Starting or expanding a small business often requires extra cash, which many small business owners seek through loans. Knowing how much you can borrow for a small business loan is crucial to planning your business goals and budget. From understanding loan types and limits to knowing what lenders look for, this guide covers small business loan amounts all.
What Factors Determine How Much You Can Borrow?
The amount you can borrow for a small business loan depends on several factors. Here’s a breakdown:
1. Business Credit Score
- Definition: A business credit score reflects your business’s creditworthiness. Just like personal credit scores, this score shows lenders how reliable you are in repaying debts.
- Impact on Borrowing Limit: Businesses with higher credit scores generally qualify for larger loans at lower interest rates. If your business credit score is low, you might still get a loan, but the amount could be lower, and you may face higher interest rates.
2. Annual Revenue
- Definition: This is the total amount of money your business makes in a year before deducting any expenses.
- Impact on Borrowing Limit: Lenders typically use annual revenue to determine how much debt your business can handle. Many lenders offer loans that range between 10% and 15% of your annual revenue.
3. Profitability
- Definition: Profitability is the amount left after covering all business expenses from revenue.
- Impact on Borrowing Limit: If your business is profitable, lenders may be more willing to offer larger loans, as it indicates the business can afford to repay the debt.
4. Type of Business and Industry
- Definition: Certain industries come with different levels of risk in the eyes of lenders.
- Impact on Borrowing Limit: Some industries, like restaurants or retail, may face more restrictions due to higher risk, meaning they could have lower borrowing limits than more stable industries.
5. Collateral Available
- Definition: Collateral is an asset (like equipment, property, or inventory) that secures the loan. If you can’t repay, the lender can claim the asset.
- Impact on Borrowing Limit: Businesses with valuable collateral can often borrow more. Lenders see it as a backup in case the business can’t make payments.
6. Business Age and Financial History
- Definition: This refers to the number of years your business has been in operation and your financial records.
- Impact on Borrowing Limit: Established businesses with a proven track record often qualify for higher amounts than startups. Startups may still obtain loans but might be limited to smaller amounts.
Types of Small Business Loans and Their Typical Borrowing Limits
There are several types of small business loans, each with different terms and borrowing limits. Let’s explore them:
1. Term Loans
- How It Works: A term loan provides a lump sum that is repaid over a fixed period, usually with monthly payments.
- Typical Borrowing Limits: Borrowing limits generally range from $5,000 to $500,000, although some lenders offer up to $1 million.
- Best for: Larger investments, like purchasing equipment or expanding operations.
2. Business Line of Credit
- How It Works: A line of credit allows you to borrow up to a certain limit, similar to a credit card, where you only pay interest on the amount you use.
- Typical Borrowing Limits: Lines of credit usually range from $10,000 to $250,000.
- Best for: Managing cash flow, covering unexpected expenses, or handling short-term needs.
3. SBA Loans (Small Business Administration Loans)
- How It Works: SBA loans are government-backed loans that reduce risk for lenders, often resulting in better terms for borrowers.
- Typical Borrowing Limits: SBA loans can offer up to $5 million, though smaller amounts are available.
- Best for: Businesses needing larger sums for expansion, acquisitions, or long-term investments.
4. Equipment Loans
- How It Works: Equipment loans are specifically for purchasing equipment, which also serves as collateral for the loan.
- Typical Borrowing Limits: Small business loan amounts between $5,000 and $500,000, depending on the equipment’s value.
- Best for: Purchasing equipment, machinery, or vehicles necessary for business operations.
5. Invoice Financing
- How It Works: Invoice financing allows businesses to borrow against their outstanding invoices, providing cash flow while waiting for customers to pay.
- Typical Borrowing Limits: Borrowing amounts depend on the value of the invoices, often up to 90% of the invoice’s worth.
- Best for: Businesses with many unpaid invoices needing immediate cash flow.
6. Microloans
- How It Works: Microloans are small loans offered by nonprofit organizations or community lenders to help new or small businesses.
- Typical Borrowing Limits: Amounts are generally between $500 and $50,000.
- Best for: Startups or small businesses needing only a small amount of capital.
How to Estimate Your small business loan amounts
To understand how much you might qualify for small business loan amounts, consider these steps:
1. Calculate Your Debt Service Coverage Ratio (DSCR)
- Definition: DSCR is a metric that shows how much cash you have available to cover debt payments.
- How to Calculate: Divide your net operating income by your total debt obligations. Many lenders prefer a DSCR of 1.25 or higher, meaning you have 25% more income than needed to cover debt.
2. Determine the Loan-to-Value (LTV) Ratio
- Definition: LTV compares the loan amount to the value of the collateral.
- How to Calculate: Divide the loan amount by the value of your collateral. Many lenders prefer an LTV of 80% or less.
3. Consider Personal and Business Credit Scores
- Impact: Higher credit scores can increase the amount you qualify for, as lenders see you as a lower risk.
Steps to Maximize Your Borrowing Potential
Here are strategies to improve your chances of qualifying for a larger loan amount:
1. Improve Your Business Credit Score
- How to Improve: Pay bills on time, reduce debt, and check for any errors on your credit report. Establishing good credit history is key.
2. Increase Your Annual Revenue and Profit
- Tips: Focus on growing sales, managing expenses, and seeking new revenue streams to boost profitability, which will increase your borrowing potential.
3. Prepare Strong Financial Documentation
- Benefits: A solid financial history can prove to lenders that you’re a reliable borrower. This may include bank statements, balance sheets, and tax returns.
4. Provide Collateral
- Why It Helps: Collateral reduces lender risk and could result in larger loan offers with better terms. Make sure to have your assets appraised to show their true value.
5. Maintain a Positive Cash Flow
- Why It Matters: Positive cash flow ensures that you can make monthly payments on time, which reassures lenders of your ability to repay a loan.
How Different Loan Purposes Impact Borrowing Limits
Lenders consider why you’re borrowing and what the funds will be used for:
1. Expansion and Growth
- Borrowing Limits: Generally higher, as expanding can increase the business’s potential income, making repayment easier.
2. Working Capital
- Borrowing Limits: Often moderate, covering day-to-day expenses. Working capital loans are usually smaller and have shorter terms.
3. Inventory or Equipment Purchases
- Borrowing Limits: Based on the value of the assets, as they can be repossessed if payments aren’t met. Equipment and inventory loans often allow for high borrowing limits relative to the asset value.
Common Mistakes to Avoid When Applying for a Business Loan
Here’s what not to do when seeking a business loan:
1. Borrowing More Than You Need
- Borrowing more may seem smart, but it can lead to higher interest payments and potentially create debt that your business struggles to repay.
2. Ignoring Loan Terms and Conditions
- Look at the interest rate, loan term, and fees. Choose a loan with manageable terms so you’re not overwhelmed by monthly payments.
3. Failing to Compare Lenders
- Different lenders offer different amounts, terms, and interest rates. Comparing can help you find the best option.
4. Neglecting Cash Flow Projections
- Accurate cash flow projections ensure you can repay the loan. Lenders will also see you as a responsible borrower if you provide detailed projections.
Conclusion
How much you can borrow for small business loan amounts depends on your business’s credit score, annual revenue, profitability, and the type of loan. Larger, well-established businesses with good financial history and collateral can usually borrow more than newer or riskier ventures. By preparing strong financial records, improving credit scores, and considering collateral, you can increase your chances of securing a loan that meets your needs. Remember, borrowing responsibly and choosing the right loan type are crucial steps to using borrowed funds to support your business’s growth.