How Do Business Startup Loans Work?

How Do Business Startup Loans Work?

One of the most important aspects of every startup is financial funding. Access to financing can be extremely challenging for startups especially in their initial stage.  There’s also the grim statistic that only half of the businesses with employees survive their first five years.

Fortunately, entrepreneurs can opt for taking a loan from a national or a commercial bank, with a low-interest rate and flexible maturity dates in order to jumpstart their business. Such initial financial help can make a huge difference in the business’s growth. 

In this overview, we will take a look at one of the most popular modes of startup funding — small business loans.

What Is a Small Business Loan?

The first question that can come to your mind about small business loans is:

How does a small business loan differ from other types of venture financing? 

Unlike other commercial bank loans, a small business loan implies a subsidy from the government. Every country has a government agency that monitors and helps small businesses.

For the US, the organization in charge of this is the Small Business Administration (SBA). The common misconception is that SBA issues the loans. However, SBA does not issue the loans — in order to qualify, you need to find a local bank that cooperates with the SBA.

If you’re not from the US, the first step is to find the organization that’s in charge of small businesses in your country, research their documentation and start from there. Here are some of the government’s small business agencies in their respective countries.

  • Australia: government’s business department
  • UK: British Business Bank’s government-backed loans
  • Canada: government’s business and industry department
  • Ireland: Microfinance Ireland

It is important that you read their instruction information carefully to determine whether your business is eligible for the loan. In case you have any doubts or confusion, call the organization in charge and get some clarification.

Benefits and Drawbacks of Small Business Loans

Taking the loan can seem like a big step for your business and it is. Not everyone feels comfortable with applying for the loan and making a financial commitment. That’s why you need to rationalize this decision. 

If you are still weighing out the pros and cons and wondering whether a small business loan is the right choice for your startup, here are some of its top benefits:

  • allows you to finance your venture at very low-interest rates
  • access to bigger capital that can transform your business
  • the possibility of a maturity date based on your preferences and projections
  • possible grace period (if arranged with the bank)
  • the down payment is usually lower than with other types of loans
  • it’s easily accessible – not a lot of red tape or requirements
  • access to different government associations and departments – some government agencies let you take advantage of their resources if you get approved for their loan

Like any type of venture, business loans also carry some disadvantages. Here are some of the minus sides that you can expect if you take out a government-subsidized startup loan:

  • high level of supervision and auditing from the government
  • a limited array of products and services you can spend the funding on
  • usually, no possibility for early repayment
  • riskier than some other types of venture financing (see Crowdfunding below)
  • usually, a relatively low upper limit for loans (USD 5 million in the US)

Whether you will be convinced by the advantages or disadvantages is left completely up to you and your business needs. However, try to be as objective as you can and determine how the loan will impact your business.

How to Take out a Government-Subsidized Startup Loan?

The requirements and specific procedures for taking out a government-subsidized small business loan differ greatly from country to country, so you will have to rely on government resources for all information and questions.

We will illustrate a simplified explanation of taking out an SBA small business loan if you are a business owner in the US:

  1. Check the different types of SB loans you qualify for 
  2. Set a loan amount
  3. Find the lowest interest rate
  4. File the necessary documentation

The information about documentation can be found online. Pay attention to how old the documents can be. 

Additionally, to give you some idea of requirements for being an eligible candidate for the loan, these are the qualifications that SBA is looking for:

  • 620+ credit score
  • 2 years in business (startups can also qualify, particularly for SBA microloans)
  • $100,000+ annual revenue

SBA also included some non-negotiables they are looking for (stated on their website):

  • Doing business in the U.S.
  • The personal investment of time or money in the business (showing entrepreneur’s will to succeed)
  • Be for-profit
  • Have exhausted other financing options

Of course, specific qualifications for the loans in your country need to be discussed with the qualified organization. 

In case you aren’t sure whether your startup meets the requirements, try to set up a meeting or talk to a representative over the phone. There might be some exceptions or possibilities that aren’t stated online so don’t rely simply on that information. 

Conclusion

Before you decide on a mode to finance your startup, make sure you do thorough research beforehand. Each startup has its unique demands and necessities so you need to search for the loan that will fulfill your requirements. 

If this is your first startup (ad)venture, a government-backed small business loan is usually the best option, because of its low-interest rates and flexibility. Once you get your business up and running you’ll see how beneficial this initial capital was. 

 Author’s Bio

Erica Sunarjo is a freelance entrepreneur, translator, and freelance writer. Besides running her business, she works as a translator for TheWordPoint. She is dedicated to consistently improving her knowledge by accepting various business opportunities. Erica actively takes courses that add to her existing business knowledge. Her passion is traveling and she uses her free time to visit countries around the world. Since she speaks several languages, Erica always aims to immerse herself in exotic cultures and work on her language skills.

Conquer your to do list  - reach your goals!