What Is a Startup Business Loan?
A company may need to have been in operation for at least one year before it is eligible for certain types of business funding. In the case of new businesses in need of funding sooner, a startup business loan could be a good option.
A startup business loan is a form of financing made available to businesses with no or little business credit history. It is common for startups to obtain funding through term loans or Small Business Administration (SBA) loans, but they may also consider business credit cards or asset-based financing. Startup owners can also utilize less traditional financing methods like crowdfunding to access the working capital they need to launch and grow their businesses.
Why are startup loans for new businesses important?
Starting a business consumes many resources. In addition to finding a market fit, hiring the right team, and ensuring your product is market-ready, you will need to find ways to cover your costs. This can be somewhat challenging, primarily because revenue generation takes some time. Startup loans are available to help finance those initial costs.
Types of Startup Business Loans
Obtaining a small business loan can be challenging if your company does not have a successful track record. Nevertheless, several types of startup loans are available that meet a wide range of requirements and qualifications.
✅ Term Loans
Many people think of term loans when searching for options for small business loans. You borrow money from a traditional bank or online lender using a term loan and repay the loan over a period (often at a fixed interest rate). It is possible to obtain a competitive interest rate on a term loan if you have good personal and business credit scores, particularly if you approach a traditional lender. Furthermore, online lenders typically provide term loans with faster application and funding processes. On the downside, this type of funding may require a personal guarantee — an agreement that you will repay the loan with your funds if the business does not repay it.
✅ SBA Microloans
The SBA Microloan program provides startup loans up to $50,000 to qualified business owners. The loan term is six years, and the interest rate is typically between 8% and 13%, although this number varies depending on the lender. The qualification criteria are often less stringent than those for other business loans.
Microloans can provide an infusion of cash to underserved small business owners looking to start a company or grow an existing one. Startups with limited financial records and poor credit history can access loans through nonprofit lenders and other financial institutions, which the SBA backs. However, microlenders can request a personal guarantee and collateral to secure funding.
✅ Asset-based Financing
Asset-based financing is a means of obtaining financing from a lender by securing loans against a company’s valuable assets, such as inventory, machinery and equipment, accounts receivables, and real estate. Secured financing usually involves less risk for the lender, so more flexible lending standards often accompany it. Therefore, it is a good option for startups that cannot qualify for traditional business loans.
Invoice factoring is one of the most common types of asset-based lending, which is performed by selling outstanding invoices to a third party while receiving a lump sum of cash—usually between 80% and 90% of the total invoice amount. In this way, startups can gain access to working capital without demonstrating a solid credit score or meet other stringent requirements.
✅ Equipment Financing
If your business requires funding to purchase equipment or machinery, equipment financing may be a good option — the equipment you purchase serves as collateral for the loan. In the event of a default, the lender may repossess and resell the equipment to recoup its losses.
You may be able to lock in competitive interest rates because collateral lowers the lender’s investment risk. In general, APRs range from 8% to 30%, and the loan amount is based on the cost of the equipment your business requires and other factors. On this type of loan, lenders may offer repayment terms of up to 25 years.
Creditworthiness can significantly impact your business’s ability to obtain equipment financing. With good credit, you are more likely to be approved and may be able to get lower interest rates. On the other hand, bad credit might make it difficult for you to obtain a competitive equipment loan.
✅ Personal Loans for Business
A personal loan for startup owners is an alternative to a traditional business loan. In particular, personal loans are more accessible for a new business owner to qualify than a business loan, especially for startups with little or no business history.
Additionally, for some lenders, the application and approval process may not be as rigorous as a business loan. It is also possible for startup owners to obtain lower annual percentage rates (APRs) than are offered by some business loans, although borrowing limits are typically lower.
A borrower who uses a personal loan to fund a startup is personally responsible for paying back the loan. Nevertheless, most lenders determine a startup business loan applicant’s credit score when evaluating their application, which may result in startup owners being personally liable for the loan.
It is important to remember that using personal loan funds for business purposes also involves mixing personal assets with those of a business, which may result in bookkeeping, tax, and legal issues. Furthermore, some private loan lenders restrict the use of funds for business purposes, so ensure that you confirm this with the prospective lender before applying.
✅ Business Lines of Credit
An unsecured business line of credit allows you to borrow money on an as-needed basis while paying interest only on what you borrow. It is similar to a credit card in some respects. You are approved for a credit limit by the issuing bank, and as you use and repay the money you owe, you can access that same credit line again during the draw period.
You may be able to access the credit line for a period of time, but eventually, the draw period will expire (often after 12-24 months), and you will not be able to access it after that. The repayment period begins at that point, lasting up to five years.
You may find that business lines of credit are a flexible funding source if you require open-source financing. They may also be helpful for projects with unpredictably high costs.
Generally, obtaining a business line of credit with favorable terms usually requires good credit and collateral. You might also be required to sign a personal guarantee with unsecured credit lines. Moreover, interest fees are typically applied immediately upon withdrawal of funds without a grace period, as with credit cards.
✅ Friends & Family
As a startup with no or little credit history and financial record, it can be challenging to obtain business financing. Small business owners who do not qualify for a traditional business loan or another method such as a business credit card or those who are eligible only for a small startup loan may wish to borrow funds from friends and family.
Startup business owners can raise funds for their projects or ventures using crowdfunding platforms.
The crowdfunding model may be viable if traditional lending tools do not provide an effective alternative and borrowing from friends and family feels too personal. Potential borrowers who do not qualify for a business loan as a startup may use a crowdfunding platform such as Kickstarter or Indiegogo to access funding and cover operating costs.
For a business startup to obtain funding through crowdfunding, the owner will have to share the business’s goals and objectives with a large group of people in the hope that some people (the crowd) will aid in funding the venture.
To get started, select an online fundraising platform, create an account, and decide how much money you want to raise. After a crowdfunding campaign has been made, users can donate money that becomes available after the campaign ends.
In addition to requiring no financial institution approval, this form of business funding does not require business owners to give donors startup equity in exchange for the financing. The startup is also not charged interest or any other lender fees.
✅ Small Business Grants
Grants for small businesses are provided to new startups and other companies to assist them in getting started and growing. Unlike other startup financing methods such as loans and credit cards, business grants do not require repayment, and business owners are not charged interest or fees. Grants are available from various sources, including state and local governments, the federal government, and private organizations.
Some grants are also dedicated to supporting specific types of businesses, such as those run by women, minorities, veterans, and immigrants. You should note that this type of funding is highly competitive, and applications are typically lengthy and rigorous.
Grants are available from several sources:
✔ Federal government
✔ State and local governments
✔ Private foundations
✔ Businesses supporting entrepreneurship
Finding Your Best Option
Startups require careful planning to identify the best funding options. The amount your business needs and the repayment terms you are comfortable with is critical. When you have made plans, you will find the best rate that meets your requirements and fits your qualifications.
Term loans are well-suited for businesses that need a large amount of funding up front, while lines of credit are better suited for those who need to access funds periodically. Make sure you consider more specific options, such as equipment loans, if they are appropriate for a looming purchase or expense for your company.
Michael Choi is a senior lawyer based in Hong Kong whose background includes international trade and trade financing. Over his career, he has assisted numerous international corporate clients in raising capital and increasing their funding levels. Michael has also provided free legal advice to the public in Hong Kong since 2011 to assist those who cannot afford to pay the legal fee.
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