Beginning a new startup can be an exciting time in the life of an entrepreneur. You have an idea. You have a plan. Now you’re taking the plunge into the waters of the great unknown. Before you dive in, it’s important you have the tools and resources necessary to keep your business, and your head, above water. The first step is understanding these eight types of small business loans for startups.
The most important lifeboat for new business owners often comes in the form of working capital. While many business people already understand the importance of working capital, securing it can be easier said than done for a startup. So, how do you find small business loans for startups? What options are available? And what differentiates a loan for a startup when compared to other small business loans?
What Makes Small Business Loans for Startups Special?
Small-business startup loans are specifically designed to help small businesses secure the capital they need to thrive and succeed as a business owner. Small businesses account for an overwhelming percentage of the American economy, so it’s only natural to want to foster growth within these companies.
Small business loans come in the form of government loans and private loans from banks, online lenders, and other alternative lenders. Small business loans are different from a standard loan for business or a line of credit because lenders understand your business has little or no credit history. That makes it exponentially harder to get any type of financing.
Many small business loans and lines of credit have strict requirements and call for an extensive financial history and excellent credit scores to qualify. By their nature, startups haven’t been around long enough to establish the credit history necessary to qualify for a traditional bank loan. Thankfully, there are other types of financing available, from SBA loans to equipment loans for startups that are specifically designed with your business in mind.
With a better understanding of what’s out there, startups are able to set realistic and attainable goals for their business without biting off more than they can chew.
Small Business Loans Available for Startups
1. Traditional Equity Financing
Anyone who has watched “Shark Tank” is familiar with the idea of equity financing. Equity financing is when you raise money by offering an ownership interest in your company. Let’s say your business is valued at $1 million, and you are hoping to raise $100,000 through equity financing. For the $100,000, you offer an investor a 10 percent ownership stake in your company.
Equity financing can be beneficial because of their investment, your new partners have a stake in the success of your business. That’s because it’s also their business now. With equity financing, you may also be off the hook for repaying the loan in certain situations if your business fails.
However, equity financing is not without its downsides, including the loss of control in your business. As someone that worked hard to build your company from the ground up, it can be hard to let go and not have full say in how things run.
You may lose say in how you seek business capital, choosing lending partners, retirement savings, equipment leasing, articles of incorporation, and more. Even so, if you don’t have the funding, a partner can help make your dreams a reality.
2. Crowdfunding
As technology and social media continue to grow as financing options, crowdfunding also keeps pace as a popular type of small business loan for startups. The Securities Exchange Commission (SEC) approved a new section of the JOBS Act in 2015 called Title III. What Title III did for small businesses seeking business capital was loosen the purse strings and allow companies to raise up to a maximum of $1 million in a rolling 12-month span. Title III also changed up who is allowed to invest in companies, in exchange for equity. Equity was only available to accredited investors with a lot of money (at least $1 million net worth). Now, companies can offer equity to all kinds of investors through online crowdfunding platforms. The big disadvantage is that, with so many different people holding equity shares in your company, it can be difficult to seek capital and secure funding through more traditional means later on.
Equity financing can be beneficial because your new partners are more invested in the success of your business. That’s because it’s also their business now. Equity financing can also keep you off the hook for repaying the loan in certain situations if your business fails. A downside of equity financing can be the loss of control in your business. As someone that worked hard to build your company from the ground up, it can be hard to let go and not have full say in how things run.
3. Commercial Bank Loans
Debt financing is what you think of when it comes to getting a loan. It’s money that’s loaned to your company with the expectation that it will be paid back over time with interest, and often with fees attached.
Among available debt financing is the commercial bank loan. Securing a loan from a traditional lender can be a boon to startups, but you may have an easier time catching a unicorn at the end of a rainbow. It can be difficult for even well-established companies to qualify for a traditional bank loan or line of credit. To qualify for the lowest rates and payback terms, you must have an impeccable credit score, a solid payment history and repayment ability.
Requirements may differ between unsecured and secured business loan options. An unsecured business loan requires no collateral but may be more difficult to qualify for. A secured loan requires collateral to guarantee the loan. You may also need a minimum credit score, which should be higher than a FICO score of 580 or poor credit, and a traditional bank loan lender will almost always do a credit check.
It can be nearly impossible for a startup. Many bank loans require two years of operation, so it’s not really a safe bet for businesses in the startup phase.
4. Small Business Administration (SBA) Loans
SBA Loans are a great option for startups. SBA loans are government-backed loans with small businesses specifically in mind. The most important thing to remember about SBA loans is that these are long-term loans meant to get small businesses off the ground and up and running.
Because SBA loans are operated by the U.S. government, they have strict eligibility requirements that can make them difficult startups to come by, including:
- Your type of startup must operate for profit
- Do business in the U.S. or its territories
- Have a reasonable amount of owner equity to invest
- Be willing to use alternative financial resources, including personal assets, before seeking financial assistance and startup capital.
It’s also important to note that these loans are for businesses that are in it for the long haul. We’re talking about 10 or 15 years. This is great for a local business looking to gain a foothold but might not be ideal for a startup looking to find money fast.
5. Equipment Loans for Startup Businesses
Startups find themselves looking for loans for more than making payroll and keeping the lights on. There are all sorts of unforeseen expenses when it comes to starting your own business. A large part of these expenses is equipment costs. And equipment covers more than you might think. This is where equipment loans for small businesses come in. It’s not all about tractors, nuts, and bolts. Your equipment costs also cover computers, office supplies, and many of the other tools that help you to keep your business running every day.
Equipment loans for startup businesses are also known as equipment financing. The reason they call it equipment financing is that the equipment for which you use the loan also acts as collateral for the same loan. This built-in collateral helps to mitigate the risk associated with the loan, making it much easier for startup businesses to qualify. Even better, equipment loans for startup businesses come in both short-term and long-term varieties; so your company can decide how much it needs and for how long.
6. Online Invoice Financing
The first year in the life of a startup can be sink or swim. Because it’s still so early in the life of the business, startups often don’t have the extra cushion or working capital to cover cash flow gaps that arise through net payment terms. This can prove fatal when your company is desperately awaiting payment on a large invoice to fund new orders and keep the doors open.
Online invoice financing is an alternative lending option that is gaining favor in the startup community. It works through a small business or startup borrowing against its existing invoices or accounts receivable. The startup provides the existing paperwork for its invoices and is then advanced up to 100 percent of their invoiced amount in as little as 24 hours. Because the money is being loaned against invoices for services the company has already provided, there’s less risk for the lender. This makes it much easier for startups to qualify.
7. Credit
When all else fails, sometimes there’s only one thing left to do: charge it! We kid, but taking on debt through credit is never something that should be done lightly. That said, it can still be a valuable resource for startups looking to make ends meet.
A line of credit can be obtained through a commercial bank or even a high-balance credit card. The key difference with a line of credit from a bank is that you’ll often get much better interest rates (and a larger credit limit) than anything you’re going to find with a credit card. In a pinch, credit can be a great way to bridge the gap in the early days of a startup, but it’s important not to hamstring your business too early with a tremendous amount of debt.
8. Personal Loans
As the business owner of a startup, much of your business is relying on what you, personally, bring to the table. This early in the life of a company, lenders are investing in the people of a business just as much as they are its products or services. The same is true when applying for a loan. While it can be difficult for startups to qualify for traditional bank loans, you might have better luck applying for a personal loan instead.
If you have a fantastic credit score and a sound credit history, there’s a good chance you can qualify for a personal loan to find the money your business needs. However, it’s important to keep in mind that personal loans can be risky. When you take out a personal loan, you’re the one who is on the line. If your business goes south, there won’t be anyone to help and it will be your credit taking the hit.
Tips to Improve the Chances of Getting a Small Business Start-Up Loan
Financial institutions are betting that you won’t default on your small business startup loan. That’s why it’s so difficult to qualify. But, there are several tips to improve your chances.
- Apply early. There’s nothing fast about the government and it can take months to get approved for a small business loan. Even banks and credit unions can sit on your traditional loan application waiting for credit scores and verifying the type of business, loan amounts, time in business, cash in the bank, if there’s business credit card debt, your personal credit score, and more. Funding times vary, but it’s always a good idea to apply early, because it can take awhile to get approved.
- Improve your credit history. Like personal loans, small business startup loans look at your credit history (and your credit score) to determine if you’re a good (or bad) credit risk. You can improve your credit history by paying your bills on time and not taking on any more debt. Even a business credit card will lower your credit score by a few points.
- Be prepared. Putting together a detailed business plan, including your financial and bank statements, that outlines your personal finances and business purposes, is the first step in improving your chances of getting a small business startup loan. Lenders want to know your seriousness about the future of your business and this proves you are.
- Get advice from an expert. Small business owners and financial experts have been in your shoes. They know the application process, the funding options for startups, how to read loan offers, and what it’s like to need business financing to ‘get the job done.” Or the job started.
Is a Start-up Loan Right for Your Business?
Start up loans can provide you the funding and support you need most during the early stages of starting your business. Designed for small businesses that have been in business for more than two years, this loan option can be both affordable and flexible, while giving you the access to capital you need.
But is it right for you?
Startup loans give you the money you need to start your business, buy equipment and materials, purchase inventory, etc. Plus, unlike a partnership or crowdfunding, you maintain complete control of your business. Besides, if you have little or no business credit or business tax returns, applying and being granted a startup loan can help you build credit for when you need working capital down the road.
On the downside, even startup loans can be challenging to get. Business startups like you need a credit history, assets to be used as collateral and a large down payment. Remember too, that your personal credit may be impacted when you apply for a startup loan. it’s best to weigh the pros and cons, but if you can’t fund your business out of your pocket, you’ll likely need a loan.
How to get a small-business start-up loan
Getting startup business funding can be challenging. And, startup loan requirements can be difficult to satisfy. But if you need the cash to get started, there are steps you can make the process of getting a loan for business a lot less arduous.
Step #1: Decide how much money you’ll need. A strong business funding plan will outline exactly how much financing you’ll need so you’re not too cash poor. It will also keep you from borrowing too much, so you’re not heavily in debt at the start. Adequate financing is imperative to getting your company off the ground, and deciding how much to borrow is the first step.
Step #2: Figure out how you will use the loan money. How you use the money for your business is entirely up to you, as long as you can pay it back by the end of the term. Will you buy a piece of equipment, pay for inventory, fund a commercial space, or use the loan funds for general monthly expenses?
Step #3: What’s your Debt-to-Income Ratio (DTI)? You may have a pretty good idea of how much money you need to get your business up and running but if you haven’t set a budget yet, it’s time to do so. There will always be limitations on how much you can borrow and pay back with interest.
Figure out your debt-to-income ratio (DTI), which looks like this.
Debt-To-Income Ratio = Total Monthly Debt / Gross Monthly Income
Ideally, your debt-to-income ratio should be about 36% or lower. Too high, and you may have problems paying off the loan.
Step #4: Improve your credit score. If your credit score is holding you back from getting the money you need to start your business, you may want to do all you can to improve it. That means making sure your bills are paid on time every month, not taking on additional debt (if possible), not applying for more credit than you can handle, and keeping your credit utilization under 30%.
How to get a loan to start a business if you have bad credit
It can be challenging to get a small business loan if you’re a startup. It can be even more challenging if you have bad credit, or a credit score under 580. It’s not impossible, but you won’t qualify for the same loan amount or the same rates or terms than if you had excellent credit.
There are alternative lenders that will offer short-term loans that are secured by collateral. But if you miss a payment or default no your loan, you risk losing your collateral. There are also other types of financing available if you have bad credit including:
- Lines of credit — a LOC works much the same way as a credit card. You are approved for a set amount of money, which you can borrow from anytime. Pay off what you borrowed, and you can take out money again.
- Merchant cash advances — A MCA is a loan that provides quick cash for businesses. It’s a lot like a paycheck advance, expect it for businesses instead of individuals. Unlike most loans, MCAs use a factor rate that typically falls somewhere between 1.2 and 1.4.
- Asset-based loans — These loans or lines of credit are secured by collateral, like inventory, equipment, or property you own. This type of loan is usually only used in the short-term to cover an expense or cover cash-flow issues.
Small Business Loans for Startups Make the Impossible Possible
The power of the entrepreneurial spirit and the excitement of starting your own business is almost impossible to resist. For the brave people willing to take the plunge and put themselves out there, a little help in the form of a small business loan can go a long way.
Now that you have a better idea of the sorts of small business loans available for startups, you’ll be that much more prepared to find the funding you need to succeed.
