Types of startup business loans

Startup business loans can help fill the financial gaps that may be holding an organization back from growth. These are designed for businesses that haven’t been in operation long or have little-to-no credit history, which can make it harder to qualify for traditional business loans.

You’ll have to shop around to find lenders willing to work with startups. Many lenders require that your business have a certain amount of time in the industry, such as six months. But some lenders accept startups, helping you get the funding you need.

Along with finding the right lender, you’ll also want to consider different types of startup business loans and what they’re designed for. For example, you might choose a business line of credit if you need revolving credit that you can reuse as you need funding. Or you might choose an online business loan for its relaxed eligibility requirements and fast funding.

Let’s look at the most common types of debt financing for startups and the pros and cons to using each type.

What are small business startup loans?

A startup loan is designed to fund the initial expenses and growth of small businesses. You may also be able to borrow loans backed by the SBA or find nontraditional lenders that can meet your funding needs.

Like any other loan, startup loans are paid back over time with interest according to terms set by your lender. They may be easier to qualify for than conventional business loans, but not every startup will be eligible for every loan. Explore the types of startup loans to get a better idea of what your business could use during its early stages.

Types of debt financing for startups

Startup business loans can take a variety of forms from SBA loans to business lines of credit. The right loan for you will depend on the features of each loan and whether it matches your funding goals.

Bank loans

Bank loans are typically harder to qualify for than other types of loans. Traditional banks like Bank of America and Capital One may require two or more years in business and annual revenue between $100,000 and $250,000.

But interest rates and terms are typically more favorable, so it’s worth looking into. Some banks offer certain loan products that startup business owners may be eligible for. For example, Wells Fargo’s Small Business Advantage line of credit is open to people who have been in business for less than two years.

Pros

• Builds business credit
• Low interest rates
• Higher loan amounts compared to online lenders

Cons

• Lengthy application process
• Slower funding than alternative lenders
• Lack of information on websites

Online business loans

Online lenders offer alternative business loans that are faster to fund and have more relaxed eligibility requirements compared to banks. The application process is completed online, and most lenders have a streamlined underwriting process. Once an applicant is approved, loans can be funded in a matter of hours or days rather than weeks.

Lending requirements are more flexible. A limited credit history, time in business and annual revenue likely won’t prevent you from securing funding. There are even options for business owners with bad credit. Typically, these lenders like to see a minimum of six months in operation, credit scores in the 600 range and annual revenue of $100,000, sometimes less.

The downside to online business loans is that they tend to come with higher interest rates, which can often soar well past 30 percent, depending on your credit score.

Pros

• Flexible lending requirements
• Fast funding in 24 to 48 hours
• Online application

Cons

• High interest rates
• Shorter repayment terms
• Lower funds compared to traditional banks

SBA loans

SBA loans are loans offered through approved lenders and guaranteed by the U.S. Small Business Administration. These loans are designed to help small business owners who can’t secure funding through conventional loans. But the SBA isn’t a direct lender, so you’ll also have to meet the eligibility requirements of the lender you work with. In most cases, this can often mean needing two or more years in business, although some SBA lenders work with startups.

The SBA microloan program is ideal for small businesses in the startup phase as well as those with plans to expand. Loans up to $50,000 are administered through nonprofit, community-based organizations and can be used to cover various purchases, excluding real estate. Many SBA microlenders relax eligibility requirements, such as accepting a low or no credit score and accepting startups who haven’t opened their doors.

Pros

• No application, processing, origination or brokerage fees
• Capped interest rates
• Long repayment terms

Cons

Microloans

In addition to the SBA microloan program, microloans are available through non-profit lenders, microlenders and peer-to-peer lenders. These small loans are great for startups because eligibility requirements are not strict since lenders recognize the need for accessible funding, especially for minorities and women.

The available loan amounts, interest rates and repayment terms vary from lender to lender. For example, Accion Opportunity Fund offers microloans from $5,000 to $250,000 with interest rates from 8.49 percent to 24.99 percent, with customizable repayment plans. Each qualifying business must have a minimum of 12 months in operation, $50,000 in annual revenue and a 600 FICO score to qualify.

Kiva, meanwhile, offers crowdfunded no-interest microloans. Startups and small businesses can borrow up to $15,000. Funding does take a few weeks, so this option may not work for companies that need funds to deal with emergency expenses. Term lengths are up to 36 months.

Pros

• Low interest rates
• Lenient eligibility requirements
• Customizable repayment plans

Cons

• Low borrowing limits
• Restrictions on how loan funds can be used

Business lines of credit

Banks and online lenders offer secured or unsecured business lines of credit. This specific type of funding option is usually revolving, which means that borrowers can repeatedly draw from the line of credit up to a preapproved amount, called the credit limit. Business owners then repay the loan with interest only on the amount they borrowed.

Like a business credit card, the available credit resets each time the borrowed amount is repaid, so business owners can continue to spend as needed. Typically, startups with little to no credit that have been in business for at least six months may be eligible for lines of credit from online lenders.

Pros

• Improves business cash flow
• Line of credit resets when the balance is paid
• Only repay what you spend

Cons

• High fees
• Low borrowing limits
• May require collateral

Equipment financing

Equipment financing is an option when you need certain equipment to operate your business, such as vehicles or machinery. The loan works like a term loan, offering you funding for the equipment that you repay within a specified amount of time.

The loan is backed by the equipment as collateral, so if you default on the loan, the lender can seize the equipment. However, the collateral lowers risk for the lender, leading them to offer lower interest rates and more favorable terms.

Most equipment loans can cover a range of options, from restaurant equipment to semi trucks. You may need a down payment such as 10 percent to 20 percent, although some equipment lenders offer 100 percent financing.

If equipment financing doesn’t seem like the right option for you, equipment leasing allows you to rent equipment for a specified period rather than purchase it.

Pros

• Lower interest rates
• Tax deductible
• Once the loan is repaid, the equipment is owned by the business

Cons

• Lender may require a down payment of at least 20%
• Collateral or personal guarantee may be required by the lender
• Equipment can be repossessed if payments aren’t made

Invoice financing or factoring

Invoice financing uses the money owed to you by customers to secure the loan. Your lender advances you a portion of the amount owed, typically up to 90 percent. Once your customers pay you, you repay your lender the advanced amount, plus fees.

A similar option is invoice factoring, which sells your invoices to an invoice factoring company. You receive a percentage of the total invoice amount up to 90 percent. Then, the factoring company works to collect the invoices from your customers. The remaining invoice amount, minus fees, will be sent to you once the loan is repaid.

Since the amount you borrow is based on customer invoices, these types of loans are often more accessible than other types of loans. Lenders consider the creditworthiness of your customers more than they consider your credit history. But the downsides include shorter repayment periods and higher financing fees.

Pros

• Fast funding
• Open to startups
• Doesn’t weigh business credit as heavily

Cons

• Higher rates and fees than other loans
• Short repayment terms, such as 30 to 90 days

What can small business startup loans be used for?

How you use your startup loan funds will depend on the type of loan you get. General SBA loans, term loans and lines of credit can be used to cover a wide variety of expenses. On the other hand, equipment loans can typically only be used to purchase the equipment your business has been approved for.

What you might use your startup business loan for:

• Startup costs. Any expenses associated with getting up off the ground — including marketing, advertising and supplies — fall within the umbrella of startup costs. In many cases, term loans or lines of credit will be the best choice for any startup expenses you know your business will have the cash flow to repay.
• Day-to-day expenses. You can use lines of credit, merchant cash advances or invoice financing to cover day-to-day operations, such as marketing or making payroll. Just remember to make a plan to repay the loan and only use funding for this reason when necessary. Needing funds for day-to-day operations can signal weak revenue, and you may need to strategize to bring more money in.
• Equipment. Equipment loans tend to be the best choice for the machinery or technology your business needs to get off the ground. The equipment acts as collateral for the loan.
• Building credit. As long as the lender reports to the business credit bureaus, the loan will help you build business credit. It then helps to increase your chances for future financing and qualifying for lower rates.
• Inventory. You may need a business loan or line of credit to buy inventory to stock your business so that you’re ready for sales. Almost any type of business loan can help in this situation.
• Real estate. If your business needs space to grow and you have the revenue to afford a commercial real estate loan, there are lenders that work with startups. You will need to demonstrate your ability to repay and your need for the space in your application.
• Debt consolidation. If you have taken on debt in the past, you might qualify for a loan that allows you to consolidate it and put any leftover funds toward your new startup. To get the most out of business debt consolidation, the monthly payments and total interest paid should ideally be lower than your previous loans.

Alternatives to startup business loans

If a business loan is too big of a commitment for your startup, consider these alternatives.

Grants

Business grants offer business owners free money to cover startup and operating costs. Unlike a loan, grants allow business owners to avoid taking on debt because they don’t need to be repaid.

Depending on the grant, you simply submit an application with details about your business and how the funds will be used. You can get as little as a couple of hundred dollars to thousands.

Business credit cards

With business credit cards, business owners make short-term purchases up to a certain limit, pay their balance and spend again. Unlike business loans, credit cards have a grace period that lets you avoid paying interest if you pay your balance in full each month. This helps make business credit cards one of the most efficient ways to build business credit.

Interest rates vary: If you have great credit, a business line of credit may offer better rates as low as 18 percent, though they can go as high as 30 percent. But if you’re receiving loan offers with APRs of 40 percent or more, a business credit card may be a better option.

Merchant cash advances

A merchant cash advance gives business owners the option to borrow based on business credit card sales. Similar to a loan, the borrower receives the cash in a lump sum, but the money is repaid using a portion of the credit card sales.

You can receive funding quickly, but this option requires an aggressive repayment schedule, requiring you to repay daily or weekly.

Since merchant cash advances aren’t loans, they are also not subject to usury laws, which restrict lenders from charging extreme interest rates. If you’re not careful, a merchant cash advance could end up having triple-digit rates. This option works best if you don’t qualify for other types of financing and need cash for an emergency.

Crowdfunding

Crowdfunding is a unique way business owners can raise capital through online fundraising campaigns. Using a funding platform, such as SeedInvest or GoFundMe, business owners launch their campaigns by providing fundraising details and setting a fundraising goal and timeframe. Once the campaign has launched, the business owner receives donations from people who want to invest in their company.

Most platforms feature sharing tools so business owners can share their fundraisers via social media, email and text, allowing them to reach a larger audience and increase donations. Once the fundraiser is complete, the money can be used to fund startup costs or a specific project. Depending on the type of crowdfunding campaign and platform, contributors receive rewards or equity in the company in exchange for their donations.

Here’s a brief look at four different types of crowdfunding:

• Rewards. Funds are donated with the expectation of some tangible benefit in return.
• Donation. Like a gift, people contribute funds with no expectation of anything in return.
• Debt. Like a traditional loan, this type of crowdfunding must be repaid over time with interest
• Equity. Funds are raised in exchange for partial ownership in the business.

Special purpose credit programs

Special purpose credit programs are designed to make borrowing possible for business owners of economically disadvantaged groups. Lenders can create a special purpose credit program to provide more favorable lending requirements, such as a lower credit score, less time in business or a lower down payment.

For example, in 2022, JPMorgan Chase made a $30 billion commitment as part of the launch of its special purpose credit programs to increase access to credit for small business owners in underserved communities. Its program enhanced the lender’s loan application process, expanded the one-on-one coaching program and opened a new resource center where business owners have access to free advice.

Bottom line

When you’re just launching your small business and need funding, startup business loans can provide the perfect opportunity. These are simply business loans offered through lenders willing to work with startup businesses, and they’re not available everywhere.

You can get many types of startup business loans for different purposes. You might choose a bank loan if you want to establish your business with a lender that you can use for future funding. Or you may go with an equipment loan if you need to buy equipment for your business and want to secure the lowest rates.

No matter which loan you go with, you’ll need to do your research to compare different types of debt financing and lenders to find the right fit.

Frequently asked questions about small business startup loans

• What type of loan do I need to start a business?

  You can start a business with nearly any type of business loan, depending on what you plan to use the loan for. However, you will need a business loan with flexible eligibility requirements, such as accepting startups with six months or less in business. You can contact the lender to see if they will work with you, or look at the lender’s eligibility criteria online.

• Can I take out a loan to start a business?

  Yes, you can take out a loan to start a business. But you may have fewer options due to your limited time in business, business credit score and annual revenue.

• What credit score is needed for a startup business loan?

  The credit score needed for a startup business loan depends on the lender. Traditional banks may require credit scores of 670 and above. But online lenders are more accessible, and you can find some lenders willing to work with business owners with credit scores in the 500s.