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What is a startup business loan? How does it work?

Small Business
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Key takeaways

  • The majority of new businesses need financing to cover operating expenses or expansion.
  • Getting a loan for a new company can be difficult as lenders consider new businesses higher risk.
  • Because of this, many lenders will examine your personal credit and require a personal guarantee.

A startup business loan is any loan that helps get a new business off the ground. According to the Fed Small Business’s 2023 Firms in Focus, 70 percent of companies under two years old used loans to fund operating expenses, and 67 percent used loans to pay for expansion in 2022.

Given the risks of financing new companies, startup loans require lenders to assume greater risk. But you can still find both traditional banks and online lenders that are willing to take a chance.

The best startup business loans will fund projects for companies with little time in business and limited credit histories. In return, you can expect additional requirements like significant collateral or a higher interest rate. 

How a startup business loan works

Startup loans ultimately work like any other business loan: You apply for funding, a lender assesses your creditworthiness and, if your loan is approved, you repay the funds with interest. Use these steps when applying for a startup loan:

1. Know the requirements

Startup loans may offer more lenient requirements in some respects, such as accepting borrowers with low revenue streams. But because many new small businesses fail, you may have to meet other requirements to offset lenders’ increased risks. You may have to provide greater collateral for approval, sign a personal guarantee or pay a higher interest rate.

Getting a startup loan is often easier if you launch your business before you apply for funding. Showing lenders your business has an operating history is a big help when seeking financing.

2. Gather documents

Before you apply for a loan, put together the documents you need when applying. This includes basic information about yourself and your company, such as ID, Social Security number and business formation documents. You also want to gather business bank account statements, licenses and other information that show details about your company’s operations.

Putting together a business plan that shows how you’ll use the funds and how you can repay the loan can also be a big help.

3. Focus on credit

You’ll also want to improve your credit. Small business lenders tend to prioritize your personal credit above your business credit. If you have strong personal credit, the personal guarantee you sign can help make it easier to get a business loan. 

Finally, limit your debt service coverage ratio. That is, try not to take on too much other debt before you apply for your startup loan. 

Startup loan vs. conventional loan

Startup loans are often offered by the same lenders as conventional loans. They may be marketed as startup loans or simply small business loans with relaxed minimum requirements for credit or time in business. 

Startup business loans Conventional business loans
Who offers them SBA, banks, online lenders, nonprofits SBA, banks, online lenders
Time in business requirement As little as 0 to 6 months Typically at least 2 years
Personal credit score requirement Minimum score as low as 500 to 560 for some loans Minimum score of 600 or higher for most loans
Business credit score requirement 155 on the SBSS scale is recommended; lenders may not require this 155 on the SBSS scale is recommended
Amounts  Most lenders cap loans at $1 million or less Most lenders cap loans at $5 million or less
Interest rates Typically higher Typically lower
Collateral required Typically yes, plus a personal guarantee in most cases  Depends on the lender
Bankrate insight

Based on the Fed Small Business’s 2023 Firms in Focus, banks are the most popular sources of financing for new companies, with 48 percent getting financing from large banks and 39 percent from small banks. However, based on the difficulty that startups have securing funding, businesses aged zero to two years were twice as likely to use personal savings versus a financial institution or lender.

Types of startup loans

There are many different types of loans startups can apply for, each suited to a different purpose. For example, a startup valuing flexibility may prefer a line of credit, while one needing to make a one-time large purchase may feel a term loan is a better fit.

Understanding the different types of startup loans and when to use each is key to getting the right financing for your company.

  • SBA loans: These loans are backed by the government and offer easier approvals and large loan limits. Through the SBA 7(a) program, borrowers can get loans up to $5 million.
  • SBA Community Advantage loans: a special type of SBA loan, these focus on underserved communities, offering loans up to $350,000.
  • Microloans: These are small loans, often available from SBA lenders. The maximum loan amount from the SBA is $50,000.
  • Term loans: Term loans disburse funds all at once, making them useful for one-time purchases. You can get short-term or long-term business loans.
  • Lines of credit: Lines of credit give you source of funds that you can draw from up to a certain limit as needed. Most are revolving, which means that you repeatedly borrow from the credit line as you pay back past loans.
  • Equipment financing: These loans are used to buy expensive equipment and have long repayment terms. The equipment serves as collateral, which can help make qualifying easier.
  • Invoice factoring and financing: Invoice factoring and financing allow you to sell the value of unpaid invoices to a third party to access funds quickly.
  • Private loans. You may also be able to get a direct loan from an investor, peer-to-peer lending or family and friends.
Bankrate insight

As of October 2023, the SBA has approved over $27 billion in 7(a) loans and more than $6 billion in 504 loan funds, according to the SBA’s weekly lending report.

Alternatives to startup business loans

Startup loans are a useful source of funding for new companies. But like any form of financing, they have pros and cons. It’s important to consider all of your options when looking to fund a business. Some alternatives to startup business loans include:

  • Grants: A grant can provide funds to help start or expand a company without requiring repayment. Grants may target specific industries or groups, but the application process is long and competitive. That said, it’s a great option to consider if you want to avoid debt financing.
  • Business credit card. Credit cards are a flexible option to assist startups with operational expenses. Some of the best business cards offer introductory interest rates and rewards that can help you save money. Additionally, if you pay the balance back in full each month, you won’t be charged interest.
  • Merchant cash advance: If your startup needs quick funding, a merchant cash advance is a good option that many businesses qualify for. Merchant cash advances use your company’s future debt and credit card sales to repay the loan. But losing a percentage of future revenue to repay the loan can make it easy to get trapped in a cycle of debt.

The bottom line

You’ll have the best chance of getting approved for a startup loan if you have at least six months in business and an established business credit score. Start by comparing lenders and figuring out how much you need. Requesting too much funding could result in a rejection.

Frequently asked questions

  • The amount a startup can borrow depends on many factors, including its current debt, revenue and its owner’s credit. SBA Community Advantage loans have a limit of $350,000, but 7(a) loans have a limit of $5 million, so it’s possible to borrow a large amount.

  • Getting a business loan to start a company can be tricky. Most lenders prefer to lend to companies with at least six months to two years of operating history. If you have strong personal credit and sign a personal guarantee, that could help you qualify.

  • If you have a good business plan and a path toward profitability, borrowing money is still a risk, but that doesn’t mean it’s a bad idea. The majority of startups borrow money to help cover operating expenses or buy equipment or other assets that help them grow. Just make sure you understand the risk, especially if you sign a personal guarantee, and don’t borrow more than you can afford to repay.

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