A Complete Guide to Business Loans
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Loans in general are very common. Most people are familiar with personal loans, such as student loans, car loans, and mortgages. Business loans are actually quite similar, but they can certainly seem overwhelming at first glance. And while they are an effective tool to kickstart your business, there’s a bit more to them than that. But not to worry, we have you covered!
Before applying for a business loan, it is critical to understand what they are, the standard terms and language used in business loans, what you’ll need to apply and qualify for a business loan, and the different types of business loans and their advantages. Some of this guide may seem straightforward, but at First Bank, we take pride in keeping you informed and in‑the‑know.
Additionally, business loans can be hard to get, and the requirements can be strict. But that’s exactly what we’re here for — we want to help your business grow. Follow our step‑by‑step guide to prepare your business loan application and improve your odds of being approved.
What This Guide Covers:
- What is a business loan?
- What are key terms to know regarding business loans?
- What factors do most lenders consider for business loan approval?
- What documents might you need to apply for a business loan?
- How can you improve your odds of being approved for a business loan?
- How does a typical business loan process work?
- What are the advantages of business loans?
- What are the different types of business loans?
What Is a Business Loan?
Business loans are used to finance a variety of business operations and expenses by borrowing money from a lender under specific terms and conditions. When a company needs financing or capital, it can turn to a bank or other financial institution for a business loan. Whether you’re starting, acquiring, or expanding a business, you won’t want to drain your entire savings or disrupt your current business’s cash flow to front the initial investment on your new venture. Fortunately, lenders offer loans that are paid back with interest to help businesses fund their operations and growth strategies.
Let’s break down the basics. Essentially, the bank will lend you a sum of money based on a predefined list of terms, including the interest rate you’ll pay in return, the time in which you have to pay back the loan, how the loan is structured, and more. These intricacies can become rather complex, especially given the wide variety of circumstances, lenders, and businesses. For this reason, it is imperative to research the many different types of business loans before initiating any sort of application process.
When borrowing any sum of money, start by identifying the specific purpose for which you need financial assistance. If the answer to that question is not clear, you likely have a lot of work to do before speaking to a lender of any kind. You’ll want to have a strategic, concrete plan for your business, an itemized list of requirements, and a general idea of how long you may need to have to pay the money back. Knowing these details at the outset will only make things easier!
As businesses and banking evolve, many different types of business loans have arisen to accommodate their changing needs. This article will explore the many different types of business loans and will share everything you need to know about navigating the business loan process.
What Are Key Terms to Know Regarding Business Loans?
Business loans can be complicated, so it’s essential to know and understand several key terms that you will likely encounter. Below are nine terms and phrases you should be familiar with when applying for a business loan.
Assets – Assets are something of value owned by the borrower or business. Lenders such as banks and credit unions often require some form of “collateral” to be eligible for a business loan. Your business assets may include items such as equipment, vehicles, buildings, and inventory.
Cash Flow – Cash flow is the net amount of money going in and out of a business used for day‑to‑day business expenses. Positive cash flow indicates that a company is earning more than it is spending, enabling it to settle debts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges.
Cash flow differs from revenue in that it is not accrued. Instead, cash flow tracks actual cash in hand and the cash that flows in and out of the company. The critical importance of cash flow lies in the company’s ability to operate, as a business must always have sufficient cash to meet short‑term financial obligations.
Closing Costs – Some types of loans may have fees and costs associated with securing the loan itself. Lenders provide a list of included fees so the borrower won’t be surprised, but you’ll want to be sure to ask. Your closing costs may cover items such as the origination fee, title insurance, loan packaging fee, commercial real estate appraisal, survey charges, environmental site assessment, tax monitoring fees, certificate of good standing, filing and recording fees, flood certification, and more.
Collateral – Collateral is any form of asset the borrower offers to a lender to obtain or secure a business loan. The lender can acquire these assets if the borrower cannot pay back the loan or if the borrower defaults. Examples of collateral include real estate, equipment, inventory, and personal assets.
Current Liabilities – Current liabilities are obligations of debt that a business has within 12 months or their normal operating cycle. These include accounts payable, accrued liabilities, short‑term debt, wages, income taxes, and more.
Down Payment – A down payment is the amount of cash the borrower will contribute to the project upfront. Requirements for down payments typically range from 10 to 30 percent of the principal balance, but it depends on the type of loan and other qualifying factors.
Interest Rate – The interest rate is a percentage of the principal loan amount applied to the total amount borrowed to be repaid over time. Many factors affect the interest rate of your business loan. The type of financing you’re seeking, your business or industry and its associated risk, the length of time you’ve been in business, market interest rates, your business’s credit, and the owner’s finances and credit can all impact the rate.
Repayment Schedule – Sometimes known as an amortization schedule, this is a set plan of monthly payments to repay the loan. Not only does this establish the time horizon you will have to repay the loan, it is an important factor in your monthly payment.
Personal Guarantee – Many lenders require borrowers and business owners to sign a personal guarantee to be approved for a business loan. This is an agreement to use personal assets or cash flow as collateral to cover the loan if the business can’t pay it back itself. The guarantee is typically signed by an officer or owner of the company.
What Factors Do Most Lenders Consider for Business Loan Approval?
So now that you know a bit more about business loans, let’s take a look at what’s involved in the approval process. Getting approved for a business loan involves the lender evaluating various factors, depending on the type of loan you are seeking. These same factors influence the rates, terms, and amounts for which you can get approved. Below are six important aspects that are commonly considered during the business loan qualification process.
Cash Flow
Cash flow is the net amount of cash and cash‑equivalents being transferred into and out of your business. If you have positive cash flow, it shows your company is adding to its cash reserves, allowing it to reinvest in the company, pay out money to shareholders, or settle future debt payments. These are all good things, and they will leave a lender optimistic.
There are three forms of cash flow: operating, investing, and financing. Operating cash flow includes all cash generated by your company’s primary business activities, like the sale of products and services. Investing cash flow consists of all purchases of capital assets and investments in other business ventures. Financing cash flow includes all proceeds gained from issuing debt and equity and payments made by the company.
Most lenders will want to know your business’s cash flow as part of the loan qualification process.
Debt Service
Debt service is the cash required to cover the repayment of interest and principal on any debt your business has for a particular period, which could be calculated monthly or annually. Think of this like trustworthiness or reliability. The lender wants to know that you can safely and realistically cover the loan payments.
An organization’s debt service ratio helps determine the borrower’s ability to make debt service payments because it compares the company’s net operating income with the amount of principal and interest the firm must pay. If a lender decides that a business cannot generate consistent earnings to service debt, the lender will most likely not make the loan.
Most lenders are also interested in knowing that a company can cover its current debt load in addition to any potential new debt. To carry a high debt load, a company must generate consistent and reliable profits to “service the debt.”
Credit Score
A credit score is a valuation based on your credit in use, credit history, payment history, and amounts owed versus income. Most business loan applications take your credit score into account, but each lender will have its own requirements. The quality of your credit score will also affect the interest rate and other terms of your loan. We all love online shopping, but it’s important to do your best to maintain a high credit score. Mobile apps and digital banking can help you better manage your credit.
Annual Revenue
Your annual revenue is equivalent to your total yearly income, which includes gross sales and any other money your business brings in, like rent. Many lenders have different criteria for annual revenue minimums based on the type and length of the loan you are seeking. For SBA loans, your revenue can’t be higher than the SBA’s definition of a small business, which varies by industry.
Business Plan
Any business that applies to borrow money will need a formal written business plan. A business plan is essentially a road map for how your business will operate, earn money, and succeed. The document should clearly outline the business’ goals, the methods for how these goals can be attained, and the timeframe within which these goals need to be achieved.
A thorough business plan might include:
- A cover page and table of contents
- An executive summary which briefly summarizes your business on one page
- A company description, including a mission statement, the company principals, any strategic partners, and your corporate structure
- A market plan and analysis with an industry overview and outlook, any differentiation in your sector and niche, information on your target market, and the company’s marketing strategy and how it will make your company stand out
- An organization and management section that itemizes your company’s management structure, which may include an organizational chart with specific roles, a structure description, and salary forecasts
- The service or product you are selling, its estimated lifecycle, and any research and development completed, in progress, or planned. It should also include a description of any trademarks, patents, or other intellectual property rights, if applicable.
- A marketing and sales plan for how customers will find out about your products, the sales channels and methods you will use, and what your growth strategy is
- A financial analysis with three to five years of projections for your income, cash flow, capital expenditure budgets, and balance sheets
- A funding request that clearly itemizes why you need business financing, what amounts you’re requesting (both current and prospective for the next five years), and what you will use the amounts for
- An appendix with any supporting documents, which could include: Principals’ résumés, tax returns, relevant real estate documents, processing flowchart, letters of intent to purchase from buyers, advertisement and marketing materials, relevant training certificates, sales forecast, personnel plan, profit and loss statement, and balance sheet
Collateral
Most lenders will want businesses to secure their loans with collateral. Collateral is an asset the borrower pledges to the lender for the life of the loan. If the borrower defaults on the loan, or can’t make the required payments, the collateral can be seized and sold to repay the outstanding balance. Lenders use collateral to reduce the risk of losing money on the loan.
The amount of collateral needed varies widely based on several factors, including the borrower’s credit rating, the reason for the loan, the type of lender, and the nature of the collateral. Some lenders will allow or even require borrowers to pledge both business and personal assets to secure a business loan.
Most lenders prefer collateral in the form of assets that can be quickly liquidated. These assets include cash held in demand deposit accounts and negotiable securities like Treasury debt, certificates of deposit (CDs), stocks, and corporate bonds.
Property can also be used for collateral. However, this requires more work for the lender to liquidate, making its value less certain. This includes buildings, equipment, fixtures, inventory, homes, and vehicles the business or the business owner already owns. Another class of collateral is based on collection of historical earnings that have not been received yet, known as accounts receivable.
When using collateral to secure a loan, lenders will calculate a business’s loan‑to‑value ratio. The ratio is the amount a lender will lend to you based upon the value of the collateral. For example, a bank might offer an 80% loan‑to‑value ratio for a business loan if you pledge a warehouse as collateral. That means it will lend you $80,000 if the property is worth $100,000.
What Documents Might You Need to Apply for A Business Loan?
To save time and streamline your loan application, you will want to gather up the information most lenders require before starting the process. We’ve put together a quick checklist of what you might need to help get organized before you apply for a business loan. You may not necessarily need all of this documentation, but it never hurts to be prepared. Try to gather your:
- Annual business revenue and profit
- Personal and business tax returns
- Time in business
- Bank statements
- Personal financial statement
- Loan purpose
- Desired loan amount
- Business plan
- Industry
- Entity type
- Business licenses and permits
- Employee Identification Numbers (EINs)
- Proof of collateral
- Balance sheet
- Copy of your commercial lease
- Disclosure of other debt
- Accounts receivable and accounts payable aging
- Ownership and affiliations
- Legal contracts and agreements
How Can You Improve Your Odds of Being Approved for a Business Loan?
There are, of course, steps you can take to put your business in the best possible position to secure the funding you’re seeking to borrow. Lenders usually have different criteria, but they all want to minimize their risk of a default. Doing your homework ahead of time and being prepared can save you and the bank valuable time and energy. Here are some insider tips to help improve your chances for approval:
- Know the lender’s minimum qualifications. Do some research before applying to a bank to understand the basic requirements you will need to meet to be considered.
- Gather financial and legal documentation. To submit an application, you will need to provide proof of your finances and business standing. Have that information handy to make the process go more smoothly.
- Develop a strong business plan. Lenders want to be confident they are lending to an organization that can repay the loan. Make sure your business plan is thorough and contains all the essential elements. If it is your first time creating a business plan, consider getting the advice of a consultant or an experienced entrepreneur who can assist you with that process and provide valuable feedback.
- Determine eligible collateral. How much collateral you can put forth can often determine how much a bank will lend your business. Assess all available collateral that you are willing to offer. This includes hard assets like buildings, land, vehicles, and inventory, as well as paper assets, like Accounts Receivable, CDs, stocks, and bonds.
- Build personal and business credit scores up. Banks use your credit history to see if you have a track record of paying bills on time and how much credit is already extended to you. Check your credit report to see how you score and if there is room for improvement, and feel free to ask for help from any of our First Bank experts.
How Does a Typical Business Loan Process Work?
While every bank has its own procedures for processing loan applications, there are six basic steps to expect when applying for a business loan.
Business Reaches Out to a Lender
There are countless banks to choose from when selecting a lender for your business loan. Shop around for a bank that has offerings suited to your needs with competitive rates and terms. It is okay to speak with more than one lender to ensure you get the best rate, but First Bank specializes in offering flexible options for financing business growth.
Lender Provides Information That Best Meets the Business’s Needs
When you speak with a lender about a business loan, they can help you find the type of loan best suited to your needs. At First Bank, we will gladly explain all the terms and associated costs with the type of loan you are considering. We’re here to make things easy.
Lender Requests Documentation
Next, the lender will ask you to provide the supporting documentation we covered earlier in this article to assess your application. Depending on your lender, the required documentation may be submitted electronically or physically.
The Business Loan Goes into Underwriting and Then Closes
Loan underwriting is the process in which a bank, loan provider, or online lender reviews your application and accompanying documents to determine the risk and benefits of loaning you money. The underwriting time period varies by lender, but on average, a business loan takes two weeks to underwrite once all information is received and sometimes happens much quicker.
Once a borrower’s credit, capacity, and collateral have been assessed and the organization is deemed eligible for the loan, the lender determines the amount, interest rate, and repayment terms they will offer. To close on the loan, both the lender and the borrower will have to sign documents agreeing to the terms.
Business Owner Receives Funds
Time to receive your loan! After the loan has closed, the borrower will receive the funds via wire, account transfer into their account, through a closing attorney, or as otherwise agreed to in the loan documents.
Business Repays the Loan According to the Established Terms
Based on the agreed‑upon loan terms, the borrower will then begin making payments. Some lenders may charge a penalty for repaying the loan early, so be sure to read the fine print to understand the terms you agreed to.
What Are the Advantages of Business Loans?
Business loans are a commonly used tool to start or grow an organization, as they offer a range of benefits depending on the circumstance. Let’s take a look at some of the primary advantages of business loans:
Advantages of Business Loans
- Establish a relationship with a banker or bank
- Access to lending for a variety of uses
- Avoid diluting the equity in your business by taking on new partners or investors
- Accelerate your growth
What Are the Different Types of Business Loans?
Businesses come in all shapes, sizes, and industries, and each one has a unique set of characteristics specific to that operation. For this reason, there are many different types of business loans to meet a range of particular needs and business objectives. The application and qualification process also varies based on the type of business loan. Below, we dive into some of the most commonly sought‑after business loans today.
Business Line of Credit
A line of credit is a flexible loan from a bank or a financial institution that consists of a defined amount of money that you can access as needed and repay either immediately or over time.
Interest is only charged on a line of credit when the money is borrowed. Lines of credit are most often used to cover the gaps in irregular monthly income or finance a portion of a project.
For example, if you have a $100,000 line of credit with your bank, you have a card or checks that give you access to the cash, but you are not paying interest on it yet. If you draw $20,000 from the account to fund a marketing campaign, you will begin accruing interest on just the $20,000.
Lines of credit are good options for funding short‑term operating needs. Businesses can repay and reuse the credit line as many times as needed throughout the duration of the loan’s term.
The quick and convenient access to funds makes lines of credit a popular choice with organizations who need flexibility and quick access to liquidity.
Before opening a line of credit, make sure you understand your chosen lender’s qualification criteria, loan conditions, interest rates, and fees. There may be charges for account set‑up, transactions, and annual fees. To reduce risk, it’s not uncommon for many lenders to require the business to pay down their outstanding line of credit balance to $0 at some point during the year, often for at least 30 days.
As a best practice, apply for a line of credit when your cash flow is strong and think strategically about your capital needs for the year to determine if a line of credit is the right financing option for your business. Once you have a line of credit, periodically pay down your balance and avoid keeping your average running balance near your credit limit.
How to Qualify for a Business Line of Credit:
- Provide basic business information such as the name, tax ID number, proof of identity, and the business address
- Submit the most recent 2‑3 years of business and personal tax returns
- Provide a personal financial statement
- Demonstrate accurate monthly financial statements
- Prepare an updated and actionable business plan
- Provide a personal guarantee (if required)
- Obtain a good credit score
Accounts Receivable Financing
Accounts receivable financing allows your company to borrow against your outstanding business‑to‑business receivables. The lender gives you a cash advance the day you invoice, so you don’t have to wait 30 days, 45 days, or more for the capital you need to run and grow your business. This provides you with more flexibility than you would get with traditional invoice factoring or invoice discounting because you’re borrowing against your invoices rather than selling them.
Accounts receivable financing is tailor‑made for the time you need money, but are held up by unpaid invoices. In addition to getting cash fast, the lender also relieves you of the burden of tracking down those that owe you money and collecting.
To secure an accounts receivable financing loan, your credit can be less than great. Lenders are typically more interested in the credit of the company that owes you money, but both your company and the companies that owe you money will be evaluated upon application.
How to Qualify for Accounts Receivable Financing:
- Be a business‑to‑business or business‑to‑government organization that invoices customers
- Demonstrate promising business performance and an upward trajectory
- Have outstanding receivables
- Work with creditworthy customers
- Provide proof of identity and the business address
Equipment Loans
Equipment loans enable businesses to buy, replace, repair, or upgrade the various equipment they need to process, manufacture, or produce their product. These loans are particularly helpful for acquiring equipment that would normally be too expensive to buy with cash. This can include equipment such as medical and dental machinery, trucks, forklifts, refrigerators, conveyor belts, payment processing equipment, solar panels, accounting software, restaurant ovens and supplies, phone systems, computer monitors, printers, copiers, furniture, tools, vehicles for commercial use, specialized machinery, industrial equipment, and more.
An equipment loan is an excellent way for companies that want to grow their revenues with a certain tool or piece of machinery. Some of the other benefits of an equipment loan include typically quick approvals, the preservation of cash flow, and improved equipment life cycle management.
How to Qualify for Equipment Loans:
- Provide detailed and accurate statements
- Demonstrate proof of upward business trajectory
- Show a good credit score
- Maintain a steady cash flow
- Provide proof of identity and the business address
Business Credit Cards
Just like personal credit cards, businesses can have credit cards with a spending limit and set interest rate. Business credit cards are user‑friendly and provide flexible access to finances without having to take out a business loan, and some cards even earn rewards that can be redeemed for travel, meals, gift cards, or other business‑related expenses.
The credit card company will determine your credit limit and interest rate based on your annual income and the company’s credit rating. Expect an interest rate between 8% to 24%, and you can shop around for introductory offers that feature a lower or no‑interest time period for new cardholders or balance transfers.
Applying for a business credit card is easy and very similar to the process you have undertaken for personal cards. Most credit card companies will want your business to provide documentation of your business history.
How To Qualify for a Business Credit Card:
- Provide basic business information such as the name, tax ID number, proof of identity, and the business address
- Describe the business type or business structure
- Select the industry type and/or nature of the business
- Specify your personal role at the business
- Include information such as address and phone number, years in business, number of employees, annual revenue, and estimated monthly spend
- Have a guarantor signature on the application
Business Term Loan
For decades, the reliability of business term loans has made them a popular financing option. A business term loan is a lump sum of capital that you pay back with a specified repayment schedule that has a fixed or adjustable principal and interest rate. A business term loan can vary significantly in terms of amounts and durations.
With a business term loan, funds can be available within a couple of days and the money is often used to expand your business, purchase equipment, hire staff, etc. Payments are typically made monthly.
How to Qualify for a Business Term Loan:
- Provide basic business information such as the name, tax ID number, proof of identity, and the business address
- Submit the most recent 2‑3 years of business and personal tax returns
- Provide a personal financial statement
- Demonstrate accurate monthly financial statements
- Prepare an updated and actionable business plan
- Provide a personal guarantee (if required)
- Obtain a good credit score
Commercial Mortgage Loan
Businesses use many different types of commercial properties to operate depending on their industry. These can be office spaces, retail spaces, warehouses, restaurants, factories, production facilities, hotels, or mixed‑use properties, to name a few.
To finance these significant capital expenditures, business entities like corporations, developers, limited partnerships, funds, and trusts can take out a commercial mortgage. Commercial mortgages are secured by liens on the commercial property.
Lenders usually base commercial mortgages on the value of the property you use as collateral and cash flow of the company. Commercial real estate loans usually involve fees that add to the overall cost of the loan for items such as appraisals, legal, loan application, loan origination, and/or survey fees.
When evaluating commercial real estate loans, most lenders consider the loan’s collateral, the creditworthiness of the entity (or principals/owners), including three to five years of financial statements and income tax returns, and financial ratios, such as the loan‑to‑value ratio and the debt‑service coverage ratio.
When applying, many commercial lenders will look for a property in a low‑risk location, a credit score above 680, 20%+ for a down payment, qualifying incomes, established tenants and long‑term leases, a strong history of stabilized occupancy, good condition of the property, and previous property management experience.
Use this calculator to see how much a monthly payment would be for a commercial loan.
How to Qualify for a Commercial Mortgage Loan
- Provide accurate information on your business such as purchase contract, condition of property, proof of identity, and the business address
- Divulge all lease and/or tenant agreements
- Submit 3 years of tax returns for the business and all owners
- Provide a personal financial statement from all owners
Business Acquisition Loan
A business acquisition loan is designed to finance the purchase of an existing business or franchise. For business owners who have one or more partners, this type of loan could also be used to finance a partnership buyout.
The requirements to qualify and the amount you can borrow vary by lender and the loan’s terms can be revolving, or a lender may offer a set term length for repayment. Compared to other types of loans, acquisition loans may have more stringent criteria you’ll need to meet for approval.
How to Qualify for a Business Acquisition Loan
- Have strong guarantors
- Specify if you are buying a franchise or an existing business
- Provide items such as credit history, business tenure, and revenue for lenders to evaluate
- Document your business performance and valuation, business plan, financial projections, and any relevant experience in the industry
- Provide proof of identity and the business address
SBA Loan
To promote the development of businesses, the Small Business Administration (SBA) created SBA loans. These loan programs provide government‑sponsored loans when traditional bank financing may not be an option.
The SBA gives the government’s guarantee to loans made by commercial lenders to help small businesses and startups obtain the credit they need. The SBA will guarantee up to 85% of these loans. Since this is a bank loan, applications are submitted to the bank and loan payments are paid to the bank. The bank is also responsible for closing the loan and disbursing the loan proceeds.
The SBA’s involvement is limited to reviewing the loan application the bank submits to assure the borrower meets eligibility and credit standards. The SBA provides the bank with a written authorization outlining the conditions of the SBA guarantee, and any material changes to this authorization generally require SBA approval.
Most commercial banks and some non‑bank commercial lenders participate in this program, and SBA loans can be used for a variety of business purposes. These include, but are not limited to, working capital, equipment acquisition, debt refinancing, and long‑term fixed assets.
When applying for an SBA loan, you may need to provide your business license, two years of business tax returns, two years of personal tax returns, year‑to‑date (YTD) profits and losses, YTD balance sheet, debt schedule, and possibly more.
Different Types of SBA Loans
- SBA 7(a) Loan
- SBA 504 Loan
- SBA Express Loan
- SBA CAPLines Program
- SBA Export Loan
- SBA Microloans
- SBA Disaster Loans
How to Qualify for an SBA Loan:
- Be a for‑profit business that is officially registered and operates legally
- Do business in the United States, and be physically located and operate in the U.S. or its territories
- Provide proof of identity and the business address
- Invest your own time or money into the business as the owner
- Exhaust your financing options from any other lender
The Takeaway
We know that the world of business loans can be intimidating. With so many different types of loans, options, and requirements, it can be challenging to even know where to start. At First Bank, we strive to empower you and your business with the tools and resources you need to succeed. Whether you are a small business, established organization, large corporation, municipality, or nonprofit, we offer customized loans for every business, at every size. Let us help you find the financing you need. Ready to grow your business? Contact one of our First Bank experts today.
