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Find a Solution Financial Solutions

A Guide to Choosing the Right Small Business Loan

Choosing the right small business lender and type of loan can be difficult. Our guide will help you understand the different kinds of lenders and the various types of loans to help you determine which is best for you.

Before you start applying for a loan, you need to answer several critical questions to help you determine which kind of lender and loan is best for you:

  • How much money do you need?
  • What do you need the money for?
  • How quickly do you need the money?
  • How long will it take you to pay it back?
  • How long have you been in business?
  • What is the current financial shape of your business?
  • How much collateral, if any, do you have to put up for the loan?

Answering these questions will help determine if you should pursue a government-backed loan, a loan or line of credit through a bank, or a cash advance, line of credit or loan from an alternative lender.

Editor's Note: Looking for information on business loans? Fill in the questionnaire below and you will be contacted by alternative lenders ready to discuss your loan needs.  

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Here's a breakdown of what you need to know about each type of lender.

  • The Small Business Administration (SBA) offers several loan programs designed to meet the financing needs of a wide range of business types.
  • With these loans, the government isn't directly lending small businesses money. Instead, the SBA sets guidelines for loans made by its partners, which include banks, community development organizations and microlending institutions.
  • The SBA helps eliminate some of the risk to lenders by guaranteeing that the loans will be repaid.
  • Businesses have a variety of SBA loan types to choose from, each of which comes with its own parameters and stipulations on how the money can be used and when it must be repaid.

Pros and cons: The government guaranty, which typically covers between 75 and 90 percent of the loan, eliminates much of the risk for the lender. In addition, the terms of an SBA loan also tend be more favorable to borrowers. The downsides are that additional paperwork needs to be filed, extra fees need to be paid, and it takes longer to get an approval.

What the experts say: "The SBA provides a guaranty that enables the bank to extend credit it would have otherwise declined," Javier Marin, a consultant with the Florida Small Business Development Center at the University of South Florida, told Business News Daily. "This is true for startups, companies with a tight cash-flow stream, and business owners with borderline, not bad, credit scores."

To learn more about specific SBA loans, review the SBA loans portion of the Types of Loans section below.

  • While banks are often the sources of SBA loans, they also are lenders of conventional loans.
  • The biggest difference between SBA loans and non-SBA conventional loans is that the government isn't guaranteeing that the bank will get its money back. 
  • While a specific plan is still needed to get approval, bank loans don't come with such stringent use terms that SBA loans do.

Pros and cons: The biggest pluses of conventional bank loans are that they carry low interest rates, and because a federal agency is not involved, the approval process can be a little faster. However, these types of loans typically include shorter repayment times than SBA loans and often include balloon payments. Additionally, it's often difficult to get approved for a conventional bank loan.

What the experts say: "Even though approval rates have increased, big banks approve [only] slightly more than 20 percent of the loan requests they receive," said Rohit Arora, CEO and co-founder of Biz2Credit. "Smaller banks approve a little less than half of the loan applications they receive."

To learn more about specific conventional bank loans, review the conventional bank and alternative lender portion of the Types of Loans section below.

  • Alternative lenders are particularly attractive to small businesses that don't have a stellar financial history because approval requirements aren't as stringent.
  • Alternative lenders typically offer online applications, make decisions on approvals in a matter of hours and providing funding in less than five days.
  • There are direct alternative lenders, which lend money directly to small businesses, and lending marketplaces, which provide small businesses with multiple loan options from different direct lenders.
  • Examples of direct alternative lenders include Fundation, Kabbage and OnDeck Capital. Examples of lending marketing places are BizFi and Biz2Credit.

Pros and cons: The positives of working with an alternative lender are that your business doesn't need to have a perfect financial status, there are few restrictions on what the money can be used for, and the loans can be approved almost instantly. The downside is that interest rates can be significantly higher than those charged by a bank.

What the experts say: "While a borrower is able to get money quickly, he or she pays a premium for that in the form of higher interest rates," Arora said. "Alternative lenders are more willing to provide money to companies that might not have great credit ratings. The increased risk the lenders take is reflected in the interest rate charged."

To learn more about alternative lender loans, see our Best Alternative Lenders for Small Business reviews.

Currently, the SBA offers four types of small business loans:

  • 7(a) Loan Program: 7(a) loans, the SBA's primary lending program, are the most basic, common and flexible type of loan. They can be used for a variety of purposes, including working capital, to purchase machinery, equipment, furniture and fixtures, the purchase of land and buildings, construction of new buildings, renovation of an existing building, to establish a new business or assist in the acquisition, operation or expansion of an existing business, and debt refinancing. These loans have a maximum amount of $5 million, and borrowers can apply through a participating lender. Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets.
  • Microloan program: The SBA offers very small loans to new or growing small businesses. The loans can be used for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery or equipment, but can't be used to pay existing debts or purchase real estate. The SBA makes funds available to specially designated intermediary lenders, which are nonprofit organizations with experience in lending and technical assistance. Those intermediaries then make loans up to $50,000, with the average loan being about $13,000. The loan repayment terms vary based on several factors, including the loan amount, planned use of funds, requirements determined by the intermediary lender and the needs of the small business borrower. The maximum repayment term allowed for an SBA microloan is six years.
  • Real estate and equipment loans: The CDC/504 Loan Program provides businesses with long-term fixed-rate financing for major assets, such as equipment and real estate. The loans are typically structured with the SBA providing 40 percent of the total project costs, a participating lender covering up to 50 percent and the borrower putting up the remaining 10 percent. Funds from a 504 loan can be used to purchase existing buildings, land or long-term machinery; to construct or renovate facilities; or to refinance debt in connection with an expansion of the business. These loans cannot be used for working capital or inventory. The maximum amount of a 504 loan is $5.5 million, and these loans are available with 10- or 20-year maturity terms. 
  • Disaster loans: The SBA provides low-interest disaster loans to businesses of all sizes. SBA disaster loans can be used to repair or replace real estate, machinery and equipment, as well as inventory and business assets that were damaged or destroyed in a declared disaster. The SBA makes disaster loans of up to $2 million to qualified businesses.

Banks and alternative lenders offer some similar loans to those offered by the SBA, as well as funding options that the SBA doesn't offer, including the following:

  • Working-capital loans: Working-capital loans are designed as short-term solutions for businesses in need of money to help run their operation. Working-capital loans are available from both banks and alternative lenders. The advantage of a working-capital loan is that it gives small businesses the ability to keep their operations running while they search for other ways to increase revenue. Some downsides of a working-capital loan are that they often come with higher interest rates and have short repayment terms. 
  • Equipment loans: In addition to the SBA, both banks and alternative lenders offer their own types of equipment loans. Equipment loans and leases provide money to small businesses for office equipment, like copy machines and computers, or things such as machinery, tools and vehicles. Instead of paying for the large purchases all at once up front, equipment loans allow business owners to make monthly payments on the items. One benefit of equipment loans is that they are often easier to obtain than some other types of loans because the equipment being purchased or leased serves as collateral. Equipment loans preserve cash flow since they don't require a large down payment and may offer some tax write-offs. 
  • Merchant cash advance: This type of loan is made to a business based on the volume of its monthly credit card transactions. Businesses can typically receive an advance of up to 125 percent of their monthly transaction volume. The terms for repaying a merchant cash advance vary by lender. Some take a fixed amount of money out of a business's merchant account every day, while others take a percentage of the daily credit card sales. The best candidates for merchant cash advances are businesses with strong credit card sales, such as retailers, restaurants and service businesses. The advantages of merchant cash advances are that they are relatively easy to obtain, funding can be received in as quickly as a few days, and the loan is paid back directly from credit card sales. The biggest downside is the expense: Interest on these loans can run as high as 30 percent a month, depending on the lender and amount borrowed. 
  • Lines of credit: Like working-capital loans, lines of credit provide small businesses money for day-to-day cash-flow needs. They are not recommended for larger purchases, and are available for as short as 90 days to as long as several years. With a line of credit, you take only what you need and pay interest only on what you use, rather than the entire amount. These loans are usually unsecured and don't require any collateral. They also have longer repayment terms and give you the ability to build up your credit rating if you make the interest payments on time. The downsides are the additional fees charged and that they put small businesses in jeopardy of building up a large amount of debt. 
  • Professional practice loans: Professional practice loans are designed specifically for providers of professional services, such as businesses in the health care, accounting, legal, insurance, engineering, architecture and veterinary fields. These types of loans are typically used for purchasing a practice, buying real estate, renovating office space, buying new equipment and refinancing debt.
  • Franchise startup loans: Franchise startup loans are designed for entrepreneurs who need financing to help open their own franchise business. These loans, offered by banks and alternative lenders, can be used for working capital, or to pay franchise fees, buy equipment and build stores or restaurants.

Now that you've got the basics, you might be ready to make some decisions on which type of loan and provider are right for you. If you're interested in an alternative loan, check out our best picks for alternative lenders.

Still have more questions about the different loan options? No problem. Here are 10 questions and answers that may help you come to a decision.

Q: How do I know which type of lender is right for my business?

A: Every situation is different, so it is very important to evaluate your needs and situation before choosing which type of lender and loan to pursue. 

"If speed is of the essence, then a cash advance or other alternative lending product might be the right answer," Arora said. "If finding the lowest interest rate is the preference, then an SBA loan or conventional bank loan would be better options."

Q: If I am applying for an SBA loan, what type of information will the bank ask for?

A: When applying for an SBA loan, small business owners are required to fill out forms and documents for the specific loan they are trying to get. In addition, the SBA encourages borrowers to gather some basic information that all lenders will ask for, regardless of the loan type. The following items are required:

  • Personal background and financial statements
  • Business financial statements
  • Profit and loss statement
  • Projected financial statements
  • Ownership and affiliations
  • Business certificate/license
  • Loan application history
  • Income tax returns
  • Resumes
  • Business overview and history
  • Business lease

Q: What questions will I have to answer when applying for an SBA loan?

A: The SBA recommends being prepared to answer several questions, including the following:

  • Why are you applying for this loan?
  • How will the loan proceeds be used?
  • What assets need to be purchased, and who are your suppliers?
  • What other business debt do you have, and who are your creditors?
  • Who are the members of your management team?

Q: Where can I find an SBA loan application?

A: Loan applications are available on the SBA website.

Q: What will I need if I'm applying for a conventional loan from a bank?

A: When applying for a bank loan, you'll be required to share all of your financial details. You'll need to provide your lender with all the financial background on your company, future growth plans and often your personal financial information. The more information you have to illustrate that you've run your business well, the more confidence banks will have about investing in you. You will also need to show exactly how you will use the requested money. For example, if you are looking to purchase a new piece of equipment, provide quotes on the exact costs, how much capital you need to facilitate this purchase, and specifically how the new equipment will help grow your business. 

Q: What do I need to consider when applying for a loan through an alternative lender?

A: Experts recommend that, when considering an alternative lender, you take several factors into consideration:

  • Interest rates: Small business owners should know that they can pay off the loan relatively quickly to avoid hefty interest charges.
  • Fees and policies: Be sure to speak with each lender's representative about any fees that may apply when the loan is funded, and how the payback will affect your cash flows, to make sure that you can run your business while paying back the loan.
  • The lender's ratings and review: There are many companies today that say they are alternative lenders, but try to find a company that has an A+ rating with the Better Business Bureau.

Q. What's the difference between a direct lender and a lending marketplace?

A.While both help businesses find funding, lending marketplaces use technology to quickly present small businesses with multiple funding options from a variety of funding partners that can satisfy each particular situation, said Stephen Sheinbaum, founder of Bizfi, an alternative finance company.

"In less time than it takes to brew a cup of coffee, a business owner can be looking at real choices tailored to his needs," Sheinbaum told Business News Daily.

The biggest benefit is the choice they provide. Rather than having to spend time contacting individual direct lenders to find the best deal, lending marketplaces compile all of that information for you, Sheinbaum said.

"In a marketplace environment, they may discover equipment financing meets their needs better than short-term funding," he said. "They may find that the marketplace can offer financing specifically for franchisees or health care businesses, or they may find that they can get a long-term loan backed by a guarantee from the U.S. Small Business Administration with less paperwork than if they went through a traditional bank.”

Q: What type of information do I need to provide to alternative lenders when applying for a loan?

A: Even though it can be easier to obtain a loan from an alternative lender, you still have to provide them with an array of personal, business and financial information. Not all lenders ask for the same information. Some pieces of information they could request include a plan for how the money will be used, your credit history and a verification of your income and assets. 

Q: What do lenders consider when deciding whether or not to approve you for a loan?

A: There are a variety of factors that are considered by both banks and alternative lenders when deciding whether or not to approve you for a loan, including:

  • How long you've been in business: The longer the better. The longer track record you have, the more comfortable lenders will feel in loaning you money.
  • Credit score: While some lenders place more stock in credit scores than others, they all take the scores into consideration. Having a bad credit score won't necessarily rule you out, but it will affect your loan terms. The worse your credit score is, the higher your interest rate is going to be.
  • Monthly revenue: Lenders want to ensure that you have enough money coming into your business to pay off the loan.

Other factors lenders may consider are previous tax returns, whether you have a history of paying creditors on time, whether you have had any bankruptcies or bounced checks, whether you have sufficient collateral and what you plan to use the money for.

In addition to using these factors to determine if you are approved, these same factors, as well as the length of the loan, are used to determine your interest rates.

Q: Does it cost money to apply for a loan?

A: It all depends on the lender. It is important to ask what types of fees are associated with the application. Some lenders charge an application fee, while others charge fees for items tied into the application, such as the cost to run your credit report or get your collateral appraised.

If you think an alternative lender is right for you, we encourage you to check out our roundup of our best picks for various types of loans, our reasoning for picking each and our thorough alternative lender list.

Editor's Note: Looking for information on business loans? Fill in the questionnaire below and you will be contacted by alternative lenders ready to discuss your loan needs.  

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Chad  Brooks
Chad Brooks

Chad Brooks is a Chicago-based freelance writer who has nearly 15 years experience in the media business. A graduate of Indiana University, he spent nearly a decade as a staff reporter for the Daily Herald in suburban Chicago, covering a wide array of topics including, local and state government, crime, the legal system and education. Following his years at the newspaper Chad worked in public relations, helping promote small businesses throughout the U.S. Follow him on Twitter.