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A Guide to Choosing the Right Small Business Loan

A Business News Daily Buyer's Guide

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  • Small business owners use business loans to shore up cash flow, purchase expensive equipment and pursue growth.
  • Business loans tend to be cheaper to get than credit cards and don’t require you to give up a piece of your business to an investor. Alternative business loans are easy to obtain, even if your credit score is less than stellar.
  • Before shopping for a business loan, you have to ask yourself how much money you need, what you are using it for, and how long it will take to pay it back.
  • This article is for business owners who are considering applying for a small business loan.

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 alternative lenders in 2020.

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.

Business loans have long been a viable way to keep operations going. They are used by business owners for many reasons, such as a short-term boost to cash flow or to cover the cost of pricey equipment.  Business loans can also be used to pursue growth and to consolidate high interest debt. There are a lot of benefits of going taking funding route, including the following:

  • You keep full control of your business. When you take out a business loan your bank or alternative lender isn’t going to tell you had to use the funds. That’s not true when you have investors providing capital. They usually want a say in how the business is run. Bank loans do come with interest and fees, but you aren’t giving up a stake in your business, a piece of the profits, and control in operations.

  • Funding is fast. Raising capital via venture capitalists or other investors can take as long as 12 months. Borrowing money from a bank, credit union or online lender is much faster and when you apply online, some lenders can approve your application in minutes.

  • Interest rates are lower for loans than credit cards. When it comes to credit cards and business loans, the latter tends to win out in terms of the cost to borrow. For business owners with the best credit scores, business loan interest rates range from 2% to 13% according to Experian. For business credit cards that rate range is 13.9% and up, according to CreditCards.com. Keep in mind your credit score plays a big role in the cost to borrow and if you'll get approved for a loan.

Key takeaway: Business loans provide business owners with fast access to funding that is cheaper than credit cards and doesn't require them to share control of their businesses.

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?

Key takeaway: Before you begin shopping for a business loan, you need to know how much money you need, how you will use it and how long it will take to repay. You also need to know your credit score and how it will affect your interest rates and decide if you have any collateral that you are willing to pledge.

  • 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.
Our Best Picks
To help you find the right business loans, we researched and analyzed dozens of options. Here is a roundup of our 2020 best picks for business loans and an explanation of how we chose them.
Best for Merchant Cash Advances
Best for Merchant Cash Advances
Rapid Finance's merchant cash advances range from $5,000 to $250,000. You repay your loans by giving Rapid Finance a fixed percentage of future credit card transactions.
Featured Sponsor
Featured Sponsor
Through its online platform, Biz2Credit offers business funding products from $10,000 to $4 million. The lender uses data, cash flow insights and its technology to provide a quick funding process. Biz2Credit offers a wide range of lending products, including working capital, term loans and CRE loans. It takes just a few minutes for small businesses to use the Biz2Credit platform to find the funding products that make the most sense for their specific needs and submit an application. Funding decisions can be made within 24 hours, with loans funded within 72 hours. Lending requirements include having been in business at least two years, at least $10,000 in monthly revenue and a minimum credit score of 575.
Best for Working Capital
Best for Working Capital
Offering uncomplicated qualification requirements and lenient rates, SBG Funding provides the best option for working capital loans for small business owners. Loan terms range from six months to five years. Credit score requirements are as low as 500. SBG examines your monthly income and the profitability of your business to determine whether you're eligible for funding.
Best for Bad Credit Loans
Best for Bad Credit Loans
OnDeck offers fixed-rate loans up to $500,000. To qualify, you need a minimum credit score of 500, annual revenue of at least $100,000, and you must have been in business for at least one year.
Best for Invoice Financing
Best for Invoice Financing
Noble Funding provides two invoice financing options: invoice factoring and accounts receivable lines of credit. It also helps borrowers arrange loans with other lenders. They take the time to analyze your business's finances so they can offer the best loan option for your company. Loan types include term loans, cash advances and unsecured business loans.
Best for Small Business Lines of Credit
Best for Small Business Lines of Credit
Kabbage's line of credit loans go up to $250,000. Each time you draw against your line of credit, you have six or 12 months to repay the funds. Instead of paying interest, however, you pay fees ranging from 1-10% each month.
Best for Equipment Financing
Best for Equipment Financing
Crest Capital offers equipment financing up to $1 million. Documentation of your company's finances isn't necessary if you're seeking $250,000 or less. The lender has a range of loan and lease terms, including fixed-rate loans, $1 purchase agreements, 10% purchase options, fair-market-value leases, guaranteed purchase agreements, and operating leases.

Pros and cons:

The government guarantee, which typically covers 75% to 90% 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% of funding requests in March of 2016, which was considered a new high. Compared to the near 61% 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, 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.

Key takeaway: Choices abound when it comes to the type of lender a business owner can borrow from. The three main lender types are the Small Business Administration, banks and alternative lenders.

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% of the total project costs, a participating lender covering up to 50% and the borrower putting up the remaining 10%. 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% 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% 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.

Key takeaway: The SBA, banks and alternative lenders offer a variety of business loans that include term loans, working capital loans, lines of credit and invoice factoring.

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.

If speed is of the essence and you have a great credit score, online lenders are going to be the quickest route to funding. You can apply and be approved in minutes and receive your funding in a couple of days. If you have a less-than-stellar credit score, you have a better shot getting approved with an alternative lender than you do a traditional bank. SBA loans are another option, but the application to approval time can take much longer than with an online lender. 

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.

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.

A. Loan applications are available on the SBA website.

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

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?

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.

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.

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.

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.

Additional reporting by Donna Fuscaldo.

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.

Matt D'Angelo

I'm a staff writer for Business.com and Business News Daily. I cover various small business topics, including technology, financing and marketing.