The Best Small Loans of 2020
Small business loans are typically used to start a business, purchase inventory or equipment, purchase real estate, or expand an existing business. According to a report from the National Small Business Association, about three-quarters of small businesses were able to access adequate financing at the end of 2017, including through loans, credit cards, venture capital and crowdfunding.
The NSBA report indicates small business loans are a key component of economic growth for small businesses and their employees. There is a direct correlation between small business financing access and the ability to hire employees.
While small business loans can be difficult to obtain, there are options. In this guide, you’ll learn how small business loans work and how you can find the best loan to start or expand your small business.
What Are the Best Small Business Loans of 2020?
BlueVine: Best Lender for Borrowers With FICO Credit Scores As Low As 530
Funding Circle: Best Lender for Up to Five Year Loan Terms
OnDeck: Best Lender With No Collateral Required
Rapid Finance: Best Lender for Up to $1 Million Loan Amounts
StreetShares: Best Lender for Borrowers With Six Months Or More In Business
TD Bank: Best Lender for Online Loans And Lines of Credit Under $100,000
U.S. News conducted an in-depth review of the top small business loan companies to recommend the best traditional and alternative lenders. Factors including customer service ratings, product availability and loan terms were used to select the best lenders.
These lenders are a good starting point for most businesses. But there is no one-size-fits-all loan that is perfect for every business, so you should carefully research each option yourself.
How Do Small Business Loans Work?
Small business loans are used for business expenses. While some loans are for general business funding, other small business loans are for specific uses, such as working capital, commercial mortgage, or the purchase of new equipment or furniture.
Types of Small Business Loans
Term loans. A business term loan offers a lump sum with a fixed term and repayment amount. With each payment, you'll pay the principal and interest.
Business lines of credit. Business lines of credit are very similar to credit cards and offer a lot of flexibility. With a business line of credit, a lender approves you for a revolving line of credit with a maximum limit you can borrow. Similar to credit cards, you’ll be charged interest for the amount of money you draw, not on the maximum limit.
You can access your line of credit for any of your business needs, whether it’s to purchase inventory or equipment, invest in marketing or manage fluctuations from seasonal sales. As long as you make the minimum payments and don’t go over your limit, you can use your line of credit and repay what you borrowed for as long as you like.
Equipment loans. Equipment loans can be used to purchase and spread out the cost of a large piece of machinery or equipment for your business. The down payment can be up to 20%, but some loans may be available with no down payment. Usually, the equipment serves as collateral for the loan. Instead of taking out a loan, you may also have the option to lease equipment.
Invoice financing. If your small business struggles with cash flow issues because you’re waiting on invoices to be paid, you can use invoice financing, also known as factoring. With invoice factoring, you sell your unpaid invoices to a lender at a discount. The lender will provide you with the majority of the amount owed on the invoice upfront and hold a portion of the outstanding amount (usually 20%) until the invoice is paid.
You should carefully weigh the costs when considering invoice financing. There is a fee that is based on a percentage of the invoice, plus interest charged on the cash advance.
Merchant cash advances. If you need cash immediately, a merchant cash advance can provide access to capital. With a merchant cash advance, the lender provides you with a lump sum of cash in exchange for a portion of your future sales. You’re responsible for paying the amount of the loan plus fees.
You repay the advance with either a portion of your future credit and debit card sales, or with fixed daily or weekly transfers from your bank account. Your fee is determined by a risk assessment, with lower fees for lower-risk borrowers. Because of the high interest rates which can be in the triple digits, merchant cash advances are not recommended.
Commercial mortgage loans. The money borrowed from a commercial mortgage loan is used to buy, develop or refinance commercial property such as a warehouse, mixed-use building or retail center.
Franchise loans. If you want to purchase or expand a franchise, a franchise loan can help you pay for it. Franchise loans can be used for standard business opening expenses and franchise-specific expenses such as marketing fees or the franchise fee, which is paid upfront to open a franchise. While you can finance a franchise with a traditional term loan, some lenders that offer loans specifically for franchises. Some franchisors may offer funding to help you establish your franchise.
SBA Loan Guarantees
The Small Business Administration, a government agency that offers support and resources to small businesses, offers guarantees for loans. These SBA-backed loans were created by the SBA to help small businesses and startups, and are executed by commercial lenders who are approved by the SBA. With 7(a) loans, the SBA's primary lending program, the SBA guarantees up to 85% of loans up to $150,000 and up to 75% of loans over that amount, so there is reduced risk to the lender. The SBA doesn’t directly offer the loan, only the guarantee. There are four types of SBA-backed loans:
7(a) loan program. The SBA’s primary lending program, 7(a) loans are the most common, flexible and simple type of SBA loan.
Loans under the 7(a) program can be used for many different purposes, including toward working capital, construction of new buildings, renovations, establishing new businesses, the expansion of existing businesses and debt refinancing. There are restrictions, such as not using the money to pay back an owner for money they’ve already put into their business.
There are also special types of 7(a) loans to provide financial assistance for businesses with short-term capital needs, for businesses affected by NAFTA and to help with employee stock ownership plans.
There is an Express Loan Program where you will receive a response within 36 hours of submitting an application. The maximum loan amount is $350,000 and the SBA provides a 50% guarantee for loans granted through this program.
Loans of up to $5 million are available and are typically repaid in monthly installments. You can apply through a participating lender. The loan maturity depends on how the money is used but typically ranges from five to 25 years.
Microloan program. New or expanding small businesses are eligible to receive loans up to $50,000. These loans can be used for working capital or purchasing inventory, equipment, furniture, supplies or machinery. Microloans can’t be used to pay existing debts or purchase real estate.
The SBA makes funds available to designated intermediary lenders, which are nonprofits with demonstrated experience in lending and assisting others in business management. The maximum repayment term is six years, and the loan repayment terms vary according to several factors, including the loan amount, planned use of funds, the intermediary lender’s requirements and the small business borrower’s needs.
Real estate and equipment loans. The CDC/504 loan program provides businesses with long-term, fixed-rate financing for major assets such as real estate and equipment. These loans are provided by a Certified Development Company, which is a nonprofit corporation that helps with the economic development of its community.
Funds from a 504 loan can be used to purchase existing buildings, land or long-term machinery, to construct or renovate facilities, or to refinance debt in connection with an expansion of the business. These loans cannot be used for working capital or inventory. The typical 504 loan includes a 50% nonguaranteed loan secured from a private-sector lender; a 40% loan secured by the CDC, which is 100% backed by the SBA; and a 10% equity contribution from the borrower. The maximum amount of a 504 loan is $5.5 million, and these loans are available with 10- or 20-year maturity terms.
Disaster loans. These low-interest loans can be used to repair or replace real estate, machinery and equipment, and inventory and business assets that were damaged or destroyed in a declared disaster. The SBA offers disaster loans of up to $2 million to qualified businesses and includes assistance in both economic injury and physical damage.
Types of Small Business Lenders
Banks and credit unions. Banks and credit unions typically serve larger, more well-established businesses, including those that are categorized as small businesses. The APRs, terms and length of loans offered by banks and credit unions may vary, but rates on commercial and industrial bank loans have remained below 5% since 2009, according to the U.S. Small Business Administration.
If you’re having trouble getting approved for a small business loan through a big bank, you’re in good company. According to the NSBA report, only 15% of small businesses received a loan through a large bank.
You’ll have a better chance of getting a loan from a traditional bank with an SBA-backed loan. While SBA loans have more requirements for approval, they reduce the risk for the lender and can make it easier to get approved for a small business loan.
Alternative lenders. “Small businesses should be aware there are multiple channels available for borrowing needed funds,” says S. Michael Sury, lecturer of finance at the University of Texas at Austin. “There is a cottage industry full of private investors, hedge funds and private equity firms that have entered the direct lending business.”
Alternative lenders can be more flexible than commercial banks, as they have less regulation on the types of loans they can make.
There are two categories of alternative lenders:
Direct lenders. Direct lenders are finance companies that fund your loan with capital other than a bank and without a middleman such as a broker, investment bank or private equity firm. Some direct lenders offer SBA loans. Typically, small to midsize businesses borrow from direct lenders.
Peer-to-peer lenders. Online peer-to-peer lending directly connects you with investors who usually have a diversified loan portfolio made up of small portions of loans. A loan is often divided among several investors.
Borrowing criteria is usually less stringent than at traditional brick-and-mortar banks. Alternative lenders provide loans to borrowers who otherwise may not have access to financing, such as startups or businesses with a shaky financial history.
Because financing through a P2P marketplace poses a larger risk to lenders, the interest rates are often higher. Interest rates vary, but alternative loan products can have annual rates from 15% for a 36-month P2P loan and up to 45% for a four-month institutionally backed loan, according to the U.S. SBA. This is compared with an interest rate of less than 5% for industrial and commercial bank loans.
What Should You Do Before You Apply for a Small Business Loan?
You may be excited about your business, but lenders will need convincing to determine that your business is worth the risk. You’ll need to know how much you need to borrow, and have good credit and a solid business plan.
Take these steps to prepare before you apply, and you can increase your chances to get approved for a loan:
1. Determine how much funding you need. Examine your business expenses and consider how much of a loan payment you can afford. You can find out how large of a loan your business can afford by calculating your Debt Service Coverage Ratio.
The formula is a simple one: net operating income / total annual debt = DSCR.
Lenders are looking for small businesses that have a 1.0 ratio. This means your cash flow is equal to your monthly loan payment. However, it’s ideal to have a bit of a buffer, so lenders prefer a 1.35 DSCR. For example, if your annual net operating income is $135,000 and your total debt is $100,000, your DSCR is 1.35.
You’ll want to consider the impact taking on new capital will have on your small business, says Sury. There are a number of cases where businesses were able to borrow significant sums of capital, believing they were building a great capital reserve cushion, only to find that the ongoing borrowing costs and interest payments had a crushing impact on their bottom line.
“Just because capital can be borrowed, doesn't mean that it should be,” says Sury. “Small businesses should be mindful of exactly what terms are really needed and not try to exceed them simply for the sake of having excess cash in the bank.”
To minimize risk and ensure you net a positive return on your investment, you can perform a small business loan performance analysis before you commit to taking out a loan. A loan performance analysis will forecast how the small business loan will financially impact your business.
2. Check your credit score. Your personal credit score is a crucial part of the small business loan application process, as lenders often consider your personal credit, especially with startup business loans. The higher your credit score, the better terms and lower interest rates you’ll get on a small business loan.
“As a sole proprietor, your personal credit may be considered in the business loan application if you are using personal credit to secure the business debt,” says Rod Griffin, director of public education for Experian, one of the three major consumer credit bureaus. “Doing so is fairly common for a small business owner. Note that if the loan is made using your personal credit, failing to pay it may affect your personal credit history and your ability to qualify for new credit in the future.”
Carefully review your credit report so that it’s free of errors and identify and resolve other problem areas. Inaccuracies on your credit report can hurt your chances of getting a loan approved and may negatively impact your score. It’s important you try to clear these up before beginning the application process.
You can order a free credit report each year from all three credit bureaus on AnnualCreditReport.com. This is different than receiving your credit score. Some services require you to pay a fee to see your score, but many financial institutions offer free credit score access to customers.
If you’re already in business, you should check your business credit score. Whereas your personal credit is linked to your Social Security number, your business credit is tied to your Employer Identification Number. There are credit reporting agencies that deal only with business credit, such as Dun & Bradstreet.
Whereas a personal credit score on the FICO scoring system ranges from 300 to 850, the range for a business credit score is from zero to 100 or zero to 300, depending on the model. Like personal credit scores, your payment history, credit utilization and credit accounts affect your business credit score. Public records such as judgments, liens and bankruptcies will be reflected on your report. Other variables, such as the size of your business and how long it has been around, may also be considered.
3. Draft a strong business plan. A solid, comprehensive business plan is the foundation of your small business and shows potential lenders how profitable your venture is.
“It’s vitally important for small businesses to have organized, well-thought-out and professionally presented business plans,” says Sury. “If a small business approaches a lender without a compelling business plan in hand, it’s a recipe for disaster.”
A business plan includes:
Summary, which provides an overview of your plan
A description of your business and its main objectives
The primary products and services your business will offer
You and the management team’s skills and backgrounds, and how they relate to the success of your business
Your target customers, market and the competition
Sales and marketing plans
Organization and management, which includes the setup and responsibilities
Financials, such as the estimated cost to start or grow the business, a breakdown of ongoing expenses and what the funds would be used for
Projections, which include projected income and balance sheets for the first few years
Appendix, which provides supporting documents for your business plan
4. Talk to a business mentor. A business mentor can help you tighten up your business plan, connect with resources and more. You can find a business mentor through professional associations, former employers or networking mixers. Another option is Score, which is a nonprofit group with volunteer business counselors throughout the U.S.
5. Explore local resources for small business owners. Some of these include SBA District Offices and Score chapters, Veteran’s Business Outreach Centers and Women’s Business Centers. You may receive free counseling, advice or financial assistance for your new small business. If you’re a veteran with strong credit, you may qualify for a guaranteed loan through a Veteran’s Business Outreach Center.
How Can You Get a Small Business Loan?
Small business loans require significant documentation. You’ll need to fill out an application and provide supporting documents, which you should be ready to submit to the lender. Required documentation often includes:
Personal background. You’ll need to provide personal information on the application or a separate document, such as:
Resumes. Besides submitting your resume, you’ll need to submit professional resumes of each principal. Some lenders require applicants to have previous management or business experience, particularly for startup business loans.
Business plan. All loan programs require a sound, detailed business plan. The business plan should include a complete set of projected financial statements, including a profit and loss statement, an in-depth, five-year projected financial statement and a cash flow and balance sheet.
Income tax returns. Most lenders require applicants to submit personal and business income tax returns from the previous three years.
Loan history. You’ll provide records of past and current business loans.
Bank statements. Many lenders require one year of personal and business bank statements.
Collateral. Collateral requirements vary greatly. Some loan programs do not require collateral, but loans involving higher risk factors for default require substantial collateral. A strong business plan and financial statement might help you avoid collateral requirements. However, it’s still a good idea to prepare a collateral document that describes the cost and value of personal or business property that can be used to secure a loan.
Use of loan. This document outlines how you plan to use the loan.
Debt schedule. A debt schedule shows all your business’s outstanding loan and credit amounts, monthly payments, interest and payment dates.
Legal documents. Depending on your loan’s specific requirements, your lender may require you to submit one or more legal documents. Make sure you have the following items ready, if applicable:
Business licenses and registrations
Business lease (either a copy of your current business lease or proposed lease from landlord)
Business formation document, such as articles of incorporation or LLC filing
Copies of contracts you have with any third parties, such as subsidiaries and affiliates
How Should You Choose a Small Business Loan?
You should focus on eligibility requirements, loan options, costs and reputation when choosing a small business loan lender. Focusing on these factors will help you identify a lender that is most likely to approve your loan, offer acceptable terms and costs, and offer good service during approval, closing and repayment.
Minimum credit score
Minimum years in business
Minimum annual revenue
Loan types: Find a lender that offers the type of loan you’re looking for. To save time and ensure you get enough capital to start or grow your small business, create a business plan and pinpoint the type of funding you need before you begin your search.
Loan limits: If the lender doesn’t offer loans in the amount you need to start or grow your business, you’ll need to find one who will. Settling for a lower amount could burden you with a loan that falls short of adequately addressing your capital needs.
Loan term: Your loan’s term is the time frame you have to repay the loan. Loans with shorter lengths have higher monthly payments, but you may pay less in total interest on the loan. If you take out a loan with a longer term, your monthly payments may be lower, but you may have to pay more in total interest over the life of the loan.
Keeping loan costs minimal allows you to invest profits back into your business and not back to the lender. Look for a lender with the lowest costs, including:
APR. Short for annual percentage rate, this is the interest charged on your loan every year, plus all loan fees and costs associated with the loan.
Down payment. In some cases, the down payment for your small business loan is covered by collateral. Other small business loans require an equity investment. Down payment requirements vary, but you should expect to invest at least 10% to 30% of your own capital when taking out a loan.
Factor rate. A factor rate is typically used for merchant cash advances and short-term loans to determine how much you will owe in interest. Instead of a percentage, like with APRs, the interest rate for invoice factoring is expressed in decimal form. For example, if a small business takes out a $5,000 loan with a 1.2 factor rate, it will pay a total of $6,000 on the loan. Your factor rate is determined by the industry your business is in, how long you’ve been in business, the stability of your business and your monthly credit card sales. With factor rates, you generally pay more in interest than with loans that use APRs.
Origination fee. This fee is for processing a new loan. Some lenders include the origination fee in their interest rate or total loan balance, and some do not charge an origination fee.
Underwriting fees. These fees are charged by underwriters to review and verify the provided documentation in your loan application and for preparing the loan.
Closing costs. These fees are any other costs tied to closing the loan, such as a business valuation, commercial real estate appraisal, filing and recording fees or loan-packaging fee.
SBA loan guarantee fee. The lender pays this fee and has the option to pass it along to you at closing. This fee is not based on the total loan amount, but the maturity and dollar amount guaranteed. If the guaranteed amount of an SBA-backed loan is 85%, the fees are based on that 85%. For example, for a 7(a) loan with a maturity of more than one year, the fee is 3% of the portion that is guaranteed by the SBA on loans of $150,000 to $750,000, and 3.5% on loans that are more than $750,000. Note that lenders can’t charge a separate origination fee on an SBA 7(a) loan, though they can charge packaging fees that are reasonable and customary for the services performed.
Additional fees. Other fees associated with a small business loan include late payment fees, check processing fees and prepayment fees, which are charged if you make early payments.
It’s important to carefully read the fine print of loan agreements, says Sury. “In some situations, small businesses may be given loans, but these loans come with such restrictive terms on what it can be spent on, what ongoing reports must be made to the lender, and what activities can or cannot be done, that it makes the relationship untenable.” By carefully combing over the fine print, you won’t be blindsided by the terms and agreements of the loan.
A lender’s reputation can tell you what you should expect from it. You can research a lender’s reputation by finding information on current and past customer experiences. The J.D. Power U.S. Small Business Banking Satisfaction Study is a good place to start. The annual study surveys banking customers and measures factors including overall satisfaction, fees and problem resolution.
Not every lender is included in the J.D. Power study, particularly alternative lenders. For lending companies that aren’t included, look at reviews in comparable categories from Trustpilot, which rates companies based on an aggregate of customer reviews, and the Better Business Bureau.
What Are the Best Banks for SBA Loans?
Traditional banks can offer a good reputation, stability and potentially lower interest rates, but loan approval for small businesses can be tough. They tend to have more strict eligibility requirements than alternative lenders.
Applying for a government-backed SBA loan increases the likelihood you’ll be approved for a small business loan with a traditional bank. SBA loans have fairly standard eligibility requirements and fees, and limits on the loan and APR, so it is difficult to compare banks solely based on their SBA offerings. Instead, you should compare them based on their likelihood of approving your application, as meeting SBA requirements does not necessarily mean you’ll be approved by the lender.
Below are the banks that most actively approve SBA loans as of September 2017. They offer SBA and non-SBA loans, however, non-SBA small business loans have more strict eligibility requirements that typically limit lending to businesses that are well-established and successful. These lenders are a good place to start your search for small business loans with a traditional bank.
What Can You Do if You're Denied a Small Business Loan?
If you are denied a small business loan, you aren’t at a complete loss for options. Consider the following:
Take out a personal loan. With a personal loan that allows for business expenses, you can spend the money on whatever you like, including business-related costs.
Get a business credit card. A business credit card may be a good option for a line of credit if you aren’t able to obtain a small business loan. They are easier to get than a small business loan. On the downside, the interest rates tend to be much higher than with small business loans.
Some perks of a business credit card are that you have access to a revolving line of credit and may earn rewards points you can use for travel or purchases for your small business.
Apply for a small business grant. There are a number of grants available for small business owners. For instance, if your small business is engaged in scientific research and development, you may qualify for federal grants under the Small Business Innovation Research and the Small Business Technology Transfer programs.
There are also grants that are specifically for women and minorities, for those who are either currently operating or want to start a small business in a specific region or state, or are opening a franchise. Some grants even include additional resources to get your small business off the ground such as mentorship and workshops.
Author: Jessica Merritt