What Is a Business Loan and How Do You Get One?

Business loans provide businesses with financial resources to support various operational and strategic needs. These financial arrangements involve a lender providing a sum of money to a business, which the business then repays over an agreed-upon period. Businesses often seek these funds to manage day-to-day operations, invest in growth opportunities, or acquire assets.

Understanding Business Loans

A business loan is a sum of money provided to a commercial entity by a financial institution or private lender. This borrowed amount, the principal, is subject to interest, the cost of borrowing. The business repays both the principal and interest over a predetermined loan term, according to a structured repayment schedule. Payments are typically made monthly or bi-weekly.

Businesses pursue loans for diverse purposes, such as covering startup costs, funding expansion, or maintaining working capital for daily operations. Loans also facilitate the purchase of equipment or the acquisition of inventory. The business must adhere to the agreed-upon terms, including timely repayments.

Types of Business Loans

Term loans provide a lump sum upfront, repaid in fixed installments over a specified period. These loans are often used for significant, one-time investments like purchasing property or major equipment. Repayment terms can range from one to ten years.

Lines of credit offer flexible access to funds up to a predetermined limit, allowing businesses to draw and repay money as needed, similar to a credit card. This revolving credit is useful for managing short-term cash flow gaps or financing operational expenses. Interest is charged only on the amount drawn, not the entire credit limit.

SBA loans, supported by the U.S. Small Business Administration, are government-guaranteed loans offered through conventional lenders. Programs like the 7(a) loan provide general financing, while the 504 loan supports real estate or machinery purchases. These guarantees reduce risk for lenders, often leading to more favorable terms for borrowers, including lower interest rates and longer repayment periods.

Equipment financing is a specialized loan product for purchasing business machinery or vehicles. The equipment often serves as collateral for the loan, making it easier for businesses to acquire assets without tying up other capital. Loan terms usually align with the useful life of the equipment.

Invoice factoring involves a business selling its unpaid invoices to a third party at a discount for immediate cash. This option is common for businesses with long payment cycles that require quick access to working capital. The factoring company then collects the full amount from the client.

Commercial real estate loans are used to acquire, refinance, or develop commercial properties like office buildings or warehouses. These loans typically have longer terms (10 to 25 years) and require a substantial down payment (10% to 30% of the property’s value).

Merchant cash advances (MCAs) provide a lump sum of cash for a percentage of future credit card sales. While offering quick access to funds, MCAs often have higher costs than traditional loans, with annual percentage rates (APRs) exceeding 100%. They are considered a last resort due to their expensive nature.

Preparing for a Business Loan Application

A comprehensive business plan is foundational for any loan application, articulating the company’s vision, operations, and financial projections. It includes an executive summary, detailing the company’s mission and leadership, and a description of the business model. The plan also incorporates market analysis, outlining target customers and competitive advantages, and organizational structure and management team.

The service or product line is described in detail, with a marketing and sales strategy. A funding request specifies the exact amount needed and its intended use. Detailed financial projections, including income statements, balance sheets, and cash flow statements for the next three to five years, demonstrate the business’s ability to repay the loan.

Lenders scrutinize financial statements to assess a business’s fiscal health. A Profit & Loss (P&L) statement reveals revenue, costs, and profit over a period. The Balance Sheet provides a snapshot of assets, liabilities, and equity, indicating financial stability. A Cash Flow Statement tracks cash movement, highlighting liquidity.

Both personal and business credit scores are significant factors in a lender’s evaluation. A strong personal credit score demonstrates responsible financial management, while a solid business credit score reflects the company’s ability to meet financial obligations. Lenders review scores from agencies like Dun & Bradstreet for business credit and FICO or VantageScore for personal credit.

Collateral, an asset pledged by the borrower to secure the loan, provides lenders with security in case of default. Common forms include real estate, accounts receivable, inventory, and equipment. The value and liquidity of the offered collateral influence the loan amount and terms.

Legal documents such as business registration, licenses, permits, and articles of incorporation confirm the business’s legal standing and compliance. These documents verify the entity’s existence and authorization to operate. Articulating the purpose of the loan is important, explaining how funds will be utilized and generate sufficient revenue for repayment.

Applying for a Business Loan

Finding the right lender is a crucial initial step, as various institutions offer different loan products and terms. Traditional banks and credit unions provide a broad range of loans, often with competitive interest rates for established businesses. Online lenders offer quicker approval processes and flexible criteria, while Community Development Financial Institutions (CDFIs) serve underserved communities and provide technical assistance.

The application submission process involves completing detailed forms and uploading all required documentation, including the business plan and financial statements. Some lenders may require an interview or discussions to gain a deeper understanding of the business and its financial needs. Ensuring all information is accurate and consistent across documents streamlines this phase.

Once submitted, the application enters the underwriting process, where the lender conducts a thorough review of all provided information. This involves financial analysis to assess the business’s capacity to repay the loan, an evaluation of creditworthiness, and an assessment of the proposed collateral. Lenders also consider industry risks and the economic environment.

Following underwriting, the lender communicates an approval or denial decision. If approved, the business receives a loan offer detailing the principal amount, interest rate, repayment schedule, and any associated fees. If denied, seek feedback from the lender to understand the reasons, which can help improve future applications.

Upon acceptance of the loan offer, the process moves to loan closing, where all legal documents are signed. This formalizes the loan agreement. After successful closing, the funds are disbursed to the business, typically through a direct deposit. The business then begins its repayment obligations according to the agreed-upon schedule, and some lenders may monitor the business’s financial health throughout the loan term.