How Startup Loans Work

What is a business loan?

A <a href=“https://www.startups.com/library/expert-advice/best-banks-for-business-loans”>business loan is an amount of money a business borrows from a financial institution, with set requirements for the amount of time it will take to pay back, as well as interest rates.

<a href=“https://www.startups.com/library/expert-advice/best-banks-for-business-loans”>Businesses get loans in order to help them start or to fund expansion. They’re one of a range of funding options for startups.

Types of business loans for startups

There are five main types of <a href=“https://www.startups.com/library/expert-advice/best-banks-for-business-loans”>business loans that are relevant for startups:

1. SBA small business loans
2. Business credit lines
3. Short term loans
4. Invoice financing
5. Merchant cash advances

Let’s take a closer look at each one.

SBA Small Business Loans

A SBA small business loan is a loan that is backed by the Small Business Administration (SBA).

Founded in 1953, the SBA is a federal government program that provides support to small business owners in the form of mentorship, workshops, counseling, and small business loans.

While the loans are backed by the SBA, they don’t come directly from the SBA. You’ll have to find a local lender who provides SBA loans in order to access the funding.

Who qualifies?

There are three main types of SBA small business loans:

1. 7(a) Loan Program
2. 504 Loan Program
3. 7(m) Microloan Program.

Each type of SBA small business loan has slightly different requirements, but generally, you have to qualify as a small business according to the SBA size requirements, be a for-profit business, operate within the United States, have good personal and business credit, and not have other financing options (like your own wealth).

Loan amounts

SBA loans have an upper limit of $5 million. Therefore, they’re a better option for small businesses and startups who need smaller amounts of capital, versus those who might need many millions of dollars.

Time to funds

The process for applying for a SBA loan can take up to six weeks, with some taking only a couple weeks. If you qualify for a SBA loan, you can expect your funds as soon as one week after qualifying.

Interest rates

As of May 2018, maximum interest rates on SBA loans range from 7% to 9.50%.

Pros of SBA loans

• The loan is backed by the federal government. That means banks are more likely to loan to riskier companies — like startups — than they might otherwise.
• The equity requirement is relatively low compared to other loans.
• SBA loans have a floating interest rate that’s tied to the Prime Rate. The maximum interest rate for these loans is Prime Rate plus 2.25% for loans maturing in 10 years or less, and Prime Rate plus 2.75% for loans maturing in 25 years.
• People and companies who don’t have access to other forms of capital might find it easier to qualify for a microloan than for a larger or more traditional loan type.

Cons of SBA loans

• SBA small business loans are relatively small. They have an upper limit of $5 million.
• These loans may require more paperwork than a traditional loan. Startups or founders with poor credit are unlikely to qualify.

How to apply

If you’re interested in applying for a SBA loan, you can check out the SBA website to find a financial institution in your area that provides SBA loans. You can also learn more about SBA loans in our full guide.

Credit cards

While not a traditional “loan,” business credit cards are a great option for very early stage startups who need help getting going.

Choose one with a 0% introductory APR, because that means that as long as you’re able to pay off the balance each month (or at least by the end of the first year, which is when most credit cards interest rates kick in), you’re basically getting a free loan.

However, beware of high interest rates — and don’t overestimate how quickly you’ll be able to pay back a credit card. Once that introductory period is over, any balance you’re carrying will likely come with a hefty interest rate.

a. Who qualifies?

Credit cards usually have very few requirements for qualification. Banks are in the business of profiting off of small businesses. (While, yes, helping them grow.)

However, people with bad personal credit will find it difficult to qualify for a business credit card, as most banks are going to look at your personal credit to determine whether or not they’re willing to give you a credit card for your new business or startup.

Most banks use the FICO scoring system, which is:

• Excellent Credit: 750+
• Good Credit: 700-749
• Fair Credit: 650-699
• Poor Credit: 600-649
• Bad Credit: below 600

Check your credit rating with one of the big three credit agencies before starting the process of applying for a first time business loan.

b. Loan amounts

The loan amount — or credit line — that you can get with a credit business card depends totally on the type of card, your personal credit history, your business credit history (if you have any), and your business itself.

However, the highest business credit limit right now probably tops out around $50,000.

c. Time to funds

Unlike other sources of small business funding, credit cards are very quick to apply for. Once you’ve been approved, you can expect to have your card in hand within seven to 10 days.

d. Interest rates

Interest rates vary from card to card. As mentioned above, it’s a good idea to go for a card that has an initial 0% APR (annual percentage rate). That way you have a year without any interest whatsoever.

As of April 2018, the common APRs offered online for business credit cards was 14%, which is about 2.5 points lower than average for personal cards.

e. Pros of business credit cards

• They’re easier to get than other loans or lines of credit.
• They have higher credit limits than personal credit cards.
• They can help boost your credit rating.
• It’s easier to keep personal and professional expenses separate.
• You can build up points that can be used for travel and other perks.
• It’s easier to keep track of employee spending, if you have employees, and some even offer preset employee spending limits.
• It helps build credit history for your business.

f. Cons of business credit cards

• If you have trouble making payments, it may affect your personal credit.
• High interest rates, late fees, and annual fees can add up and be brutal.
• Many business cards don’t have purchase protection.
• Business credit cards often have a higher APR than personal cards.
• Interest rates can fluctuate.
• A business credit card may come with foreign transaction feeds.

g. How to apply for a business credit card

First, get your credit score so you can determine which business credit cards you even qualify for. You can get it from one of the big three credit agencies.

Once you have that, calculate your business’ annual revenue — the credit card agency is going to want to know that information.

Decide what kind of rewards program you want, and then go take a look at different business credit cards to see what’s the best fit.

Maybe make a spreadsheet of the factors most important to you — like APR, credit score needed, limits, rewards, signup bonuses, etc. — in order to do a side-by-side comparison.

Then, apply via the card’s website. That’s it! If you’re rejected for your first choice move on to the next. There are plenty of options out there.

Here are some of Credit Karma’s best recommendations for Business Credit Cards and Business Loans.

Short-Term Loans

Short term loans relatively small amounts of money that have to be paid back within three to 18 months.

They’re often used as a stop-gap when a company is having cash flow problems, for emergencies, or to help companies take advantage of a business opportunity.

a. Who qualifies?

Short term loans are a good option for startups with good cash flow who have been in business for at least two years.

If your startup has good cash flow, it may even override other factors like poor credit. Therefore, a short term loan might be a good first time business loan option for founders with poor credit.

Companies who make between $25,000 and $150,000 yearly, with a credit score of at least 600, and who have been in business for at least two years may consider this option.

b. Loan amounts

Short term loans are usually between $2,500 and $250,000.

c. Terms

The loan terms for short term loans are usually between three and 18 months.

d. Time to funds

The time to funds for short term loans is extremely fast! If you qualify, you can expect access to the funds as quickly as one day.

e. Interest rates

Interest rates start at 10%.

f. Pros of short term loans

• People with less-than-perfect credit may apply.
• There’s very little paperwork required.
• Short term loans come with a set payment structure.
• They can be used for a range of purposes.

g. Cons of short term loans

• Payments have to be made weekly.
• May have higher annual costs than longer-term loans.

h. How to apply for a short term loan

Short term loan applications exist online only. You’ll need your driver’s license, a voided business check, proof of ownership of your company, bank statements, your credit score (business and personal), and your personal tax returns.

Check out NerdWallet’s list of options for companies that offer short term loans.

Invoice Financing

Invoice financing is a type of business loan that uses your outstanding invoices as collateral for a loan. The company applies for a cash advance on a percentage of payments owed, then pays it back when they get paid.

Who qualifies?

Invoice financing is a great option for B2B companies with outstanding invoices. It’s not an option for B2C companies that don’t have invoices to leverage.

b. Loan amounts

The loan amounts for invoice financing vary depending on the amount of money owed your company.

However, the bank will usually offer about 85 percent of the amount owed, with the option to receive the final 15 percent later.

Many institutions will also take the applicant’s credit into account when determining how much they will loan.

c. Terms

The money needs to be repaid once the customer with the outstanding invoice makes their payment.

d. Time to funds

Funds can be available in as little as one day.

e. Interest rates

Invoice financing doesn’t use interest rates, but instead charges fees for loaning you the money.

Most institutions will charge a processing fee of 3 percent, as well as a “factor fee,” which is a weekly percentage owed.

For example, many institutions charge a 1 percent factor fee, which means they take 1 percent out your loan out of the 15 percent held in reserve every week until the total is paid.

f. Pros of invoice financing

• Time to funds is short.
• They don’t take long to pay back.
• They can be a great way to solve a short term cash flow problem.
• Founders with not-great credit (over 600) will probably qualify.

g. Cons of invoice financing

• If your clients take a while to pay you, the fees can be hefty.
• They’re not an option if your company doesn’t use invoices.

Equipment Financing

Equipment financing is a popular type of business loan for startups and companies that need to purchase major pieces of equipment.

It’s fast, relatively easy, and a good option for startup founders or new business owners, as the equipment itself stands in for collateral for the loan.

Who qualifies?

Most businesses qualify for equipment financing, because the equipment stands as collateral. That means if you don’t pay back the loan, the financial institution has the right to take the piece of equipment back from you.

Founders with some revenue and less than perfect credit (over 630) can still apply.

b. Loan amounts

Loan amounts can be up to 100 percent of the cost of new equipment.

c. Terms

The loan terms for equipment financing are usually the expected life of the equipment.

d. Time to funds

Equipment financing funds can be available in as little as two days.

e. Interest rates

Interest rates for equipment financing range from 8 to 30 percent.

f. Pros of equipment financing

• Funds arrive quickly.
• There isn’t too much paperwork involved.
• Equipment being purchased serves as collateral, so it’s a good option for founders with limited revenue or not so great credit.

g. Cons of equipment financing

• Certain equipment may become obsolete before the loan is repaid.
• Some equipment depreciates over time, meaning you can’t deduct the full amount every year.

h. How to apply for equipment financing

In order to apply for equipment financing, you’ll need your credit score, as well as financial documents (like tax returns and bank statements) showing that your business is in good financial standing.

You’ll also need your driver’s license, a voided check, and an equipment quote showing how much the piece of equipment you’re trying to buy is worth.

Merchant Cash Advance

Who qualifies?

A merchant cash advance is a good option for a startup or small business that needs cash now and also has customers that pay via credit card.

In this type of loan, a financial institution gives a cash advance in exchange for a percentage of daily credit card transactions, plus a fee.

b. Loan amounts

Merchant cash advances range from $2,500 to $250,000.

c. Time to funds

It’s possible to receive funds in as little as two days.

d. Interest rates

Merchant cash advances have factor fees of 1.14 to 1.18. A factor rate is what you multiply your loan amount by to figure out the total you’ll owe.

e. Pros of merchant cash advance

• Money is accessible quickly.
• The approval process is relatively simple.
• Founders and companies with bad credit may still apply.
• The money can be used for a range of different purposes.

f. Cons of merchant cash advance

• The fees are higher than a normal loan. It’s the most expensive type of business loan.
• Repaying through daily credit card transactions means a reduced cash flow.
• You may have trouble changing merchant service providers.

h. How to apply for merchant cash advance

Merchant cash advances are almost always given online. The institution will look at your credit card processing statements and some will also ask for your credit score and banking documents.

Other funding sources

Don’t miss our guides to the full range of startup funding options, below.

Federal Government Grants for Small Business: What You Need to Know

Venture Capital: What It Is & Why Use It

Series A, B, C, D, and E Funding: How It Works

What is Crowdfunding?

Types of Crowdfunding: Donation, Rewards, and Equity-Based

Private Investors for Startups: Everything You Need to Know

Convertible Notes (aka Convertible Debt): The Complete Guide

Small Business Startup Loans: What You Need to Know