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What is a Small Business Loan? Types, Uses and Eligibility

What is a Small Business Loan? Types, Uses, & Eligibility

Written by: Pretha Yasmin

September 7, 2023

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What is a Small Business Loan? Types, Uses, & Eligibility
7 min read

Read our small business loan guide to gain a better understanding of what lenders look for, how to prepare for loan applications, and how to increase your chances of securing the finances you need.

Key Takeaways

  • In this guide, we will explore the various financing options available to you and how you can use them.
  • Learn how to effectively assess your small business financing needs so you can choose the right type of loan and lender.
  • Find tips to increase your chances of business loan approvals and how to manage your loan and repayment plan.

What are Small Business Loans?

A small business loan is a fixed amount of money borrowed by entrepreneurs to bridge any financial gaps or make investments for growth. This loan comes with specific terms and repayment times set out by the lender. Small business loans can often be used for almost any business expense.

What are Small Business Loans Used For?

Small business loans have a variety of uses and can suit nearly every business need. Here are some common uses for small business loans:

Working Capital: Small business loans can help cover day-to-day operation costs like rent, utilities, employee payrolls, marketing, and inventory. Working capital provides the cash flow needed to keep the business running smoothly.

Equipment Upgrades: Loans can be used to finance expensive machinery, special equipment, or vehicles. Small business loans allow businesses to acquire the resources they need without messing up cash flow.

Expansion: Businesses often require additional funding when they are expanding. Small business loans can be used to finance new locations, hire more employees, invest in marketing, or expand their product/service line.

Inventory Management: Small business loans can be used to purchase inventory in bulk or to manage seasonal downtimes.

Renovations: Businesses can attract more customers and better their image by renovating or upgrading their facilities to create a better experience for their customers.

Types of Small Business Loans

These are the most common types of small business loans:

Term Loans: This is a standard loan where the lender provides a specific amount with a set repayment period. Businesses are expected to pay it back, plus interest, in monthly, weekly, or daily installments over the set time period. Term loans are a broad term that include several different types of loans designed for specific business needs such as working capital loans, bridge loans, and short-term loans. These loans can be customized to best suit your business goals and financial situation.

Lines of Credit: This is a flexible lending solution that provides the borrower with access to a certain predetermined amount. You can borrow funds as needed up to the approved limit.

Small Business Administration (SBA) Loans: SBA offers government-backed loans to small businesses at often a lower interest rate. The SBA provides several different types of loans such as the 7(a) loan program or the 504 loan program.

Equipment Financing: These loans are designed specifically for businesses looking to upgrade equipment. Equipment financing loans can be used to buy heavy machinery, vehicles, tools, or tech.

Types of Lenders

The most common types of small business lenders include:

Traditional Banks: Commerical bank loans are usually the first place entrepreneurs go to look for funding. Traditional banks can offer a range of loan types but may have rigid eligibility criteria.

SBA: The Small Business Administration works with approved lenders to provide business loans. SBA loans usually offer favorable terms and ensure government-backed guarantees making it an ideal choice for small business owners that are not looking for immediate funding.

Private Investors: Start-ups and fast-growing businesses can seek out funding from private investors or venture capital in exchange for equity.

Alternative Lenders: Alternative lenders offer a straightforward application process with quick turnaround times, making it a top choice for small business owners in need of quick funding for short-term purposes.

How to Assess Your Small Business Loan Needs

Assessing small business loan needs before submitting the application is crucial to ensure the right type of loan and amount of money is borrowed.

Identify Loan’s Purpose: Determine exactly what the loan will be used for. Clearly defining the needs will help you prevent borrowing too much or too little.

Evaluate Your Finances: Assess the business’s current financial situation including cash flow, revenue, expenses, and remaining debt. Are you willing to give up collateral? This will give a clear picture of the business’s ability to take on additional debt.

Calculate Desired Loan Amount: Once you have your purpose and an understanding of the business’s finances, calculate how much money you need. Be realistic in estimating the amount needed to achieve your business goals.

Determine Repayment Strategy: After assessing the business’s finances and calculating the desired loan amount, determine how much you can realistically and comfortably pay back. Would you prefer to pay back on a monthly, weekly, or daily basis?

Explore Loan Options: Research various loan types available such as term loans, lines of credit, SBA loans, or alternative funding. Compare interest dates, fees, eligibility requirements, and how long their approval to funding process time is.

Understanding the Loan Terms

Understanding the business loan terms allows you to make an informed and educated decision for your business.

Financial Impact: Carefully review the interest rates, fees, and repayment schedule to understand the total cost of what you are borrowing and how it will impact your cash flow. Look out for any hidden fees.

Repayment Structure: Pay attention to the repayment structure including the frequency (how often) and the loan term (how long). Make sure the presented repayment schedule is realistic for your business before agreeing to the contract.

Collateral & Personal Guarantee: If the loan requires collateral or personal guarantee, find out the details and understand the potential risks involved. Be aware of what assets or personal guarantee is being used as security and the consequences.

Prepayment Penalties: Some loans may charge you a penalty if you decide to repay your loan earlier than the set term. Always ask if there is a prepayment penalty for any loan you take out and assess whether it is right for your business.

Terms & Conditions: Carefully read and understand all the terms and conditions outlined in the loan agreement. Please contact customer support or seek out legal or professional advice if possible. Pay attention to any restrictions that may affect your business operations and clauses related to late payments or changes in interest rates.

Tips to Improve Your Eligibility

Each lender has its own criteria, so even if one lender rejects your application, you may still find success with another. Our lending partners typically require a business to be active for at least 6 months with an annual revenue of $250,000 a year to be considered for approval. While nothing can guarantee a business loan approval, here are some tips to improve your loan application eligibility.

Keep a Good Credit Score: A strong credit score indicates your creditworthiness. Pay your bills on time, keep credit card usage low, and avoid bankruptcies or missed payments.

Create a Business Plan: A well thought out business plan demonstrates to potential lenders your understanding of the business and market. Include your market analysis and repayment strategy.

Offer Collateral or Personal Guarantee: Offering collateral or personal guarantee can increase your chances of approval, especially for secured loans. Collateral can be assets such as real estate or inventory.

Improve Cash Flow: Improving your cash flow will give confidence to lenders that you will pay them back. You can improve cash flow by optimizing your expenses, increasing sales, and reducing the cost of inventory.

Reduce Existing Debt: Paying off outstanding loans or credit card debt will raise your credit score and will demonstrate to potential lenders that you are able to pay back your loan.

Prepare all Documents: Gather all documents necessary before applying to avoid longer processing times with traditional banks and SBA lenders. Necessary documents include tax returns, bank statements, and business license.

Research & Compare: There are many lenders available with different eligibility requirements and loan products. Research lenders who have worked with your industry as they may be able to provide loans tailored to your industry needs. Compare interest rates, repayment terms, and customer reviews.

Keep in mind – every business loan application is unique so make sure to adapt the information in this guide to your circumstances.

How to Manage Small Business Loans

Understand Repayment Terms & Options: It is crucial you understand the repayment terms and options to avoid missed or late payments and penalties.

Create a Repayment Plan: This allows you to budget correctly so you can prioritize and allocate the funds accordingly while paying back your loan.

Preparing for Unexpected Financial Crises: It is essential to have a plan for unforeseen emergencies, so you don’t default to using the loan.

Communicating with Lenders: It is important to communicate with your lenders, especially during hardships, so they can offer you solutions based on your circumstances.

Are you ready to apply for a small business loan? Check out our guide on required documents for your application to help you get started.

About the Author

Pretha Yasmin

Pretha Yasmin is the consumer analyst for SmallBusinessLoans. She has more than five years of experience in marketing and studying consumer behavior for a wide range of industries including finance, construction, and hospitality. She holds a Bachelor of Business Administration in marketing from Brooklyn College.

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