A Complete Guide to Small Business Loans

Small businesses help fuel the U.S economy. Since the most recent recession, they accounted for two-thirds of net new jobs and now make up 99.7% of employer firms, according to the U.S. Small Business Administration. But survival isn’t a given: Only half of new businesses last five years, while only a third make it to a decade.

Many young companies resist outside investment, worried that the extra input will dilute internal authority.

So, they turn to lenders. But small ventures are finding that the modern debt market is vastly different than it was a decade ago. In addition to traditional bank options, options now include peer-to-peer platforms, online outfits, microlenders and more.

Here’s a guide to borrowing for your business.

What is a small business?

The government broadly defines a small business as having fewer than 500 employees. The SBA also uses an industry-specific rubric that uses both employment and revenue metrics.

Startups have some key differences. They’re designed to quickly scale up, while small businesses generally take a slower growth route. Startups tend to lean on venture capital and angel investors and think in terms of exit strategies such as initial public offerings or buy-outs. Small businesses value stability and long-term profitability.

Why use a small business loan?

Few entrepreneurs have access to the kind of capital that can sustain a small business without outside help. Hidden costs add up: market research, employee training, insurance, service vehicles, permitting, licensing and more. Unexpected pitfalls — shifty suppliers, late payments, Mother Nature — can wreak havoc on a balance sheet.

Types of small business lenders

Bank loans often feature the lowest interest rates and longest repayment terms. But the approval and payout process usually takes months. Nonprofit credit unions, which have less overhead, offer their members slightly more competitive rates and higher chances for clearance.

Microlenders step in for small businesses whose inexperience and lack of collateral mean they can’t score a traditional loan. These providers — such as Grameen America, Kiva U.S., Valley Economic Development Fund and more — generally propose smaller loans, higher APRs and faster funding turnaround. They’re often known as mission-focused lenders due to their focus on less-served or less-developed areas. The Aspen Institute does a deep dive into the segment in its most recent U.S. Microenterprise Census.

Online lenders employ more relaxed approval standards, simpler application processes and even quicker money handoffs, sometimes in less than a week. SuperMoney can help you search for multiple options. But in this category — which includes players such as Kabbage, Fundation, CAN Capital and publicly-traded OnDeck — single-digit APRs aren’t common and payback terms can be quite short.

Peer-to-peer systems, many of which started out in the personal loans space, link business borrowers with a variety of lenders who set their own loan terms. Key examples include LendingClub and Funding Circle.

Types of small business loans

The Small Business Administration doesn’t lend directly to borrowers. Instead, it helps guard against default by guaranteeing a suite of low-interest options administered by a network of banks and lending institutions.

There’s the general 7(a) loan program for companies acquiring or expanding a business, buying inventory or equipment, refinancing or trying to tap more working capital. This year, the SBA issued $17.5 billion in 7(a) loans, up from $10.8 billion in 2012.

The SBA’s long-term, fixed-rate Certified Development Company (CDC) 504 program helps fund major fixed assets such as land and buildings. The microloan program offers small, short-term loans of up to $50,000. There are also disaster loans, economic injury loans for businesses recovering from agricultural losses and even loans dedicated for exporters, military entrepreneurs and environmentally-minded companies.

Banks and credit unions offer their own loan options.

Much like with credit cards, borrowers can access funds incrementally up to a limit. This helps with temporary operations or cash flow emergencies, not major purchases. Check out this article to learn more.

These are often smaller loans due in full at the end of the term. They’re good for seasonal businesses, such as retailers, that need cash for accounts payable, have to patch inventory holes or want to tackle quick projects.[/mks_one_quarter]

A lump sum repaid month-to-month makes the larger loan amounts easier to manage and lenders more willing to offer lower APRs. Borrowers, who are often well-established firms or younger companies with solid growth prospects, like these loans for expansion efforts.

Unlike a long-term loan, where both the principal and interest is regularly paid down, only interest is whittled down during the life of this loan. The full principal is due on the final day of the contract. Borrowers usually include businesses that rely on specific payments from clients instead of a steady stream of income.

Other small business loans target specific spending on inventory or equipment.

What loan is right for you?

This depends on why and when you need the funds.

For daily expenses, try working capital loans and credit lines. Growing businesses trying to add new product lines should look into expansion loans with terms shorter than the expected life of the item or equipment being purchased.

But some businesses just want a financial buffer. Credit lines also work well here, as do low-interest term loans. If you have good credit and collateral to offer, it’s worth trying for a more affordable version from a bank.

If you need money fast, online lenders are your best bet. However, platforms such as SmartBiz now streamline the notoriously byzantine bank-based SBA process using online and email submissions and algorithms that can deliver pre-approval for smaller loans within minutes.

Who is eligible for what?

In October, loan approval rates at big banks and institutional investors improved to record highs of 23.5% and 63.1% respectively, according to the Biz2Credit Small Business Lending Index. Small banks approved 48.7%of loan requests while alternative lenders okayed 59.5 percent and credit unions cleared 41.2%.

But if you’re starting a business from scratch, you’ll like struggle to find financing at a traditional lender. Banks are picky. They want to make bigger loans to more established businesses with high credit scores and will often offer unsecured loans only to companies they see as low-risk.

For most short term loans, your credit score can afford some dings, but you’ll still need to have tens of thousands in annual revenue and at business track record of at least a year.

Online lenders are more lenient, accepting borrowers with credit scores in the 500s. Often, they’ll also take into account other information about the business, such as social media presence.

How much can you get?

SBA 7(a) loans have no minimum amount but top off at $5 million. The average loan amount in fiscal year 2015 was $371,628. Some 47%of loans fell between $350,000 and $2 million.  The SBA can guarantee as much as 85% on loans of up to $150,000 and 75 % beyond, up to $3.75 million.

Microlenders generally approve loans smaller than $50,000. Online lenders operate in the $500 to $500,000 range. Banks have the lowest interest rates, while online lenders have the highest.

At peer-to-peer organizations such as LendingClub, borrowers can request up to $300,000, paying back the loans within one to five years at rates ranging from 5.9 % for exceptional credit to more than 30 percent. Origination fees fall between 0.99% and 6.99% of the total loan amount.

A revolving business credit line from Bank of America starts at $10,000 with monthly payments based on your balance, access to funds via phone or web and interest levied only on withdrawn funds. A secured, one-time lump sum business loan starts at $25,000.

At Wells Fargo, an unsecured FastFlex loan designed for inventory purchases, emergency repairs and short-term operational costs ranges from $10,000 to $35,000. Fixed rates start at 13.99% with a single $195 opening fee. The bank’s term loan offering for larger expenses spans $10,000 to $100,00, with rates from 6.25% and an $150 opening fee. The rate for the equipment loan bottoms at 5.25%.

The application

Be prepared to show financial documentation, including business audits, cash flow statements, tax returns and detailed business plans. Lenders want to see evidence of good cash flow, annual revenue and profitability. You may have to explain issues in your credit report. Some lenders might ask for a valuation for your business to gauge how much a buyer would be willing to pay for the company. Others will want to review your personal resume.

Alternative financing options

New companies that hit a wall with small business lenders might want to try personal loans, handouts from family and friends, crowd-funding or business credit cards.

Some businesses lean on options such as merchant cash advances, which swap a one-time payment in exchange for a share of the credit card payments made by clients to the borrower. Platforms such as Small Business Funding connect alternative small business lenders offering advances of $2,500 to $500,000 to entrepreneurs making at least $8,000 a month and operating for at least three months.

Another option: Invoice factoring, in which an outside party buys unpaid invoices at a discount and advances cash. Fundbox sends 100 percent of the invoice value and takes repayment directly from the borrower instead of its clients at APRs of up to 65 percent.

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