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Updated Jan 03, 2024

What SMBs Need to Know When Choosing a Small Business Loan

Here's everything you need to know about acquiring a loan for your small business.

Mike Berner
Written By: Mike BernerSenior Analyst & Expert on Business Operations
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Small business loans are an essential tool for buying and growing a business or for staying afloat when times are tough, but it can be challenging to navigate the many small business funding options and to decide what type of financing is right for you. Before settling on a lender for your business, you should understand all of your choices, as well as your business’s needs. 

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Types of small business loans

There are many top loan options for small businesses, such as traditional loans, equipment loans and working capital loans. Lenders include the U.S. Small Business Administration (SBA), conventional banks and alternative lenders. Each has its own set of positives and negatives. 

“While there are numerous options from which to choose, not all deliver the same benefits,” said Tom Coletta, senior vice president of corporate banking at City National Bank of Florida. 

First, let’s look at some common forms of small business funding. 

Traditional bank business loans

Traditional bank loans typically feature low interest rates, a detailed payment schedule and the ability to retain total ownership of the business. 

The types of loans offered by banks include term loans, which are geared more toward expanding a business than starting a new one. They can be paid back over one to five years at lower monthly rates. However, they are better suited for more established businesses than for startups. Other funding options from banks include lines of credit, real estate financing, working capital loans and equipment loans. 

According to Jay DesMarteau, head of commercial banking at LendingClub, one of the chief concerns for borrowers is how long they need the loan. 

 “A line of credit would most often be used for short-term funding needs, while a term loan or commercial real estate mortgage offers multi-year financing for expansions or to purchase property,” DesMarteau said. 

SBA loans

Loans backed by the SBA are prized by business owners for their low interest rates and extended repayment terms. You will need to go through an extensive application process, so this isn’t the best choice for businesses that need emergency funding. That said, SBA loans are safe and attainable for businesses that might have been turned away by other lenders

“SBA loans allow approvals in some cases, such as when the down payment or a business’s cash flow is too low, because of the government guarantee,” DesMarteau said. “There is a misconception that SBA loans are a startup loan and that the government gives them away, but it is true that they have different credit underwriting standards, terms and other factors than a traditional small business loan.”

Did You Know?Did you know
Many SBA loans can be repaid over 10 years or more, which is a significantly longer term than other funding sources offer.

Alternative loans

Although traditional banks offer some of the best terms for financing, they usually maintain stricter requirements for applicants. You will need a solid credit score and proof of at least several years of profitability. Business owners with lower credit or little time in operation will likely have to pursue other sources of funding, such as financing from an alternative lender.

Alternative lenders offer many of the same types of funding as traditional banks, including term loans, lines of credit and working capital loans. The upside of alternative lenders is that you can often get approved quickly and easily, and some lenders even offer same-day funding into your business bank account. But while alternative funding features a short application process, downfalls of using alternative lenders include much higher interest rates, a shorter payback time and less control over the business.

FYIDid you know
Applying for an alternative loan differs from applying for an SBA loan. It is important to know what is required for each application.

Secured/unsecured loans

The difference between an unsecured loan and a secured loan is that a secured loan is backed by collateral. This means that if the borrower cannot repay the loan, the lender can take possession of the collateral to recoup their losses. Secured loans typically have lower interest rates because the lender has less risk.

An unsecured loan is not backed by collateral. This means that there is no property or asset the lender can take possession of if the borrower cannot repay the loan.

Secured loans are easier to acquire than unsecured loans because of the collateral required. This type of loan is often suited for new businesses with startup costs and funding needs of over $50,000. If you have good credit, you can expect to obtain an unsecured loan of up to $50,000. However, startups with business owners who have poor credit are often turned away. [Learn more about loan options for those with poor credit.]

How to choose a small business loan

Before you decide on a small business loan, it is essential to take several preliminary steps. First, make sure you assess your business’s funding needs, as well as cash flow and expenses. Thoroughly researching lenders and carefully weighing funding offers will ensure you don’t overpay for financing. 

Outline your business’s funding needs.

Before choosing a loan, business owners should write a business plan and outline their objectives for the company, Coletta said. This will give you and your lender a better idea of the best funding solution for your situation.

“Prior to meeting with a banker or lender, it is important to have a business plan in place, preferably one that has been reviewed by your certified public accountant,” Coletta said. “The plan should include articulated short- and long-term financial goals.”

Ask yourself what you need to reach your goals. From there, find a banker who can help you project the growth of your business and craft a lending solution, Coletta added.

TipBottom line
Knowing how to use SMART planning can help you set goals for your business. 

Assess cash flow and expenses.

Your cash flow cycle directly affects the type of loan needed for your business. Consider your payment cycle, the flow of cash in and out of your business, and the best way to maintain steady revenue.

“Make sure you have a solid grasp of your accounts receivable and that your banker understands your payment mix,” Coletta advised. “Talk with your banker about how these factors affect your cash flow so he or she can design an appropriate solution.”

It is also important to understand your expenses so you know how much money you will need from your potential lender. For example, if you have one office, you might not need to hire an HR professional immediately. But this could change down the line if you decide to grow your business.

“Do you have a realistic understanding of both current and potential expenses?” Coletta said. “Take a look at the size of your business and its growth potential.”

Research lenders and obtain quotes.

Begin by searching online for small business lenders in your area. Look for lenders that specialize in the type of loan you need, such as SBA loans, lines of credit or equipment financing. 

Also check with the SBA, which offers a variety of loan programs for small businesses and can help connect you with participating lenders. You can visit the SBA’s website or contact your local SBA office for more information.

Once you have a list of potential lenders, compare their rates and fees. Look for lenders that offer competitive interest rates and flexible repayment terms. Check out online reviews and ratings of the lenders you are considering. This can give you a sense of the lender’s reputation and the experiences of other small business owners who have borrowed from them.

>>Read More: Loan Repayment Calculator

Weigh your offers.

It may be a good idea to apply for loans from several lenders. Many small business funding providers can give you an opening offer without doing a hard credit pull. 

The interest rate is one of the most important factors to consider when you’re comparing loan quotes. A lower interest rate means lower overall borrowing costs. Also pay attention to the loan term, which is the length of time over which you will repay the loan. Compare the loan terms of the different quotes you receive, as a longer term may mean lower monthly payments but higher total interest costs.

Be sure to compare any fees associated with each loan — such as origination fees, closing costs or prepayment penalties — which can add significant costs to a loan over time.

Minimize your risk.

There are always risks involved with securing a business loan. Navigating small business funding can be a complex process, especially if you’re unfamiliar with the more technical aspects of finance. That’s why it’s important to discuss concerns right away and be transparent with your intentions.

“Conversations about risk should happen upfront,” Coletta said. “Banks look at debt levels, cash flow and liquidity carefully. It is important to understand your bank’s guidelines in these areas.”

With proper research, planning and transparency, any small business owner should be able to find the right funding solution. As long as you’re willing to work with your lender, you can increase your chances of securing the funding needed to grow your business.

Sammi Caramela contributed to the writing and reporting in this article. Some source interviews were conducted for a previous version of this story.

Mike Berner
Written By: Mike BernerSenior Analyst & Expert on Business Operations
Mike Berner brings to over half a decade of experience as a finance expert, having previously served as an economic analyst for the U.S. Army Corps of Engineers. His expertise lies in conducting quantitative analysis and research, providing invaluable guidance for navigating the modern financial landscape. Berner, who has a bachelor's degree in economics and a bachelor of business administration in finance, enjoys simplifying complicated financial concepts for entrepreneurs and business owners. From deciphering the intricacies of business loans and accounting to identifying the best payroll systems and credit card processors, he offers comprehensive insights tailored to meet diverse business needs. Beyond dedicating himself to exploring and evaluating the latest financial solutions, Berner has also become adept at explaining how businesses can take advantage of artificial intelligence tools. His passion for sharing knowledge extends to various platforms, including Substack, TikTok and YouTube, where he imparts tips and strategies on topics like sales tactics, savvy investing and tax saving.
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