Startup business loans: Options for funding your business

 Startup business loans may help you finance your new venture, but they can be difficult to qualify for. (Shutterstock)

Your new business may start small, but that doesn’t mean you’re making a small investment. New ventures often cost thousands of dollars: An Inc. Magazine survey of fast-growing companies found that 42% of businesses launched in 2018 with $5,000 or less in investment, and 21% required between $5,000 and $25,000. 

While relatively small compared to the millions of dollars some companies raise, these sums may be difficult for some new entrepreneurs to comfortably spend. That’s why some future business owners turn to startup business loans. In this article, we’ll go over how they work.

A personal loan can also be an option for covering business expenses. Visit Credible to learn more about personal loans and see your prequalified rates.

• What are startup business loans and how do they work?
• What are the different types of startup business loans?
• How to apply for a startup business loan
• Pros and cons of startup business loans
• Should you take out a loan to start a business?
• Other ways to fund your startup

What are startup business loans and how do they work?

Startup business loans are loans made to early-stage businesses to help them grow. They may come from banks or credit unions, or through a state or local government program. You borrow a sum of money for business expenses and use the money you earn through your business to repay your lender.

Since brand-new businesses are inherently risky, it can be difficult to qualify for small-business startup loans. Lenders will carefully scrutinize your business plan, expenses, bank statements, and financial projections before deciding whether to offer you money. They’ll also evaluate what are known as the five Cs:

• Capital — This refers to your own cash investment in the business. Lenders usually want to see that you’ve put up at least 25% to 30% of the startup costs of your business.
• Capacity — Capacity means your ability to successfully run the business. If you’re starting a new venture, this likely means a careful vetting of your business plan and your previous experience in the industry. Lenders will also want to see cash flow history and projections to make sure you have the ability to meet all your financial obligations.
• Collateral — You’ll often need to pledge something of value as a backstop in case you aren’t able to make your payments. This could be business assets, real estate, or inventory. You may also need to put up some of your own personal assets as collateral.
• Character — Lenders want to see that you take your business seriously, as well as your finances. They’ll also factor your personal credit score into their loan decision.
• Conditions — Not everything is within your control. Your lender will also consider overall market conditions, the trajectory of your chosen industry, and other external factors that can affect your business’s chances of success.

What can you use startup business loans for?

Generally, borrowers can only use startup loan funds for business expenses. These may include:

• Office space rent and utilities
• Website and technology
• Equipment and supplies
• Licenses and permits
• Legal fees
• Employee salaries
• Advertising and marketing

Your lender may have more stringent requirements for what your startup business loan can be used for. Before applying for a loan, make sure to have a detailed list of expenses you expect to run into and how much each will likely cost. 

Can you get a startup business loan with bad credit?

Probably not. While long-established businesses may be able to use their financial history to help them get a loan, a new business only has the credit of its owners. Having bad credit is a primary reason why loan applications are turned down, according to the U.S. Small Business Administration.

What are the different types of startup business loans?

As you start your business, you may have several options for loans. Each type has its own criteria for how much you can borrow and who qualifies.

SBA microloans

Microloans through the U.S. Small Business Administration allow for-profit business owners to borrow up to $50,000 to start or expand their businesses. Loans don’t come directly from the federal government; instead, the SBA funds specially designated nonprofit community lenders who issue the loans. 

Each lender may have its own criteria for who qualifies for an SBA microloan, and may also have requirements for collateral. Repayment terms of the microloan program vary from lender to lender, but the maximum loan length is six years.

You can use an SBA microloan for most types of startup business expenses, including working capital, inventory, supplies, equipment, and machinery. You can’t use these loans to pay down debt you already have or to buy real estate.

SBA 7(a) loans

If you need to borrow a bit more money, an SBA 7(a) loan may be a better option. This loan program is the SBA’s most common, and it allows you to borrow up to $5 million. SBA 7(a) loans may be a good option if you’re buying real estate as part of your business startup. You can also use a 7(a) loan for working capital, to buy fixtures and equipment, and to refinance current business debt. 

You can use these SBA loans to start a new business or buy an existing business. You’ll generally repay the loan with monthly payments, and your loan may have a fixed or variable interest rate.

Asset-based financing

While many types of small-business loans may involve collateral, asset-based financing uses the value of your business’s property as the basis for issuing you a loan. Asset-based loans can be a good option if your business has a lot of inventory, equipment, or machinery that you can use as collateral. You can use the loan funds to help you expand or manage cash flow. But if you fail to make your payments, your lender can seize the collateral — which can make it very difficult for your business to move forward.

Personal loan for business

You may choose to take out a personal loan and use the money to help start your business. Lenders will generally issue these loans to you individually, not your business, and rely on your personal credit history to make a lending decision. You may be able to borrow a small amount, as low as $1,000, or as high as $50,000 or more depending on your income and credit history. 

The better your credit score, the lower the interest rate you’ll generally qualify for. These loans may be a good option if your personal finances are in good shape and you don’t have an established business that would qualify you for traditional small-business financing.

Credible lets you compare personal loan rates from multiple lenders, and it won’t affect your credit score.

How to apply for a startup business loan

While the process will vary slightly by lender, these are the steps you’ll generally follow to apply for a startup business loan:

1. Create a startup budget. Map out the expenses you anticipate when starting your business, and research how much each one costs. You can use this SBA worksheet to help you budget your startup expenses.
2. Decide what type of startup business loan you need. If your startup expenses exceed the cash you have on hand, you may consider a loan to help bridge the gap. You can research types of small-business loans on the SBA website, or lean on an organization like SCORE or your local Small Business Development Center, to help you evaluate the best options for you.
3. Check your credit score. When you’re just starting out, your business won’t have a financial track record to show a lender. In most cases, your own personal credit will be a major determinant of whether you’ll qualify for a startup business loan. Look up your credit score so you’ll know whether you meet any lender minimums. You can get a free copy of your credit report each year from each of the three major credit bureaus, which you can request using AnnualCreditReport.com. Look over your credit report carefully for any errors, like incorrect balances or unauthorized accounts, which can drag down your score. If you find an error, you can dispute the information with the credit bureau and have the record corrected.
4. Compare lenders and loan offers. Seek out several different lenders that offer startup business loans. You can use a site like the SBA’s Lender Match to help you track down lenders in your area that might fit the bill. These lenders may ask you for details on your personal and business finances before extending a conditional loan offer. Once you’ve received loan offers from multiple lenders, compare the interest rates and terms to find the best deal. Even a small difference in interest rate can equate to thousands of dollars over the life of a loan.
5. Apply for the loan. The lender you choose will give you instructions on how to fill out a complete loan application and what documentation you’ll need to provide.

If you’re ready to apply for a loan, Credible lets you easily compare personal loan rates from various lenders in minutes.

Pros and cons of startup business loans

Like any financial decision, startup business loans have benefits and drawbacks. Here are a few to consider:

Pros

• You may be able to start up or expand more quickly. A startup business loan may be able to help you to buy the equipment or inventory you need to grow your business faster than you’d be able to by relying only on money you bring in from sales.
• You won’t need to give up equity. Other ways of raising money for a business, like taking venture capital money, require you to give up a piece of ownership of your business. Loans typically do not.
• Loans may come with support and advice. Once you’ve borrowed money, your lender has a vested interest in your success. Some SBA-backed loans come with guidance, counseling, and other support for your new business.

Cons

• Loans can be difficult to qualify for. Getting a startup business loan isn’t easy. It can be difficult to get approved for a small-business loan without a history of financial performance to point to.
• You may need to personally guarantee the loan. When you take out a startup business loan, you might not just be risking your company’s money. Many small-business loans require a personal guarantee, meaning your own financial situation is at risk.
• Debt may be difficult to repay. New businesses are a challenge, and adding a debt payment to your monthly obligations can make things even harder.

Should you take out a loan to start a business?

It’s generally not a good idea to take out a loan to start a new business. While debt financing does have its place in the small-business world, brand-new businesses are inherently risky. 

About one-third of startup businesses fail within the first two years, and more than half of small businesses close operations within five years, according to Small Business Administration data. A loan’s monthly payments can stretch your new business’s budget and ultimately put your personal finances at risk as well.

A loan to start a small business may work best if you have a rock-solid business plan, years of experience in the industry, and contracts or purchase orders lined up that’ll generate revenue immediately. But in most cases, exploring other funding options is a better idea than turning to lending.

Other ways to fund your startup 

Loans aren’t your only option for financing your new business. In fact, loans make up a relatively small percentage of how new businesses are funded — about 20%, according to the SBA. Here are a few other financing options for startups that you may consider before turning to a loan:

• Self-funding — Commonly known as bootstrapping, this means relying on your personal savings to fund your startup costs. You may also ask friends and family members to help contribute to your new business. Personal savings make up roughly 75% of startup funding nationally, according to the SBA.
• Business credit card — A business credit card works much like a personal credit card, except you only use it for business expenses. It can be a good way to borrow small amounts for a short period of time, but business credit cards can also require personal guarantees.
• Small-business grants — Some state and local governments offer grants to small businesses to encourage them to grow and hire people in their areas. A grant is free money that you don’t need to pay back.
• Crowdfunding — With crowdfunding, you pitch your ideas to the masses online via a specialized platform (such as Kickstarter or Indiegogo) and ask people to contribute a small amount of money to your business. This is often used with a product, where people can essentially preorder an item, giving you the funding you need to bring it into production. Each crowdfunding platform has its own rules for who can raise money and how.