How to Get a Small Business Loan and What to Know Before Applying

When is a small business loan right for your business?

Despite the enduring romance of the rags-to-riches success story, many entrepreneurs have at least some help when starting their ventures. Ambition and grit are essential, but unfortunately, these entrepreneurial traits don’t guarantee the immediate cash flow a business may need. What you should consider is some vital initial financing to get new businesses off the ground: business loans.

Business loans are among the most common forms of financing available to founders looking to start a business. But the choice of whether to apply for a business loan is a major decision for every business owner, and not one to be taken lightly. To get started, you can check our guide on how to start a business.

In this post, we’ll examine some of the many factors that go into deciding whether applying for a business loan is right for you and your business. We’ll look at many of the more common terms surrounding business loans and what to expect during the application process, as well as common types of business loans and what they entail.

How do you get a business loan?

Applying for a business loan takes time. Regardless of what type of loan you’re applying for, there are several steps you can take to prepare yourself before submitting an application.

  1. Calculate how much you need to borrow
  2. Gather all necessary supporting documentation
  3. Determine the right kind of loan for your business goals

Depending on the lender, applying for a business loan can take anywhere from a few minutes to several hours. But taking on a potentially significant financial obligation at the outset of a new venture is a major decision, especially for entrepreneurs launching completely untested business ideas.

At this stage, a little planning can save you a lot of effort later on.

How much does your business need to borrow—and what do you need it for?

Before you can apply for a business loan, you’ll need to use a loan calculator and have a good idea of how much funding you need. To answer this, you’ll have to identify what you need a business loan for.

For example, let’s say you run a small but growing home-based catering business and want to open a single brick-and-mortar location, from which you intend to make and sell various baked goods. At an average cost of $95,000 for kitchen equipment alone, our hypothetical catering company is already looking at a considerable business loan just to properly equip a single kitchen—and that’s before commercial real estate and licensing costs.

When estimating how much funding your business will need, it’s also worth considering the costs beyond initial investments. It may cost an average of $95,000 to fully equip a professional-grade kitchen, but how much does it cost to maintain that equipment? What about insurance? Or utility costs?

It’s all too easy to focus on the sticker price of new hardware, but there’s a lot more to consider. This can be especially important for businesses in industries with notoriously tight margins, such as food service, which can take longer to reach profitability, because this will directly affect how easily a borrower can meet their repayment obligations.

🛠️ Free tool: Our Business Loan Calculator can help you determine how much you should borrow and approximately how much it’ll cost.

Do I need a business plan?

Most traditional business loans offered by private lenders will not process a loan application unless it’s accompanied by a detailed business plan. A solid business plan is your company’s road map for the future. Without one, it’s very hard for a prospective lender to evaluate whether your idea is commercially viable.

In recent years, several online lenders have emerged that do not require formal business plans as a part of their loan application process, or they have eliminated the application process entirely.

Shopify Capital, for instance, has no application process; eligible businesses are preapproved based on a range of criteria associated with their Shopify storefronts, including total sales, in much the same way as Amazon Lending prequalifies certain Amazon merchants. This kind of financing can be a great choice for established businesses that want to expand their footprint in a financially sustainable way.

Shopify Capital is small business funding without the hassle.

That said, many lenders that do not require a formal business plan as part of the application process offer short-term loans with higher annual percentage rates (APRs). Higher APRs mean a greater share of a loan’s repayments goes toward interest rather than the principal. This often means higher repayments or longer repayment periods, or both. The APRs of these kinds of loans typically start at around 24% but can be much higher for borrowers with poor credit scores.

Ultimately, only you can decide if you need a business plan to support a small-business loan application. If you do, you can download the handy template below to start putting together your business plan.

Free: Business Plan Template

Business planning is often used to secure funding, but plenty of business owners find writing a plan valuable, even if they never work with an investor. That’s why we put together a free business plan template to help you get started.

What kind of business loan should I apply for?

If you’ve decided to apply for a business loan, the next decision you’ll have to make is what kind of financing is right for your business and growth goals. There are many different kinds of business loans, each of which has advantages.

Term loans

The most common type of business loan is the term loan. Typically repaid over a period of between 2 and 10 years, term loans are a reliable and common way of financing a business.

However, the eligibility criteria for traditional term loans are often stringent. They’re rarely suitable for (or loaned to) businesses that have been in operation for two years or less because a demonstrated history of profitability is often a requirement. Many private lenders also prefer to service larger loans—up to $500,000—making term loans an impossibility for smaller ventures that don’t need that much money or for entrepreneurs without a proven track record of success.

Most lenders insist on minimum credit scores, usually around 680. It can also take anywhere from two weeks to two months for a traditional term loan to be processed.

SBA loans

Small Business Administration (SBA) loans are very similar to standard term loans offered by private lenders. The biggest difference is that SBA loans are serviced by lenders that have agreed to offer more favorable terms to groups that might struggle to secure traditional business financing, such as women founders and minority business owners.

Loans administered via an SBA-approved lender often require a formal business plan and usually require at least some collateral, such as real estate. The term of SBA loans can be much longer than a traditional term loan; some have terms of up to 25 years. SBA loans are also typically smaller, starting at around $10,000 at the lower end, up to the average SBA loan amount of around $350,000.

SBA loans are usually a little more forgiving in terms of credit score, requiring a minimum threshold of 650. While these loans are definitely friendlier to smaller businesses, it can still take up to 90 days for an SBA loan to be processed.

Learn more: Small-Business Loans for Women and Where to Apply for Them

Short- and long-term online loans

Online loans have become increasingly popular in recent years as entrepreneurs have sought alternatives to traditional business financing. These are the kinds of loans offered by lenders such as Funding Circle and OnDeck.

There are many advantages to short- and long-term online loans. Borrowers with lower credit scores can still benefit from this type of financing, with minimum scores of between 500-600 considered acceptable by many lenders. Businesses that have been in operation for a year are often eligible for this type of loan, and annual revenue requirements are also typically lower—around the $100,000 mark in many cases.

These loans can range from as little as $5,000 to around $250,000 for short-term loans, and up to $500,000 for long-term loans. This makes them a solid choice for business owners with more modest funding needs. This type of loan almost never requires collateral, making them ideal for entrepreneurs who lack certain assets. And, in many instances, decisions can be made in a matter of days, if not sooner; some lenders offer same-day decisions.

However, short- and long-term online loans aren’t without their drawbacks. The APRs of these loans can be prohibitively high—as much as 99% in extreme cases.

Invoice factoring

Another popular yet somewhat less conventional type of business loan is invoice factoring.

Businesses that rely on invoices for payment often have to wait for prolonged periods of time before those invoices are paid—up to 90 days, in some cases. In turn, this can have an adverse impact on a business’s operations, particularly smaller businesses that cannot afford to wait three months for outstanding invoices to be paid.

Companies that provide invoice factoring services buy outstanding invoices owed to companies—also known as purchasing accounts receivables. Rather than waiting for overdue invoices to be paid by their clients, businesses can sell those outstanding invoices to an invoice-factoring company to get much faster, sometimes in as little as 24 hours.

Ultimately, invoice factoring is a trade-off. Invoice factoring allows companies to avoid waiting months to be paid, but it also means losing some of the money owed. Invoice-factoring companies will typically pay around 70% of an outstanding invoice for less creditworthy clients and up to 90-95% for billed customers with better credit. Something else to consider is that factoring may not be suitable for businesses that rely on high volumes of smaller invoices, because the service fees may not be economically feasible.

Consider your options before making a decision

Taking out a business loan is a major financial decision and not one that should be taken lightly. As 2020 has handily demonstrated, significant economic disruptions can have a profound effect on everything from revenue forecasting to the financial feasibility of a business itself.

Only you can decide whether taking out a business loan is right for your business. Before making any decisions, be sure to double-check that you’ve covered as many of your bases as possible:

  • Have as close to a precise loan amount in mind as possible before applying for a business loan, and know exactly how you’ll invest that funding into your business
  • Even if not required as part of a business loan application, consider making a formal business plan (if applicable) to identify any important points you may have overlooked, such as realistic revenue projections
  • Be realistic about how much your business can afford in terms of repayments, and identify any external factors that could jeopardize this when considering repayment terms
  • Consider discussing your plans with a financial adviser in your community to learn more about types of business financing

In uncertain times, some financial support can go a long way. Shopify Capital is here for you with quick and easy access to funds. Shopify Capital let's you get funding based on your history with Shopify and skip lengthy application processes.