How to Get Your First Small Business Loan

Getting a small business loan is a key part of your success as a business owner. Knowing the types of loans available, how to qualify and how to apply may help you find the capital you need to grow.

Whether you're an early-stage entrepreneur looking for startup funding or an established business owner ready to expand, having access to capital is essential. From self-funding to outside investors, there are many types of funding options for small businesses—including bank loans—each with their own benefits and risks.

Is it hard to get a business loan?

While getting approved for a first-time business loan may require some persistence, it's certainly achievable. In fact, a majority of organizations that apply for financing are approved for some or all of the requested amount, according to recent data from the Federal Reserve.

An important part of securing a first-time business loan is preparation. Understanding the basics—like what type of business loan will work best for your needs, small business loan requirements and how to apply—can help streamline the process.

How do business loans work?

Before starting the application process, think carefully about how much you need to borrow, what specifically the loan will be used for and which type of small business funding will best suit your needs.

Choosing the right type of business loan

Most banks offer a few types of financing options for small businesses, including term loans, lines of credit, US Small Business Administration, or SBA, loans and equipment financing. The right source of funding for your small business may depend on a few factors, including the purpose of the loan and how much you want to borrow.

For example, a small business line of credit lets you access funds as needed for short-term financing objectives like buying inventory. In contrast, a small business term loan is typically better suited for purchasing fixed assets like equipment.

As you compare small business funding options, it's important to remember that a new loan will immediately create a recurring expense, which may become one of your larger monthly expenses. As with personal loans, think carefully about how much you can safely afford each month.

Small business loan requirements

While banks don't have universal rules about what makes a business creditworthy, many will take three key factors into consideration: experience, credit and cash flow.

Experience

One of the first factors lenders may consider is your business record. Established businesses with at least a few years of consistent revenue and demonstrated profitability may find it easier to qualify for a traditional business loan than early-stage startups. SBA loans may offer more flexibility for businesses without much of a track record.

Credit

Having a good credit score for a small business loan is important. Banks typically look at a business's credit score when assessing an application for a traditional business loan, particularly for borrowers who hope to qualify for larger loan amounts or more competitive terms. Some banks may also consider your personal credit score when evaluating your eligibility.

Cash flow

Banks want to see sufficient cash flow so they know you can repay the debt. One way they may assess this is by looking at your debt service coverage ratio, or DSCR, which is calculated by dividing your organization's cash flow—sales minus expenses—by its debt payments using either monthly or annual figures.

Each lender will have its own requirements, but many consider a DSCR of 2 to be strong because it shows that a company generates enough cash flow to cover its debt twice over.

What to do if you don't qualify

If your business doesn't yet meet the criteria for any type of small business loan, you still may have a few options. For example, depending on your needs, you may want to consider opening a business credit card.

Credit cards typically charge a higher interest rate than other types of financing, making them more appropriate for funding ongoing purchases like supplies or advertising rather than significant expenses. A business rewards card can be a good choice for everyday purchases, allowing you to accrue rewards points or miles.

If you need to carry a balance, a low-interest business credit card or one with a low introductory annual percentage rate, or APR, may be helpful as you grow your business. Using a business credit card also is an opportunity to establish a strong credit history for your business.

Another option is to rely on alternative financing strategies like loans secured by existing purchase orders or invoice factoring, which involves selling outstanding invoices to a third party at a discount. Of course, the availability and attractiveness of these options will vary depending on lenders' requirements and your organization's financial outlook.

What type of collateral is required for a business loan?

Relatively new business owners or those still in the planning stages often wonder what type of collateral they'll need to secure a business loan. The answer typically depends on the type of loan and the amount.

For a line of credit less than $50,000, good credit and some personal or business assets as security may suffice. For larger amounts, your business's revenue, profit history and cash flow may matter more.

Secured term loans require some form of collateral, which can include paper assets like cash, stocks and corporate bonds. Businesses often use property and future earnings as collateral as well.

The longest-term loans are typically reserved for and collateralized by buildings, land and exceptionally large equipment, such as manufacturing systems with useful lives of at least 10 years. Shorter-term loans of lower overall value require correspondingly smaller forms of collateral.

How to apply for an SBA loan

How to apply for a business loan

When it's time to have a conversation with a banker, make sure to prepare a business loan proposal outlining how much you're hoping to borrow, what the funds will be used for and how you'll repay the loan.

Calculate how much you want to borrow

Lenders will want to see that you have legitimate reasons for requesting a small business loan, so your first step is to clearly establish what the funding will be used for. It's important to estimate how much funding you need with as much precision as possible.

Obtaining quotes from relevant vendors—like the channels where you want your advertisements to run or the contractors in your area who do buildouts—will help show a lender that your funding request is based on real-world information.

Tips for writing a business loan proposal

The proposal should clearly articulate your needs, the costs, the timing and the funding's relevance to your organization's success.

• Limit the business loan proposal to three to five pages, providing a concise overview of your business, market dynamics, your competitive differentiators and your growth plan
• Include the most recent revenue and profit figures, and briefly discuss past performance
• Communicate whether your business is doing well or if there are risks ahead, and address your plan to mitigate these risks
• Forecast revenue and profit for the next year for a short-term loan and for the next 3 years if you want a longer loan term

What documents are required for a business loan?

In addition to your business loan request, you'll need to provide a handful of documents. Depending on the type and size of the small business loan, this may include:

• Audited or reviewed financial statements
• Copies of recent income tax returns
• A year-to-date income statement
• Current balance sheet
• Accounts receivable and payable aging reports
• Personal financial statements and tax returns

What's next?

Understanding how to get a first-time business loan may reduce the stress involved in finding capital to start a new business or grow an existing one. If you have the right documentation on hand and scale the loan amount you're seeking to your business's situation and needs, you can enter conversations with lenders with much more confidence.