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A Guide to Choosing the Right Small Business Loan

A Business News Daily Buyer's Guide

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Alternative lenders are important for small businesses looking for loans that may not have the option of being financed through a traditional bank. These lenders provide several different types of loans, ranging from merchant cash advances to equipment financing.

We scrutinized numerous providers to find the best lenders. Below is a guide to help you understand the overall loan market and choose an alternative lender and loan option for your small business. If you have a good idea of what you're looking for and are familiar with basic loan concepts, check out our best picks for the top alternative lenders in 2018.

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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Before jumping into the details on the types of loans offered and what loan makes the most sense for your business, take time to assess your current needs. Here are some good initial questions to answer so you have clear goals set before you start your research.

  • How much money do you need?
  • What do you need the money for?
  • 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?
  • What's your credit score?
  • Do you have any other outstanding loans?
  • Are you looking for a short or long-term loan?

Once you've answered these questions, it's best to consider the several different types of loans and decide which is best for your business. From there, you can learn about which lenders offer which types of loans and apply to the best company. Here's a breakdown about what you need to know about each type of lender.

  • The Small Business Administration offers several loan programs designed to meet the financing needs of a 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 reduces the risk to lenders by guaranteeing 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 guarantee, which typically covers 75 to 90 percent of the loan, eliminates much of the risk for the lender. SBA loan terms also tend to 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 approved. You may also have to meet stricter requirements to qualify for a loan from a traditional SBA lender.

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

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 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. Traditional banks approved only 23 percent of funding requests in March of 2016, which was considered a new high. Compared to the near 61 percent approval rating of alternative lenders in the same timeframe, it still seems low.

  • 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 approval decisions in a matter of hours and provide funding in less than five days.
  • There are direct alternative lenders that 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 are Kabbage, OnDeck Capital, and SBG Funding. Lending marketplaces include Bizfi and Biz2Credit.

Pros and cons: The positives of working with an alternative lender are that your business doesn't need to have a stellar financial history; there are few restrictions on what you can use the money 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. Because of the nature of the loan, it's important to pore over the fine print and ensure you're entering into an agreement that makes sense financially for your business.

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; the purchase of machinery, equipment, furniture, and fixtures; the purchase of land and buildings; construction of new buildings; renovation of an existing building; the establishment of a new business or assistance 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 they can't be used to pay existing debts or purchase real estate. The SBA makes funds available to intermediary lenders, which are nonprofits 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 regarding 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 short-term solutions for businesses in need of money to fund operations. Working capital loans are available from both banks and alternative lenders. The advantage of a working capital loan is that small businesses can keep their operations running while they search for other ways to increase revenue. Some downsides of working capital loans 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 upfront, business owners make monthly payments on the items. One benefit of equipment loans is that they are often easier to obtain than 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-off benefits.
  • 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. Repayment terms vary by lender. Some take a fixed amount of money out of a business's merchant account daily, while others take a percentage of daily credit card sales. The advantages of merchant cash advances are that they are relatively easy to obtain, funding can take just a few days and the loan is repaid from credit card sales. The biggest downside is the expense: Interest runs 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 collateral. They 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 and these loans can 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 healthcare, accounting, legal, insurance, engineering, architecture and veterinary fields. These types of loans are typically used for purchasing a practice, real estate, or new equipment; renovating office space; or refinancing debt.
  • Franchise startup loans: Franchise startup loans are designed for entrepreneurs needing financing to open their own franchise. 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.
  • Invoice factoring: Invoice factoring loans are when an alternative lender advances small businesses money for outstanding invoices. As the invoices are collected, the lender receives the money in addition to a fee. This can be a good option for businesses looking to get funding upfront for invoices that have yet to be paid.

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

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 or 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're required to share all of your financial details. You'll need to provide your lender with the complete financial background of your company, your 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 in investing in you.

You also need to show exactly how you will use the requested money. For example, if you want to purchase new equipment, provide quotes on the exact costs, how much capital you need to facilitate this purchase, and specifically how the new equipment will grow your business. 

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

A. When considering an alternative lender, consider the following:

  • Interest rates: Small business owners should know that they can pay off the loan relatively quickly to avoid hefty interest charges.
     
  • Fees and policies: Speak with each lender about fees that may apply when the loan is funded and how the repayment will affect your cash flow.
     
  • The lender's ratings and review: There are many companies today that say they are alternative lenders, but look for lenders that have an A+ rating with the Better Business Bureau.

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 alternative lenders, you still need 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 reviewing a loan application?

A. There are a variety of factors that both banks and alternative lenders consider:

  • How long you've been in business:  The longer track record you have, the more comfortable lenders will feel in loaning your business money.
     
  • Credit score: While some lenders place more stock in credit scores than others, nearly all take the scores into consideration. A bad credit score won't necessarily rule you out, but it will affect your loan terms. The worse your credit score, the higher your interest rate will 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.

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

A. It 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 appraise your collateral.

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

Ready to choose an alternative lender? Here's a breakdown of our complete coverage:

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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Matt D'Angelo

Matt D'Angelo is a B2B Tech Staff Writer based in New York City. After graduating from James Madison University with a degree in Journalism, Matt gained experience as a copy editor and writer for newspapers and various online publications. Matt joined the Purch team in 2017 and covers technology for Business.com and Business News Daily. Follow him on Twitter or email him.