Small Business Loans: What They're For, How They Work, and How to Obtain One

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hether you’re just starting up or you’ve been in business a decade or longer, there will likely come a time when you need access to working capital to cover necessary business expenses or expand products and services in new markets.

If you or your business don’t have the funds to pay for expenses at the moment of need, a business loan could be an effective tactic to assist with cash flow needs. These loans are specifically available to help business owners and entrepreneurs pay for various operational and expansion expenses.

Of course, not all businesses or business loans are created equal. Financing options exist for a wide range of needs, timeframes, and business types.

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What is a small business loan?

A small business loan is a type of financing provided to small businesses by banks, credit unions, or other financial institutions. Businesses use these loans for a variety of purposes, such as:

To purchase inventory or equipment
To open a new location
To cover operating expenses during slow periods
To invest in marketing and advertising
To hire additional staff or offer extended employee benefits
To pay contractors for short or medium-term projects
To finance a large one-time project or initiative
To refinance existing debt at a lower interest rate
To fund research and development of a new product or service

Small business loans typically require a credit check of the owner(s) of the business and may require collateral, such as a personal guarantee or property. The terms and conditions of small business loans vary depending on the lender and the particular loan.

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How small business loans work

There are several types of small business loans available, and the terms vary with each. Common small business loan types include:

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Term loans

Term loans are one of the most common small business loan types. A term loan is essentially a single lump sum of cash that you receive and then must repay over a fixed term. Monthly payments are normally fixed and include interest in addition to the principal balance. They can be used for a range of needs, such as day-to-day expenses, equipment, and more.

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SBA (Small Business Administration) loans

SBA loans offer small business owners relatively low-cost, government-backed loans. However, SBA loans entail a longer approval process. Also, the application process is not handled directly through the federal government; instead, it is through an SBA-approved lender, which may or may not be a traditional bank. Getting approved and receiving the loan can take up to three months, so an SBA loan may suit your needs if you don’t need funding immediately. Otherwise, you might consider an SBA loan alternative.

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Equipment loans

Do you need to purchase expensive equipment? Consider an equipment loan, which helps small businesses get the equipment they need to run their businesses. Think trucks, commercial kitchen equipment, machinery, furniture, supplies, and tools – basically, any type of equipment that keeps its value and lasts several years. Typically, the equipment you buy serves as collateral for the loan.

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Invoice financing

If you have difficulty getting on-time payments from your customers, invoice financing is a good way to get cash up front while you collect payments. The unpaid invoices serve as collateral. This is different from invoice factoring, where you’re actually selling your invoices to a factoring company in exchange for a percentage of the invoice value.

Note that invoice financing can be an expensive option, especially if your customers don’t pay on time, and is limited to B2B businesses.

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Commercial real estate loans

Commercial real estate loans can help you finance the property where you do business, such as an office, warehouse, or retail space. Commercial real estate loans are useful if you plan on staying in your space for the long term; additionally, because you are using the loan to purchase real estate, the real estate becomes an equity asset owned by your business. If you are not in a position to purchase an entire building, say, an entire shopping center or office building, your landlord may also be open to “condo”-ing the building by subdividing it and having you purchase only your space.

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Microloans

Microloans provide up to $50,000 in funding for businesses. If you don’t need a large amount of capital, a microloan can be a good option. Microloans are typically offered through government lenders – most notably the SBA – as well as non-profits. Usually, they require some form of collateral. Note that they cannot be used to finance existing debt.

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Business lines of credit

A business line of credit works like a credit card, giving you a credit limit you can borrow, repay, and borrow again. If you don’t know exactly how much funding you’ll need, a line of credit might be for you – you only pay interest on what you borrow, not the total limit. Many business lines of credit are unsecured, meaning you don’t need to put up any collateral.

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Merchant cash advances

Though not a traditional loan, a merchant cash advance is a type of funding where you borrow against future sales. You repay the advance with a portion of your credit card sales either daily, weekly, or monthly. Merchant cash advances are typically quick to fund but have high interest rates. The short repayment cycle may also pose a challenge for some businesses that aren’t able to predict their revenue.

Loan Type
Interest Rates
Repayment Terms
Time to fund

Term Loans
6% to 36%
Short-term: 3-24 months
Mid-term: Up to 5 years
Long-term: Up to 10 years
1 day to a few months

Small Business Administration (SBA) Loans
For 7(a) loans, the base rate plus 2.25% to 4.75% (dependent on loan amount)
Up to 25 years
30 to 90 days

Line of Credit
10% to 99%
6 months to 5 years
Up to 2 weeks

Equipment Financing
Up to 100% of the cost of equipment
Useful life of equipment
1 day to a few weeks

Invoice Financing
1% to 5% of the invoice value
Until your customer pays the invoice
As little as 1 day

Commercial Real Estate Loans
3% to 20%
5 to 10 years with up to 25-year amortization period
A few days to 2 months

Microloans
Average of 8%
3 to 6 years
Varies depending on lender, but typically up to 3 months

Merchant Cash Advances
Factor rate of 1.1 to 1.5
Monthly repayments for a set amount of time
Can be 24 hours or less

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The qualifications and requirements for small business loans can vary depending on the lender and type of loan. However, some common qualifications and requirements include:

A solid business plan: Lenders will want to see a detailed plan outlining the business’s goals, strategies, and financial projections.
Good credit: Lenders will typically check the credit scores and credit history of the business owner(s) in order to extend credit to the business. This is especially true with startups.
Adequate collateral: Some lenders may require collateral, such as equipment, real estate, or inventory, to secure the loan.
Time in business: Some lenders may require that the business has been in operation for a certain period of time.
Revenue and cash flow: Lenders will want to see that the business has a consistent revenue stream and is generating positive cash flow.
Tax returns: Lenders will want to see the business’s tax returns for the past two or three years to verify financials and revenue.
Personal guarantee: Some lenders may require the business owner(s) to personally guarantee the loan, meaning they will be personally liable for the debt if the business defaults.
Specific industry requirements: Some industries have specific requirements or certifications, such as financial services or energy. Lenders will want to see that the business has met those requirements.

It’s important to note that the requirements and qualifications can vary depending on the specific loan program, lender, and stage of business.

Once you have selected the funding sources you wish to pursue, it’s best to assemble all of the necessary documentation for the application process. The following documentation will help you present yourself and your business in a complete way to banks, lenders, and others:

Business plan
Financial statements and projections
Profiles of the senior leadership team and key employees
Hiring strategy and pay structure
Details, including the price points, about the products and services you wish to sell
Inventory and cost of goods or services you wish to sell
Roadmap for future products and services to be developed and sold
Analysis of industry or local competitors
Personal financial status, including credit score

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How to get a small business loan

Steps to prepare for a loan application

To prepare for a loan application, consider the following:

Prepare a detailed business plan that outlines your company’s financial projections and the purpose of the loan.
Gather all necessary financial documents, including income statements, balance sheets, tax returns, and cash flow statements.
Review your credit score and work to improve it if necessary.
Choose the right type of loan and lender for your business.
Fill out the loan application, including any required forms and supporting documentation.
Prepare a strong loan proposal that highlights the strengths of your business and explains why the loan is necessary.
Meet with the lender to discuss the loan and answer any questions they may have.
Wait for the lender’s decision and be prepared to provide additional information if requested.
Once approved, review and understand the terms and conditions of the loan agreement before signing it.

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Tips for increasing your chances of loan approval

There are several actions you can take to increase the likelihood of the loan getting approved.

Have a strong credit score and a good credit history. Lenders will want to see that you have a track record of paying your debts on time.
Show that you have a solid business plan and financial projections that demonstrate the ability to repay the loan.
Provide detailed financial statements and tax returns for your business.
Show that you have enough collateral, or assets that can be used as collateral, to secure the loan.
Have a well-defined purpose for the loan and demonstrate how the funds will be used to grow the business.
Have a strong management team in place with relevant experience in the industry.
Have a track record of profitability and revenue growth.
Show that you have a strong potential customer base and a stable source of revenue.
Be prepared to provide detailed information about your business, including your target market, competition, and marketing strategy.
Be able to demonstrate that you have exhausted all other options before seeking a loan and that the loan is necessary for your business’s survival and growth.

If you’re looking for alternative financing options, check out our guide to small business funding.

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Strategies for managing and repaying small business loans

There are several ways that small business owners can manage their debts and obligations.

Create a budget: Develop a detailed budget that outlines all of your business expenses and income. This will help you better understand whether you can “afford” the loan because you will determine how much money you need to repay the loan each month.
Prioritize loan repayment: Make repaying the loan a top priority and allocate funds towards loan repayment before other expenses.
Make extra payments: If possible, make extra payments on the loan to reduce the amount of interest you will pay over time.
Negotiate with lenders: If you are having trouble repaying the loan, reach out to the lender to discuss potential solutions, such as a loan modification or payment plan.
Seek advice: Consult with a financial advisor or accountant to help you develop a plan for repaying the loan and managing your finances.
Increase revenue: Try to increase your revenue by creating new products, increasing sales and marketing efforts, and finding ways to cut costs.
Keep accurate records: Keep accurate records of all financial transactions, including loan payments, to ensure that you are staying on track with repayment.

It’s also important to note that paying off debts is not something that will be the same month to month or year to year. When reviewing your annual finances or planning your year ahead, consider how debt and the need to pay it off figure into your overall financial plan.

Also, keep in mind that as you pay off your business loans, you are increasing your credit profile as a business. This can be helpful when you need to access larger loans down the line.

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Resources for finding and applying for small business loans

There are several resources for finding and applying for small business loans, including:

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The Small Business Administration

The SBA offers a variety of loan programs, such as the 7(a) loan program and the Microloan program, which are designed to help small businesses access capital.

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Banks and credit unions

Local banks and credit unions often have small business loan programs and may be more willing to work with smaller, local businesses than larger national banks.

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Lending platforms and fintechs

Online or mobile lending platforms, such as Kabbage, otherwise known as “fintechs,” have facilitated the lending process for customers, including small businesses. Applying for loans and accessing capital is generally faster than that through a larger, traditional bank.

Novo Funding offers Merchant Cash Advances to small businesses. With Novo Funding, you get:

Instant access to your advance funds upon approval
A monthly repayment cycle
Ability to draw on available funds multiple times – no need to draw all at once!

Novo Funding is currently available on an invite-only basis, but we are rapidly expanding availability. Create a Novo checking account to see if you’re eligible to apply.

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Community banks

Community development financial institutions (CDFIs) are a good resource for small business owners in underserved communities.

It’s important to research and compare different loan options and terms, including the interest rates, fees, and other terms, in order to find the best fit for your business. Additionally, it’s good to have your documentation at the ready when you are ready to apply for the loan, such as your polished business plan, good personal credit (oftentimes, your business loan will be based on your personal creditworthiness), and collateral to increase your chances of getting and closing the loan.

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FAQs

Is interest from a small business loan deductible?

Interest on a small business loan is generally tax deductible. However, there are certain restrictions and limitations that may apply, such as the type of loan and the use of the funds. It’s best to consult with a tax professional or the IRS to determine the specific tax implications of the loan for your business.

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Does my business qualify for an SBA loan?

To qualify for an SBA loan, your business must meet certain criteria established by the SBA. These criteria include being a for-profit, domestic business that operates primarily within the United States, having a credit history that demonstrates the ability to repay the loan, and meeting the SBA’s size standards for your industry. Additionally, the SBA has specific loan programs for specific industry types, like economic injury disaster loans, and specific loan types, like 7(a) and 504. It is best to check with an SBA-approved lender to determine if your business qualifies for a specific loan program.

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What’s the difference between a business loan and financing?

A business loan is a type of financing where a lender provides a business with a certain amount of money, which the business is then obligated to pay back with interest over a specified period of time.

Financing, on the other hand, refers to the overall process of obtaining funds for a business. Such forms of funding can include loans, equity investments, leasing, rent-to-own, or revolving lines of credit (a credit card). A business loan is just one of the many options available for financing a business.

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Final Thoughts

A business loan could be a necessary and valuable step in taking your business to the next level.

Even if you aren’t at the point of needing funding, it’s never a bad idea to have all of your documentation in place should the moment arise. You should take time to evaluate different financing options and the requirements to apply for each. Doing your homework and even shopping around will provide you with flexibility and improve your chances of securing funding under the best terms possible.

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Novo Platform Inc. strives to provide accurate information but cannot guarantee that this content is correct, complete, or up-to-date. This page is for informational purposes only and is not financial or legal advice nor an endorsement of any third-party products or services. All products and services are presented without warranty. Novo Platform Inc. does not provide any financial or legal advice, and you should consult your own financial, legal, or tax advisors.