A small business loan is an amount of money borrowed from a financial institution by a small business person to start, run, or expand a small business.
Getting a Small Business Loan is Difficult
Unfortunately, financial institutions are notoriously reluctant to lend to small businesses – according to a recent survey by ondeck of over 10,000 business loan applicants in the U.S,, 82% were denied financing by their bank.
Loaning to small businesses, especially startups, is a riskier proposition for banks than mortgage lending or lending to larger, established businesses.
In addition, given that the underwriting costs for evaluating, verifying, and processing a small loan is roughly the same as for a larger one, banks can increase their profits by focusing on larger loans to bigger businesses (small businesses typically request loans of less than $500,000). As well as being rejected for financing more often, smaller businesses also typically pay higher interest rates on loans than big businesses.
Consider that you may have an excellent credit rating and a solid business plan and still not be able to get a small business loan because you have no collateral. Even established business people can find themselves in this position, if they do not own enough tangible assets, such as houses or other property.
In other words, the small business loan is not being granted on the status of your business; it's being granted on your personal financial status.
That's why it's important that your personal financial house is in order before you apply for a small business loan.
You will also find that many lenders just don't provide seed money. While they're perfectly willing to give a small business loan to help a business grow, they don't want to take the risk of lending to a start up.
All that being said, you have a better chance of getting a small business loan if you know where to look and are prepared to meet the lender's expectations. Keep in mind that the overarching consideration of lenders is risk management and approval will hinge on their assessment of your ability to pay back the loan.
Increasing the Odds of a Successful Loan Application
Aside from sufficient collateral, financial institutions will need the following before considering a loan application:
- A business plan document that outlines your company, products, target market, staffing, cash flow and other financial projections, etc. Banks scrutinize business plans to reassure themselves that the business they are lending to is likely to be successful. As such, the business plan needs to demonstrate a solid business model backed by sound management.
- If you are an established business, information such as loans/credit history, bank accounts, and other supporting financial information. You should also include accounts receivable and accounts payable statements, and references from vendors that indicate that you have a solid history of making payments on time. Finally, include balance sheets, corporate tax returns, and (if possible) audited financial statements for the previous few years of business.
- A personal financial summary, including details of assets such as property, vehicles, investments, etc. and liabilities such as mortgages, loans, credit card debt, etc.
Note that banks will often also require creditor insurance on business loans, which covers repayment of the loan in the case of death or disability of the business owner(s).
For more on increasing your chances of getting a small business loan, see How to Get a Small Business Loan.
Credit Unions May Be a Better Choice Than Banks
Credit unions are an increasingly important source of financing for small businesses. According to the Huffington Post: "From June 2007, the onset of the financial crisis, to December 2015, small business loans outstanding at credit unions more than doubled—growing by slightly more than 130% over the period.
Those loans at banks actually shrank by 10% during that time."
Credit unions are smaller, more locally oriented institutions and as such are more likely to lend to small businesses in their communities. Banks on the other hand, have gotten larger and more national (and international) through mergers and acquisitions. The larger the institution the less likely decisions (such as lending policy) are made at the local level.
Examples: Steven's application for a small business loan was rejected because he didn't have any collateral.
8 Sources of Start Up Money
Quick-Start Business Plan
Starting a Business: Finding Small Business Financing