Entrepreneurs need capital to start and expand operations — and that often means taking out a loan.
But before signing the dotted line on any loan agreement, it’s essential to research your options and understand how loans work. The more informed you are, the more likely you are to score a financial arrangement that’s right for your business.
Here are three important steps to getting a small business loan:
1. Understand the types of loans
Businesses have four main types of loans available to them:
- Long-term loan: These are most commonly offered by major commercial lenders to help businesses finance everything from working capital to expansion projects to equipment purchases. They are usually repaid through a monthly payment over many years and carry a lower interest rate than other types of loans. U.S. Small Business Administration (SBA) loans, which are backed by the federal government, fall into this category because of their long repayment terms.
- Short-term loan: These are repaid over a shorter period, such as six months, and are used to finance shorter-term projects or needs — for example, building up inventory quickly. They don’t carry a monthly payment, but they often carry a much higher interest rate than long-term loans.
- Line of credit: Like a credit card, a credit line allows a business to access funds on an as-needed basis. The interest rate and fees often add up to more than a long-term loan, though, so they aren’t typically used to fund major projects.
- Alternative financing: Businesses that don’t qualify for traditional loans or have specific needs may be able to get other types of financing, such as asset-based loans, factoring (using accounts receivables to back a loan), leasebacks and cash advances. Alternative loans tend to carry higher interest rates.
2. Get your ducks in a row
Before pursuing a loan, make sure your business is in solid financial shape. This includes checking that you have a strong credit score, which lenders use to determine whether to lend you money, and how much.
Carefully evaluate how much you will need to borrow and how you will generate the income to repay that amount plus interest. You don’t want to request a loan for an amount you won’t be able to repay.
The lender will likely need some key financial documents and will ask about your company’s health, cash-flow forecasts and business plans, so be ready. (The SBA provides a step-by-step guide for getting a small business loan and what type of information you’ll need to provide lenders.)
3. Find the right lender
Once you’ve determined the type of loan you need, identify lenders who offer those types of loans. Some may be small local lenders, while others may be large national banks.
It makes sense to meet with several different lenders before selecting one, so you get a sense of the various loans and terms you might qualify for. Find a lender you’re comfortable with.
Remember, you’re forging a long-term relationship with the lender, so choose your loan and your lender carefully.