A startup business loan helps new businesses get off the ground. According to the Federal Reserve Banks’ 2022 Small Business Credit Survey, 70 percent of companies under two years old used loans for operating expenses, and 67 percent used loans for expansion in 2022.

Due to the higher risks of financing new companies, startup loans require lenders to take on more risk. However, both traditional banks and online lenders are often willing to provide these loans.

The best startup business loans will fund projects for companies with limited operating history and credit. In return, you can expect additional requirements such as significant collateral or a higher interest rate.

How a startup business loan works

Startup loans function similarly to any other business loan: you apply for funding, a lender evaluates your creditworthiness, and if your loan is approved, you repay the funds with interest.

Here’s a closer look at how a startup business loan works:

Requirements

Startup business loans may have more lenient requirements, such as accepting borrowers with lower revenue streams. It’s important to review the requirements for revenue, credit score, and other criteria before applying to ensure you’re applying with a lender that will approve financing for a startup.

Given the high failure rate of new small businesses, lenders may require additional assurances to offset their risks. You might need to provide significant collateral, sign a personal guarantee, or accept a higher interest rate.

Obtaining a startup business loan is often easier if you launch your business before seeking funding. Demonstrating an operating history can significantly improve your chances of securing financing.

Applying

Once you understand the requirements, gather the necessary documents to apply for the startup loan. These typically include personal identification, your Social Security number, and business formation documents. You should also collect business bank account statements, licenses, and other information detailing your company’s operations.

Creating a comprehensive business plan is crucial. It should outline how you intend to use the funds and demonstrate your ability to repay the loan. Lenders will review the business plan to assess the strength of your business operations and your repayment capacity, which is particularly important for startups.

After gathering all required documents, complete the lender’s application and submit the paperwork. The lender may reach out for additional documents or further information about your business.

Application review

After you submit your application, lenders typically take anywhere from a few days to several weeks to review it. During this period, the lender will evaluate your creditworthiness and your ability to repay the startup business loan. Approval is granted only if the lender considers your business to be a credible risk.

If the lender determines that you lack the financial capacity to support repayment or if your industry has a high risk of failure, your loan application may be denied. In some cases, the lender might approve only a portion of the funding you requested.

If you do not receive the funding you need or your application is denied, you can work on improving your loan application and apply with a different lender. Online lenders often have more lenient requirements and may be more willing to take on risk compared to traditional banks.

Repayment

Once your startup loan is approved, review your business budget to ensure you can manage the repayments before signing the loan agreement. You can estimate the loan repayments in advance by using a business loan calculator.

After finalizing the paperwork, you will receive the funding, and repayments will begin according to the agreed-upon schedule. If you have a term loan, the funding will be provided as a lump sum. If you have a business line of credit, you’ll be approved for a specific amount that you can draw from as needed.

Throughout the loan term, it’s crucial to make all payments on time. If your revenue drops and you anticipate missing a repayment, communicate with your lender promptly. They may be willing to work with you to ensure the loan is repaid.

Startup loan vs. conventional loan

Startup loans are often provided by the same lenders that offer conventional loans. They might be specifically marketed as startup loans, or simply as small business loans with more relaxed requirements for credit scores or time in business.

Types of startup loans

Startups can explore various types of loans, each designed for different needs. For example, a startup seeking flexibility might prefer a line of credit, while one needing to make a significant one-time purchase might opt for a term loan.

Here’s a breakdown of different startup loan options and their uses:

  • SBA Loans: Backed by the government, these loans offer easier approval and substantial loan limits. Through the SBA 7(a) program, you can secure loans up to $5 million.
  • Microloans: Typically offered by SBA lenders, these small loans have a maximum amount of $50,000, ideal for startups needing modest funding.
  • Term Loans: Disbursed in a lump sum, term loans are suited for one-time purchases. They come in short-term and long-term options.
  • Lines of Credit: These provide a flexible source of funds up to a specified limit, which you can draw from as needed. Many are revolving, allowing repeated borrowing and repayment.
  • Equipment Financing: Designed for purchasing costly equipment, these loans have long repayment terms with the equipment serving as collateral, which may simplify qualifying.
  • Invoice Factoring and Financing: Allows you to sell unpaid invoices to a third party for quick access to funds.
  • Private Loans: These can be obtained through direct loans from investors, peer-to-peer lending platforms, or personal connections such as family and friends.

Alternatives to startup business loans

Startup loans can be a valuable funding source for new businesses, but they come with their own set of advantages and disadvantages. It’s crucial to explore all available options when seeking to finance your startup. Here are some alternatives to consider:

  • Grants: Grants offer funds that don’t need to be repaid, making them a great choice if you want to avoid debt. They are often targeted at specific industries or groups and can be highly competitive, but they provide a valuable opportunity for funding without the burden of repayment.
  • Business Credit Cards: These can be a flexible tool for managing operational expenses. Many top business credit cards come with introductory interest rates and rewards that can help save money. If you pay off the balance each month, you can avoid interest charges.
  • Merchant Cash Advance: For startups needing quick access to funds, a merchant cash advance can be a viable option. This financing method uses future credit card sales and revenue to repay the loan. However, it’s important to be cautious, as it can lead to a high cost of borrowing and potentially create a cycle of debt due to the percentage of future revenue that will be used for repayment.

In Conclusion

To maximize your chances of securing a startup loan, aim to have at least six months of business operations and a solid business credit score or strong personal credit score. Apply with lenders known for approving startup loans and ensure your application is well-prepared with comprehensive documentation, including financial statements and a detailed business plan outlining your repayment strategy.

Lenders will assess your ability to repay the loan before granting approval. Once approved, you will begin making loan repayments. Comparing offers from multiple lenders can help you find the best terms and conditions for your business.