 are more likely to be approved.

How to apply

Most business owners will need to show the lender bank statements, their accounting or bookkeeping dashboard, credit score and of course, outstanding invoices. It’s encouraged to use online vendors like BlueVine to streamline this process. Also, companies like BlueVine make it easy for businesses to upload bookkeeping data. Keep in mind some companies have looser or strict standards, which could include running a credit check.

Start-Up Business Loan

As the name implies, start-up loans are meant for businesses that are just starting out. However, this is an umbrella term for other types of loans like SBA microloans, crowdfunding, and business credit cards. These types of financing have terms that can range from 6 months to 4 years and rates that can fall between 8-20%.

Crowdfunding falls under this category and is a nontraditional way to obtain start-up financing. Young entrepreneurs can go to sites like Kickstarter and give viewers a sample product in exchange for funding. They can market their Kickstarter using online marketing methods like Facebook Ads and email marketing. This will help them obtain peer backed support.

Why it’s needed

Start-up loans are great for businesses that have little business history and be used to expand the business which includes buying inventory or even hiring employees. These loans are usually issued with smaller loan amounts and higher rates.

Also, the main factor that influences approval is the small business owner‘s personal credit score. The higher the score, the better the terms and businesses that have been around for more than 6 months should consider applying for more traditional loans.

How to qualify 

This type of financing is better for businesses that have been around for 0-12 months. Lenders will also use other factors like crowdfunding, grants, business model, and community when considering approval.

Since these loans are riskier for lenders; they require higher credit scores. Most small business owners should have credit scores above 700 and annual revenue of at least $75k prior to applying.

How to apply

Application processes vary depending on the type of startup loan funding. Loans from family, friends, and crowdfunding will have the least amount of time and regulatory hurdles. However, be sure to not burn relationships by paying these creditors back. Business credit cards have a simple process, which only requires showing your federal tax ID and Social Security Card.

Conversely, SBA microloans are tougher to obtain and take several weeks to process. They have higher standards and paperwork requirements. SBA microloans represent funds that are given to lenders by the government and the lenders have discretion over which startup to fund. Also, many SBA microloan lenders want to assist certain groups like minority-owned businesses and those that operate in disadvantaged areas.

Equipment Financing

As the name implies, this type of financing is used to purchase various pieces of equipment. These can range from assembly lines, machinery, computers or even vehicles. It’s one of the more popular loan types as many businesses need key equipment to function. Business owners can receive a lump sum from the lender to purchase the machine and pay them back over the equipment’s lifetime.

Why it’s needed

Equipment financing can be a great way to obtain financing in as little as two days for a piece of equipment. The loan terms can range, but it’s usually for the useful life of the equipment. Also, business owners can use a special deduction called the Section 179 deduction for business assets. This simply allows the small business owner to deduct the full amount of equipment up to $1,000,000. Keep in mind he or she can’t deduct the full cost every year as equipment depreciates or goes down in value. Be sure to check with a tax professional to properly use this deduction.

This type of financing has rates that range from 8 to 30% with the equipment serving as collateral. Therefore, the rates tend to be lower than other financing methods and it requires less paperwork to complete.

How to qualify 

Fortunately, most businesses qualify for this type of financing. However, the terms can fluctuate based on credit score, type of equipment financed and financial history. This type of financing could be helpful for those that have mediocre credit as the equipment serves as collateral. Also, lenders prefer businesses that have at least $100k in annual revenue, credit scores above 600, and have been in business for 2 years.

Also, there is a similar financing type called equipment leasing, which has a near identical process to equipment financing. The main difference between the two is that the small business owner that elected equipment financing would own that piece of equipment once the loan is paid off. Conversely, equipment leasing simply means renting the equipment and can be compared to a car lease.

How to apply

Applying for this financing is relatively simple and business owners just need credit scores, business tax returns, and an equipment quote. The equipment quote simply shows the proposed cost of the equipment. Lastly, lenders will also inquire about the purpose behind the equipment and how it will generate a positive return for the business.

Merchant Cash Advance

A Merchant Cash Advance, or MCA, is a different type of financing that entails a lender advancing a business owner a lump sum which is then repaid through a percentage of the small business owner’s credit card sales. It differs from a conventional loan as it doesn’t have a fixed payment schedule. Instead, it can vary based on the small business owner’s credit card sales. MCA loan amounts range from $2,500 to $250,000 and it’s paid back daily through a merchant account.

Why it’s needed

An MCA can be helpful for business owners that don’t have optimal credit. In fact, most MCA lenders have a relatively low bar for borrowers and would like to see a credit score in the 500s. It can be very helpful for businesses that derive a large portion of their revenue from credit card sales like retail and restaurants. The right MCA can help these businesses with short term cash flow problems, working capital, and unexpected payments.

How to qualify 

Qualifying for an MCA is relatively straightforward compared to other types of financing. Lenders prefer to approve businesses that have been around for at least 2 years and have a minimum of $180K in annual revenue.

Since this type of financing is based on credit card revenue, they will generally examine a small business’s credit card processing statements. This will ensure that the small business has enough volume to make the MCA profitable for the lender.

How to apply

Applying for an MCA is relatively simple and is done exclusively online. It’s also recommended to show the lender bank statements, two years of tax returns, credit scores, and processing statements. The merchant can receive funding in as little as a few days.

Yet, this comes at a price as this type of financing is very expensive. Instead of charging a direct APR rate, lenders charge a factor rate between 1.14-1.48. So if a business that has $10,000 of credit card processing revenue uses an MCA with a factor rate of 1.15, it would owe a total of $11,500. This would be a 15% APR and converted factor rates can climb past the 50% APR mark!

This financing option is more expensive as there is no collateral and is meant for borrowers with mediocre credit. These factors give the lender more risk, which means higher fees.

Short Term Business Loan

Short term business loans are more traditional forms of financing compared to equipment financing or MCAs. The lender gives a business owner a fixed amount of capital upfront, with the small business owner paying it back over time. Loan amounts range from $2,500 to $250K, have rates around 10% and terms from 3 to 18 months. 

Why it’s needed

As the name implies, this loan type is great for obtaining cash in a pinch. This can be used to pay off expensive debt, pay short term expenses or bridge long term financing. For example, some business owners use this type of financing to act as a cash flow buffer prior to getting a longer-term loan with better terms. 

Due to their short term nature, there is less paperwork than other options like SBA loans. It’s suitable for a large variety of business purposes and lenders are open to approving those with suboptimal credit scores. However, these loans generally have higher costs than long term loans. Also, this financing method can be tricky for businesses that have irregular income. For example, some lenders implement a weekly repayment schedule.

How to qualify 

Most lenders want to see businesses that have annual revenue of at least $150K, credit scores above 600, and have been in business for at least two years.

Yet, loan officers tend to emphasize cash flow, instead of other factors like credit scores and past business tax returns. This is due to their short term nature and businesses that don’t have ideal backgrounds can overcome this by having strong cash flow. Therefore, it could be suitable for newer businesses that don’t have a strong track record but have good financials.

How to apply

Short term business loans are usually obtained via an online application. The usual process requires small business owners to provide bank statements, credit scores, personal tax returns, and a driver’s license. Luckily, many loan officers approve these products in just a few days.

However, merchants should realize that these types of financing are more expensive than other options. The main reasons behind this are short terms and quick online approvals. Loans that require more paperwork and longer approval times are less risky to the lender which explains why those loans have more favorable terms.

Personal Loan for Business

Personal loans stand out on this list as there aren’t intended for business use. These loans can be used for everything including paying off consumer debt, purchasing a car, business expenses and more. Using a personal loan can be prudent for businesses that don’t have an extensive history. They also offer straightforward terms and lower fees than some of the other options mentioned here.

Why it’s needed

These short term loans can be good for most situations and the conditions can range due to many factors like credit score, purpose, business plans and more.

However, they have lower maximum amounts which are around $35K along with shorter terms. The terms generally range from 3 to 5 years and interest rates fluctuate from 6-36%. These can be great as they can be repaid monthly and not weekly. 

Be careful with intermingling personal and business finances. It’s imperative to be organized as this trait is what separates successful small business owners from the rest. A personal loan could be good initially, but it’s very wise to segregate and properly organize both the business owner’s personal and business finances. It also impacts the personal credit score, which can influence one’s ability to get quality financing.

How to qualify 

It’s easier to qualify for these loans compared to other options. For example, there are less complex terms and regulations compared to other options like an SBA loan or AR financing. Also, higher credit scores will give the business owner more favorable terms like a lower APR. Keep in mind that it’s not required to show business tax returns, financial statements, or other related documents.

Instead, most loan officers just require paystubs, bank statements, bank account numbers and/or personal tax returns with the loan application.

How to apply

It’s possible to apply online or in person with the lender. The application process and paperwork vary based on the lender, with some taking up to a few weeks to process. Fortunately, these loans are very simple as they just entail a lump sum and fixed monthly payments.

Yet, it’s wise to be aware of closing costs as this can reduce the total loan amount. For example, if a small business owner takes out a personal loan for $5,000 with 10% closing costs, he or she would only receive $4,500. Despite receiving a lower balance, the small business owner would have to pay interest on the original amount. Therefore, it makes sense to inquire about closing costs and other fees.

Bottom Line 

  • Every business starts out as small and needs quality business financing with reasonable repayment terms to help it grow. While selling stock or achieving an IPO is the ultimate goal for many owners; they must first start out small by exploring small business loans.
  • Debt financing can be very useful, but there are many important fundamentals every business owner should understand.
  • Besides basic terms, every business owner should understand which loan type would be best for their unique situation.
  • Knowing these fundamentals will enable business owners to grow their business, hire more employees and provide greater value to the marketplace.

Disclaimer: This post is meant as financial education, not advice. Consult a tax or financial advisor for tax or financial advice.

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