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Nearly every small business begins with this challenge: You've got a great idea and the skills to make your new venture a success, but you need funding.
When the money you have to start a business doesn't quite match up to the money you need, you might consider a business loan or line of credit to fill in the gaps. Getting a startup loan usually isn't easy, however, since a brand-new business won't have a credit history—or even a sales or operational history—to demonstrate a low credit risk. Still, it is possible to get a loan to fund a new business, and the loan-seeking process itself can be clarifying for a budding entrepreneur. If you're interested in getting a loan to start a business, you can begin by understanding what this process entails.
How to Get a Business Loan
There are three essential steps to getting a small-business loan:
- Create a business and financial plan.
- Check your business and personal credit.
- Find lenders and apply.
Writing a business plan and mapping out your business's financials is a critical step. Your plans and expense sheet show lenders (and you, for that matter) how your business will grow: what you need to get started, where your funding will come from, what you can expect in sales and expenses, the experience and skills that will propel your business forward, and what success would mean over the next five years. Because your startup doesn't have a track record, these plans help lenders evaluate its risk.
Startup funding often comes from multiple sources. For example, if you need $100,000 to launch your business, you might contribute $25,000 from your personal assets, get $25,000 from friends and family who want to invest—or from a crowdfunding campaign—and borrow the other $50,000.
Credit scores are another key metric. Businesses have their own credit scores that assess creditworthiness based on past behavior, including if the business has any collections, liens, judgments or bankruptcies in its history. For established businesses, a good business credit score can open doors and help secure favorable loan rates and terms. Your startup, though, may not even have a business credit score yet. If that's the case, lenders will rely on your personal credit score and report. Although requirements vary, you'll generally need a high credit score to get a business startup loan. Since startups are inherently risky, your personal good credit acts as a counterbalance to that risk.
Once you have your financials in order and know your credit situation, you're ready to look for a lender—or, more accurately, several. Finding the right financing for your new business may require knocking on a few doors. Fortunately, there are multiple options to explore and resources that can help.
Where to Get a Business Loan
Business loans are available through banks, credit unions, online lenders and even microlenders that specialize in smaller loans. However, not every potential lender is going to be a fit for your startup business. In fact, many require loan applicants to be in business for at least a year or two before they can be considered for a loan. It's also ideal to get multiple loan offers, if possible, which means you'll probably want to cast a wide net. The more potential lenders you find, the better your chances of getting a loan that works for your needs.
Where do you start? Here are a few ideas:
- Your bank or credit union: If you've opened a business bank account, inquire with your financial institution about business loans and credit. Even if your new business doesn't qualify for the full loan amount you're looking for at your bank, a small loan or line of credit could help. It'll establish a credit relationship for the future, which can help you build your business credit score along the way.
- Business-focused banks: These can be found in your community or online.
- Online business lenders: Startups may find online lenders more amenable to lending than regular banks, though interest rates tend to be high.
- Microlenders: If you need less than $50,000 to launch your business, a microlender like Kiva or Opportunity Fund might be worth exploring. These are nonprofits or alternative lenders looking to help businesses find small loans, often at low interest rates. Many are startup-friendly.
The Small Business Administration may serve as a helpful resource when you're searching for loans. The SBA doesn't make loans itself, but it does guarantee small business loans made through banks and credit unions. An SBA guarantee takes some of the risk out of business lending, so working with the SBA can be a real benefit to new business owners. The SBA's LenderMatch program can help you locate a lender, and counseling through its SCORE program can connect you with valuable advice from experienced business owners. The downsides: SBA loans involve a series of requirements, and the application and funding process can be lengthy.
What Do Lenders Look at When Assessing Business Loan Applications?
Generally speaking, a lender looks at your business financials and business credit to decide whether you qualify for a business loan. But when you're applying for a loan as a startup, your business financials and credit alone probably aren't substantial enough to qualify you. Even with established businesses, personal credit scores and histories often play a role in securing business credit. The Federal Reserve's 2020 Small Business Credit Survey found that 88% of small businesses that received financing used the owner's personal credit score to obtain it.
If you're planning to apply for startup financing, be prepared to provide your personal credit information in addition to any business credit history and score you may have. You may also want to consider what collateral you can use to secure a loan—and improve your chances of approval. Among established small employers who received financing in 2019, 59% used personal guarantees to secure their business debt, according to the Fed survey. However, if you have business assets—equipment or receivables, for example—you may be able to use these as collateral. Are you concerned that your credit and/or assets won't measure up? A cosigner who puts up their personal assets and credit history as a guarantee may help.
Even if your business is pre-revenue, your business plan and financials help round out the picture. By showing your projected revenue, expenses, cash flow and debt, you can help to demonstrate the viability of your business. Furthermore, your experience and insights into the industry can show your ability to lead your business to success.
Additional Business Funding Options
If a traditional business loan isn't in the cards for you and your startup, alternative funding may help get your business up and running. The most prevalent option here is self-funding. By using your savings or investments, you may be able to "bootstrap" your way to loanworthiness in a few years—or bypass the need for a loan altogether. Just be sure not to wipe out savings for your retirement and emergency fund since doing so can leave you high and dry if your business venture doesn't work out.
Here are a few alternative ideas you might try for funding your startup outside of traditional lending:
- Friends and family: If people close to you are willing and able to lend or invest, you can get your business off the ground without a long history or an impressive business credit score. Before you commit to this option, know that defaulting on a loan from a loved one can have major consequences on your personal relationship with them. Get your agreement in writing, and hold up your end of the deal.
- Venture capital: Courting an early investment from a venture capital firm or angel investor comes with its own challenges and rewards. Venture capital investors are typically looking for an equity stake and an ongoing role in your business. They favor fast-growing businesses with high growth potential. On the upside, venture capital investment isn't debt; you're working with investors and not lenders.
- Crowdfunding: You can hatch your innovation or new business on Kickstarter or one of many other crowdfunding platforms. Visit each prospective site to get a sense of which offers are successful and how they're structured. Also pay attention to terms: Know what happens if your deal falls through.
- Vendor financing: If you can sell a vendor on the merits of your business, they may be willing to work with you on financing—by offering credit, a loan or an investment in your company. This may be a viable way to finance equipment or create inventory if you're strapped for cash.
- Personal loans or credit: If all else fails and you need an additional loan or credit, you may consider using a personal loan or even your personal credit cards to fund your new venture. Just be wary about the risk you're assuming when you use personal credit to fund a new business. If you rack up a large amount of personal debt and the business fails, you could be in real financial trouble. If you use your home or other assets as collateral, you can lose these as well. Believe in yourself but think critically before making this move.
From a Startup to a Savvy Business
Your new business may need capital, but that isn't all it needs to take root and flourish. Going through the process of building a business plan, seeking out lenders and pulling together the financing you need to make your business a reality just might make you a better businessperson—and that's a lasting benefit for you and your business.
Once you get the funds you need to get your business started, do everything you can to build and maintain your business credit standing as you go. Check your business credit score and learn more about the factors that determine business credit. That way, the next time you need a business loan, you'll be that many steps ahead.