marketing, dollar, business-4646598.jpg

How Do Small Business Loans Work

There could be various reasons you would want to start your own small business like you have developed a product or thinking of a distinct solution to a common problem or love the concept of being your boss.

If you chose to pursue business ownership, you would already know that it requires sufficient money, specifically upfront, to raise and start running. A small business loan can offer the cash required for your successful venture.

How Do Small Business Loans Work

Small Business Loan

Small business loans are kinds of financing offered to companies for various purposes by different lenders. Over the years, numerous kinds of small business loans have been introduced to facilitate entrepreneurs in achieving their business goals. Hence, the approach to a small business loan works is based on the type of loan you are seeking.

Types of Small Business Loans

There are various types of small business loans you would want to consider for your business

  • Accounts Receivable Financing

It includes selling your receivables or outstanding invoices to a guarantor so you can get early payment for them. The lender takes a risk on your receivables and provides your company with the desired cash in exchange for a fee. The quality and age of the receivables play the main role in the amount of cash you’ll receive. Although fast access to cash is a benefit of accounts receivable financing, you are expected to pay more for this kind of loan option, specifically if your business credit is lower than stellar

  • Working Capital Loans

Working capital loans help finance the everyday operations and activities of your business. The operations may include payroll, rent, and debt payments. As compared to the other small business loans, working capital loans involve shorter terms and lower amounts. The loans are usually linked to personal credit, which can be a hit if you don’t make your payments on time.

  • Small Business Term Loans

If you take out a small business term loan, you gain a lump sum amount that you’ll pay back at a fixed interest rate with regular repayment options. In the majority of cases, these kinds of loans are paid back in five years and used to fund a specific investment for a small business.

Similar to car loans and mortgages, small business term loans typically follow an amortization schedule, suggesting most of your payment will be going in interest at the beginning.

  • Small Business Line of Credit

A small business line of credit works almost like your credit card. You can borrow up to a specific limit and only pay interest on the amount of money you loaned. If you take out a small business line of credit, you can draw funds and pay back as often you would like, provided you don’t go beyond the credit limit.

  • SBA Small Business Loans

SBA loans are small business loans awarded by the U.S Small Business Administration, a federal organization that helps business owners in growing their businesses. A guarantee refers to the case if you are unable to make your payments to your lender, the SBA will pay the guaranteed amount.   Owing to the guarantee, SBA small business loans can be challenging to be approved.

  • Equipment Loans

Equipment loans can support your small business replace current equipment or purchase new equipment as it flourished. If you own healthcare business, for instance, you may utilize an equipment loan to pay for let’s say X-Ray machines and other medical equipment and tools. Generally, equipment loans need less documentation as compared to other small business loans, so you are expected to receive the funding relatively faster.

  • Small Business Credit Cards

Generally, small business credit cards are similar to personal credit cards, except there are a few notable differences. A small business card may offer you with reporting feature to categorize and track the expenses. It is also expected to have a rewards program that can facilitate by saving on common business expenditures such as marketing services and office supplies. Moreover, it is exempted from the Credit Card Act of 2009.

Small Business Loans Providers

Various places can provide small business loans, some of them are described below:

  • Large Commercial Banks

As the large commercial banks have extensive demands for small business loan borrowers, they have the authority to provide large loans as compared to other lenders. It can be helpful when you are expanding your business. Additionally, small business loans from a large commercial bank allow locking in low-interest rates. While financing with a commercial bank has its advantages, the loans can be challenging to approve, specifically if you don’t have the best credit.

  • Direct Online Lenders

Various online lenders provide loans directly to small business owners. As they use the technology and algorithms, the loans are faster to get as compared to the loans from traditional lenders such as banks. Nonetheless, the costs of lending with direct online lenders are generally high. You will want to avail this route if you need quick cash and are having trouble qualifying for a loan from banks or traditional lenders.

  • Large Community Banks

Community banks are owned and run locally. As they are generally smaller than commercial banks, they can offer more individualized service, which can be a huge advantage as your business grows. Additionally, unlike the commercial banks, which may only focus on your financial statements and credit score, community banks are expected to look at your whole credit report and business aspects of your company. It is a huge benefit if you hold a good credit history but don’t have the best credit score yet.

  • Bank Lenders Supported by the SBA

Several SBA-associated lenders are banks that have strict conditions for an applicant. Although SBA loans are difficult to get approved, they are certainly worth considering, as they involve less down payment requirement, low-interest rate, and longer repayment terms as compared to other options.

  • Peer-to-Peer Lending Websites

Small business loans from peer-to-peer lending websites like Prosper and Lending Club are typically easier to qualify for than loans from typical lenders as the money comes from a group of investors rather than a single lender. These kinds of loans typically offer higher interest rates which can increase the total cost of your loans.

Qualifying For Small Business Loan

The process for qualifying for a small business loan includes the following steps:

  1. Build Your Personal and Business Credit Scores

Lenders who offer small business loans will review your credit score to help assess whether you are eligible. Your credit reflects your ability to pay back your debts like car loans, mortgages, and credit cards. The greater the credit score, the more likely you are to be approved for the loan. Typically, a score of 700 and above is regarded as good, whereas 800 and above are considered excellent. 

If your credit score is low then you need to build it better by paying your bills on time, returning debt, and keeping balances low on credit cards. After you have built the personal credit, you need to focus on the business credit score. To start building business credit, integrate or create an LLC, achieve a federal Employer Identification Number (EIN), and open business accounts in your business name.

  1. Familiarize Yourself with The Requirements

Understand the lender’s minimum qualifications and requirements, and then assess your standing and chances of getting approved. Although some lenders can be flexible, most of these sources demand borrowers meet a minimum credit score or years, and annual revenue in business.

Among all the types of business loans, loans from banks and the ones supported by the SBA are the most challenging to be eligible for. The direct online lenders and peer-to-peer lending platforms offer less stringent requirements. You have a good chance of getting them if you have a credit score low to mid 600s. Additionally, they’ll have legal and financial documentation requirements. These may include bank statements, driver’s licenses, profit and loss statements, personal tax returns, and a business plan.

  1. Create A Business Plan

The purpose of a business plan is to tell lenders you have a plan to use the money. The business plan will support in conveying the purpose of loans and ensure it will be profitable. While developing a business plan, ensure to incorporate the following details

  • Business description
  • Service or product description
  • Market analysis
  • Management team
  • Marketing and sales strategy 
  • Financial plan and projections
  1. Show Collateral If Required

Some lenders may need you to provide collateral or an asset such as equipment, property, or inventory to get the small business loan. When you provide collateral, you are giving lenders the right to end and sell it if your business sees any hiccups and you are unable to make the payments.


Getting approval for a small business loan is an easy task if you have done your research and thoroughly understood all the available options. Irrespective of what type of loan are applying for, make it a priority to pay the installments on time so it will be fruitful for your venture.

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top