How do small business loans work

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    Ashlyn Brooks

    Page written by Ashlyn Brooks. Last reviewed on April 19, 2024. Next review due October 1, 2025.

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      Securing a business loan can be a pivotal step for small and medium-sized enterprises (SMEs) aiming to grow or sustain their operations. Understanding the timeframe and process involved in obtaining financing is crucial for effective planning and decision-making. Here at Swoop, our experts wanted to provide a detailed explanation of this topic, helping business owners navigate the complexities of securing a business loan efficiently.

      What is a business loan?

      A business loan is a specific type of financing designed to meet the financial needs of a company. It provides businesses with the capital necessary to fund operational costs, expansion efforts, or equipment purchases, allowing for growth and sustainability without depleting cash reserves.

      How do business loans work?

      Business loans work by providing a lump sum of money or a credit line to businesses in exchange for repayment over time, with interest. The terms of the loan, including repayment schedules and interest rates, vary widely depending on the lender and the borrower’s financial health.

      What are business loans used for?

      Business loans can be used for a wide range of purposes, from bridging gaps in cash flow and purchasing inventory to financing large-scale expansion projects and acquiring new equipment. Each loan type is tailored to fit different business needs and scenarios, ensuring that companies can continue to operate and expand effectively.

      What can you not use a business loan for?

      Typically if it’s unrelated to your business, your business loan shouldn’t be used for it. For clarity on what you can and can’t use your business loan funds take a look at your outlined terms and conditions. These can be found in your loan agreement. 

      What are the most common types of business loans?

      There are several types of business loans available, each designed to support different financial needs and business scenarios. Here’s a breakdown of the most common ones, detailing what each type is and who it’s best suited for.

      SBA loan

      • What it is: An SBA Loan is a government-guaranteed loan that offers long-term financing options under relatively favorable terms. This type of loan is partially backed by the U.S. Small Business Administration, reducing risk for lenders.
      • Who it’s best for: SBA loans are ideal for businesses looking for substantial funding with lower interest rates and longer repayment terms. They are particularly beneficial for businesses that may not qualify for traditional bank loans.

      Term loan

      • What it is: A term loan provides a lump sum of cash upfront, which businesses repay with interest over a predetermined period.
      • Who it’s best for: This type of loan is best for businesses with predictable revenue streams who need funding to invest in long-term growth opportunities.

      Working capital loan

      • What it is: Working capital loans are short-term financing options used to cover everyday operational expenses such as rent, payroll, and inventory.
      • Who it’s best for: These loans are suitable for businesses that need to manage cash flow fluctuations, particularly seasonal businesses.

      Business line of credit

      • What it is: A business line of credit offers flexible access to funds up to a certain limit, allowing businesses to draw and repay as needed, similar to a credit card.
      • Who it’s best for: It’s best for businesses that face unpredictable expenses and want the flexibility to access funds as needed without reapplying for a new loan.

      Merchant cash advance

      • What it is: A merchant cash advance provides a lump sum based on future sales. Businesses repay the advance with a percentage of daily sales transactions.
      • Who it’s best for: This option is best for businesses with high credit card transaction volumes and those needing quick access to capital.

      Invoice factoring

      • What it is: Invoice factoring involves selling your accounts receivable at a discount to a factoring company that then takes over the collection process.
      • Who it’s best for: Best for businesses that need immediate cash and have reliable customers but long payment cycles.

      Equipment financing

      • What it is: Equipment financing is a loan specifically for purchasing business equipment. The equipment itself often serves as collateral for the loan.
      • Who it’s best for: It’s ideal for businesses that need to purchase or replace expensive machinery or equipment but do not want to deplete their cash reserves to do so.

      Where can i get a business loan?

      Business loans can be obtained from several sources, including traditional banks, credit unions, online lenders, and alternative financing providers. Each lender offers different advantages depending on your business’s specific needs, such as competitive interest rates, flexible terms, or faster funding processes. 

      Here’s a look at the two most primary sources of business lending:

      Traditional banks

      • What they offer: Traditional banks are often the first stop for business loans. They typically offer the most competitive interest rates and long-term financing options. Banks can provide a variety of loans, including SBA loans, term loans, and lines of credit.
      • Best for: Established businesses with strong financial histories and those who need larger loan amounts. Also ideal for businesses that prefer face-to-face interaction and comprehensive banking services beyond just a loan.
      • Keep in mind: The application process can be more rigorous, requiring extensive documentation and longer approval times. Additionally, traditional banks may have stricter qualifying criteria, which can be challenging for newer businesses or those with less-than-perfect credit.

      Online lenders

      • What they offer: Online lenders provide a more streamlined and accessible lending experience. They often have less stringent requirements for loan approval and can provide faster funding—sometimes within 24 hours of application approval.
      • Best for: Newer businesses, businesses with volatile cash flows, or owners with lower credit scores. Also suitable for those seeking convenience and quick funding.
      • Keep in mind: While online lenders offer the convenience of easy application processes and quick access to capital, they may charge higher interest rates and fees compared to traditional banks. 

      How to qualify for a business loan

      Qualifying for a business loan typically involves meeting certain criteria set by the lender, which may include a minimum credit score, a proven track record of revenue, and a solid business plan. 

      Lenders also often require detailed financial statements and may look at the debt-to-income ratio of your business. Strengthening your application with a comprehensive understanding of your financial situation and a clear purpose for the loan can improve your chances of approval.

      When you’re ready to apply for a business loan, there are several key factors lenders will look at to determine if you’re a good fit. Here’s a rundown of what you’ll need to have in order, presented in a more conversational way:

      1. Personal Credit Score: Generally, you’ll need a score of at least 600 for simpler loans, but the higher your score, the better your chances of getting favorable terms. Brushing up your credit score before applying can make a big difference.
      2. Revenue and Financial Health: Lenders want to see that your business isn’t just surviving, but thriving enough to take on and repay a new loan. You’ll need to show solid proof of income, usually through bank statements and financial statements like profit and loss accounts. Make sure your numbers demonstrate that you meet or exceed any minimum revenue requirements the lender might have.
      3. Business Plan: This is your chance to show off your strategic thinking. A robust business plan should lay out how your business works, who your competitors are, what your market looks like, and detailed financial projections. It’s your way of telling lenders, “Here’s my blueprint for success—and here’s how your loan fits into that plan.”
      4. Debt-to-Income Ratio: This is all about balance. Your debt-to-income ratio shows lenders whether your business earns enough to manage loan repayments comfortably. A lower ratio usually signals that your business can handle additional debt without stress.
      5. Collateral: If you’re going for a secured loan, you’ll need to offer up something valuable—like equipment, inventory, or real estate—as collateral. This is a safety net for lenders, giving them a way to recover their money if things don’t go as planned.
      6. Industry Experience: Having experience in your industry can be a huge plus. It shows lenders that you know the ins and outs of your market and are capable of navigating the challenges your business might face.
      7. Legal and Financial Documentation: Get your paperwork in order. This includes Business filings from your state, personal and business tax returns, incorporation papers, leases, and any franchise agreements. Being organized and ready to present all required documents can speed up the loan process.

      How swoop can help

      Don’t let the complexities of securing a business loan hinder your company’s growth. At Swoop, we make it easy for you to explore a variety of funding options that are tailored specifically to your business needs. Whether you’re launching a startup or planning to expand your established business, Swoop is here to help streamline the process of getting the financing you need quickly and efficiently.

      Visit us to check the available funding options and take a crucial step toward securing your business’s financial future today. With Swoop, you can ensure that your journey to obtaining a business loan is as smooth and successful as possible.


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      Written by

      Ashlyn Brooks

      Ashlyn is a personal finance writer with experience in business and consumer taxes, retirement, and financial services to name a few. She has been published in USA Today, Kiplinger and Investopedia.

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