Finance

How to Get a Small Business Startup Loan

It takes time, effort and money to launch and grow a small business. However, unlike an established business with a track record, an early-stage business doesn’t typically qualify for traditional financing programs offered by banks. Banks have strick lending stardards that a majority of brand new businesses don’t meet. To finance startup costs, new small businesses often borrow cash from family and friends, or sell equity to investors.

There are, however, several ways for a small business to get a startup loan for things like equipment, machinery, inventory, and supplies; the purchase of heavy equipment; real estate; and working capital. Startups can also use SBA loans, collateralized loans, and credit cards, among other options to finance startup costs.

If you’re unable to secure a bank loan to fund your small business startup, below are other financing options to consider.

Equipment financing loans are designed for the purchase of business equipment and machinery. The equipment may be either new or used. Equipment loans are similiar to conventional bank loans, with monthly repayment requirements typically over a term of no fewer than 3 and no longer than 10 years. The proceeds of the loan must be used to purchase equipment or machinery.

Qualifying for equipment financing is usually easier than getting a traditional bank loan because the equipment serves as the collateral for the loan. If the monthly repayment terms are not met, the lender can seize and sell the equipment to cover the cost of the loan default.

For larger equipment and realestate purchases the Small Business Administration (SBA) offers the SBA 504 loan program. The 504 program offers fixed rate, low interest rate loans to qualifying business owners with good personal credit.

An alternative to equipment financing is an equipment lease. With an equipment lease, equipment is leased from the lender for a period of time. During the term of the lease the lender maintains title to the equipment. When the term of the lease ends, the borrower has the option to renew the lease, purchase the equipment, or return the equipment to the lender. Since some equipment can become outdated quickly, an equipment lease is ideal for acquiring equipment that may become obsolete down the road. Equipment leases are typically easier to qualify for than equipment loans if a borrower’s credit is less than stellar.

Leases typically have a higher total cost than equipment loans since monthly lease payments include an effective interest rate. With a lease, available equipment is typically more limited than when purchasing outright.

For small business startups that are equipment intensive, it’s smart business to fund startup costs by financing equipment with an attractive loan program before seeking a traditional loan or higher cost investment financing elsewhere.

If startup costs are relatively low, using credit cards can be an effectively way to finance initial business expenses. Funding via credit card is accessible and allows a new business to scale up quickly. Compared to more traditional business funding methods, credit card financing provides several benefits. These include:

  • Quick access to money: When you’re just getting your business off the ground, quick access to funds can mean the difference between success and failure. Having a revolving line of credit you pull from is advantageous.
  • 0% APR: Many credit card programs now offer a welcome period that extends a line of credit with 0% APR for up to 8 to 12 months on purchases. Just payoff of the balance of the card during the welcome period, and you credit card is a good as cash. If you have strong personal credit, credit card lenders may provide credit lines up to $20,000.
  • Unsecured credit line: Most credit cards are unsecured. That means a credit card does not have collateral requirements. Based on your credit and a repayment agreement a lender extends a line of credit that can be used to make unrestricted purchases up to the credit limit.
  • Flexible payment terms: Compared to more traditional financing options, like bank loans, credit card payments are quite flexible. Payment installments are typically due once per month. If payments are not made on time, additional fees may be applied, but you’re rarely asked to pay the balance in full.

While there are many benefits to using credit cards to fund your startup business, don’t forget you’re liable for the balance even if your business does not succeed. Before using a credit card for business startup costs answer the following questions:

  • Do you have a strong business plan? Do you have a business plan that allows you to achieve important revenue miles stones enabling you to make monthly payments and repay the balance withing the welcome period? If you’re plan does not allow you to make required payments and repay the entire balance within the welcome period, seek a different means to finance your small business.
  • Do you have a proven business model? Even if you have strong business plan, chances of failure are greater for small business owners attempting to prove an unproven model. Before using credit cards to fund your startup, make sure you have proven business model that will allow you to repay borrowed money.
  • Will credit card financing provide sufficient funds to get your startup off the ground and viable? How much will it cost to finance your business to the point where it’s making sufficient cash flow to remain viable while paying off startup costs? If your business requires $20,000 to reach viability, your credit card limit is $10,000 and you do not have any other means to finance additional startup costs, do not use a credit card to finance your business. This is a recipe for disaster.
  • If your business does not succeed, will you be able to pay back the accumulated debt balance on the cards? According to analysis of data provided in U.S. Bureau of Labor Statistics Table 7. Survival of private sector establishments by opening year 20% of small businesses fail within the first year. As appealing as it is to launch a small business, it’s not worth jeapordizing your future. Do not take on credit card debt if you cannot comfortably afford to repay it if your business does not succeed.

The SBA 7(a) loan program is the SBA’s most popular lending program for financing the launch or expansion of a small business. While the Small Business Administration (SBA) itself does not lend money directly to small businesses, it guarantees and sets the guidelines for SBA 7(a) loans made by its lending partners. By guaranteeing the loans, the SBA reduces risk lenders face by making loans to qualifying small business owners. SBA loans generally offer lower interest rates and fees than traditional loans.

The SBA 7(a) loan is the best option for a small business startup when a portion of loan proceeds will be used to aquire real estate. SBA 7(a) loans can be used for:

  • Working capital (export loans, revolving credit, etc.)
  • Refinancing current business dept
  • Purchasing fixed assets (furniture, real estate, equipment, etc.)
  • Acquiring an existing business

The SBA 7(a) program offers loans up to $5 million. The terms and conditions, along with the loan amount and guarantee percentage, depend on the specific 7(a) loan program. The SBA offers the following types of 7(a) loan programs for small businesses.

  • Standard 7(a) offers a maximum loan amount of $5 million with a turnaround time of 5-10 business days
  • 7(a) Small Loan offers a maximum loan amount of $350,000 with a turnaround time of 5-10 business days
  • SBA Express offers a maximum loan amount of $500,000 with a 36 hour turnaround time
  • Export Express offers a maximum loan amount of $500,000 with a 24 hour turnaround time
  • Export Working Capital offers a maximum loan amount of $5 million for working capital with a 5-10 day turnaround
  • International Trade offers a maximum loan amount of $5 million for business in export sales with a turnaround time of 5-10 days
  • Veterans Advantage program offers reduced fee loans for veteran-owned small businesses
  • CAPLines program provides small business loans to meet short-term working capital needs

To qualify for an SBA (7)a loan, a business must meet specific income, credit, and operating criteria. Basic eligibility requirements or SBA 7(a) loan assistance include:

  • Have an established business in the United States
  • Operate as a for-profit business
  • Operate as a small business, as defined by the SBA
  • Have invested equity in the business
  • Reasonable investment of personal assets and financial resources before applying for a loan
  • Demonstrable need for a loan
  • Use of loan proceeds for business purposes
  • No delinquent debt obligations to the U.S. government
  • A minimum FICO SBSS credit score of 155 for loans of $350,00 or less to avoid a manual review

Additional eligibility requirements vary by 7(a) loan type. To explore loan options and eligibility requirements speak with an authorized SBA lender.

In 2021, 17% of SBA 7(a) loans went to small business startups. Of the 7(a) loans that go to startups, the majority go to career professionals (e.g. a dentist opening a dental practice) or business owners purchasing an existing business.

Since SBA 7(a) loans are accessible and offer favorable terms, its a financing option small business startups should explore.

SBA 504 loans offers fixed-rate, long-term, low interest rate loans up to $5 million for larger fixed assets such as equipment purchases and acquisition of owner-occupied real estate. (The owner is required to occupy over 51% of the property depending on the loan details.)

SBA 504 Loan Details:

  • Loan amounts: $125,000-$5,000,000
  • Interest rates: Pegged to 5-year and 10-year U.S Treasury issues
  • Maturity terms: 10-year; 20-year; 25-year
  • Turnaround time: 30-90 days

To qualify for a 504 loan, a business must:

  • Be based in the United States
  • Operate as a for-profit company
  • Have a tangible networth less than $15 million
  • Have an average net income of less than $5 million for the preceding two years

Other basic elegibility requirements include having qualified management experience, a viable business plan, good credit history, and the ability to repay the loan.

504 loans are typically structured as follows:

  • Borrower contributes 10-20%
  • Lender covers up to 50% of the loan
  • CDC cover 40% of the total loan

All 504 loans are made through partnership between the SBA and a non-profit Certified Development Company (CDC). The first step to exploring 504 loan options and qualifying is to find a CDC in your region.

The SBA microloan program provides small business loans up to $50,000—although the average loan is about $13,000. Microloans are designed to provide startup financing and funds for small businesses and non-profit childcare centers. Loan proceeds can be used for working capital, inventory, supplies, fixtures, furniture, machinery, and equipment. Loan proceeds cannot be used to purchase real estate or restructure existing debt.

SBA microloans are have a maximum term length of 72 months (6 years). The average term length is about 40 months. Interest rates will vary between lenders but are generally between 8 and 13 percent.

SBA microloans are provided through SBA-approved intermediaries, often Community Development Financial Institutions (CDFIs) and other non-profit financial institutions. To explore loan options and apply contact an SBA District Office in your area to find an SBA microlender near you.

In addition to the SBA, there are several other microlenders that provide small business loan programs. Unlike a traditional loan that comes from a bank or credit union, microloans are sponsored by non-profit organizations or individuals. Microloan amounts are typically smaller than traditional loans. Because microloans are not underwritten by a traditional financial institution, they often have less stringent guidelines which can be beneficial for business owners with newer credit history or lower credit score.

Small business microlenders include:

  • Grameen America provides microloans of $1,500 to women starting a small business.
  • LiftFund offers microloans for working capital, equipment, vehicles, and supplies & inventory.
  • Opportunity Fund offers microloans to minority and women-owned businesses in the state of California.
  • Accion New Mexico offers small business loans from $1,000 to $1 million in Arizona, Colorado, New Mexico, Nevada and Texas.
  • Justine Petersen based in St. Louis offers small-business loans up to $10,000.
  • Accion USA is the largest network of local microlending organizations providing loan amounts up to $1 million.
  • Kiva provides interest-free, short-term (3 to 36 months) microloans of up to $10,000. Borrowers must first have a family or friend lend to their business.
  • Pacific Community Ventures offers loans of up to $250,000 to profitable small businesses in California that have been in business at least one year.
  • ImpactFund offering microloans and small business loans up to $100,000.
  • Main Street Launch offering microloans to small businesses in the San Francisco Bay Area.

How to qualify for a microloan

Each microlender underwrites its own loans and sets its own lending guidelines. However, most microlenders will make sure you have the ability to repay the loan by evaluating your credit history, business financials, personal income, and how long you’ve been in business.

7. Collateralized Loans

We’ve already explored getting a loan to purchase equipment using the equipment as collateral, but equipment isn’t the only asset class that can be used to secure a loan to finance a small business startup. From the lender’s point of view any hard asset that can be liquidated (turned into cash) quickly can serve as loan collateral. Assets that can be used to secure a loan include:

  • Securities (stocks, Treasury bonds, CDs, Bonds)
  • Real Estate
  • Equipment
  • Vehicles
  • Inventory

These are all tangible assets that can be used as loan collateral. However, some hard assets aren’t as easy to liquidate as others, and their value is less certain. Lenders may require that certain hard assets get an appraisal to verify value before they can be used as collateral.

Accounts receivable are another type of asset that can be used to collateralize a small business loan.

Accounts receivable financing is an asset-based financing solution that allows business owners to receive a loan that is collateralized against outstanding invoices. An accounts receivable loan is typically a quick way to get money to put back in the business or cover startup costs. The turn around on an accounts receivable loan can be as little as one day.

An accounts receivable loan is a good option for startups with revenue and receivables, or a SaaS-based business with contracts. Typically, banks are willing to collateralize 30 to 60 day receivables. Receivables older than 90 days often will not be accepted as collateral for fear the receivables will become uncollectable. Banks will typically extend a 75-85% advance rate against qualifying receivables, leaving a 15-25% cushion in case some of the receivables become uncollectable.

When banks extend an accounts receivable loan they take into consideration concentration risk. Concentration risk is the level of revenue risk associated with having your accounts receivables tied up with just a few customers or having a majority of accounts receivable tied up with one large customer. The more diversified your portfolio of clients and accounts receivables, the easier it will be to get an accounts receivable loan.

While accounts receivable loans are a convenient way for a small business to access cash quickly, they’re also relatively expensive. An accounts receivable loan should be pursued only if less expensive forms of financing are unavailable.

Author: James Hoffman
James is the current Senior Vice President of Commercial Lending at LENDBASE—a one stop shop for commercial credit with offices from New York to Seattle serving clients nationwide. He is also the.... read more
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