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.

According to the 2023 Small Business Credit Survey, only 40 percent of businesses less than five years old were fully approved for the funding they applied for, whereas 53 percent of businesses aged six to 20 were fully approved. 36 percent of firms under five years old were also more likely to receive a loan from friends and family or use their own personal funds, compared to businesses that were six years or older.

While startup loans can be risky, they offer a boost in capital that can lead to growth and expansion. But, of course, it requires careful consideration of their pros and cons to choose the right one to ensure you set your business up for success.

What are small business startup loans?

A startup loan is designed to fund the initial expenses and growth of small businesses. Because startups have a range of needs, you can find startup loans from almost any lender. 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 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. Explore the types of startup loans to get a better idea of what your business could use during its early stages.

Business startup loan options

Startup business loans can take a variety of forms. Many lenders offer them, but most require that you have at least a few months in business and meet minimum revenue requirements. That being said, there are still options if you haven’t opened your doors just yet.

SBA loans

There are many types of SBA loans, all backed by the U.S. Small Business Administration (SBA). These loans may be open to small businesses, as the SBA bases eligibility on factors like how you earn revenue and the character of ownership. 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.
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. Each lender has its requirements, but the SBA microloan often has eligibility requirements that are more relaxed than other types of SBA loans.

Pros

• No application, processing, origination or brokerage fees
• Capped interest rates
• Flexible eligibility requirements

Cons

• Prepayment penalties
• Collateral or personal guarantee is typically required
• Slow application and funding process

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, so 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, though some lenders may require a minimum of six months in operation.

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
• Online application

Cons

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

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 traditional funding options are not always easy, 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, but there is no minimum credit score required, and the annual revenue varies.

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
• Customizable repayment plans

Cons

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

Business lines of credit

Banks and online lenders offer business lines of credit. This specific type of funding option is a secured or unsecured revolving credit line that allows business owners to spend up to their approved credit limit and only pay interest on the amount they spend.

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, but higher interest rates should be expected, and collateral may be required.

Pros

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

Cons

• High interest rates and 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. Similar to other types of business loans, equipment financing is offered through banks, credit unions, online lenders and the SBA, but you can also find equipment financing through direct lenders.

Most equipment loans can cover a range of options, from restaurant equipment to semi trucks.  A down payment is typically required since most financing only covers 80 to 90 percent of the value of the equipment. And when you factor in the interest rate and other fees, they can get expensive. But equipment loans still make the purchase more affordable than paying for the equipment outright.

If equipment financing seems like an expensive option, equipment leasing is less of a commitment because businesses can pay to rent equipment for a specified period rather than purchase it.

Pros

• Tax deductible
• Once the loan is repaid, the equipment is owned by the business
• Increases business cash flow

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

This is a short-term solution to cash-flow issues. Invoice financing uses the money owed to you by customers to secure the loan but typically caps the loan amount at 85 percent of the invoices. Your lender advances you a portion of the amount owed, and once your customers pay you, you repay your lender the advanced amount, plus fees.

Since the amount you borrow is based on customer invoices, this type of loan is often more accessible than other types of loans. The downsides include shorter repayment periods and higher interest rates.

Pros

• Fast funding
• Open to startups

Cons

• Higher rates and fees than other loans
• Decreased profits

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, but depending on the type of crowdfunding campaign and platform, contributors receive rewards or equity in the company in exchange for their donations.

Pros

• Money donated doesn’t need to be repaid
• No application or underwriting process
• Business owner controls when they receive donation funds

Cons

• Doesn’t build business credit
• Business owners may be required to offer contributors rewards or company equity
• Crowdfunding platform fees

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.

• 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. Like general startup costs, day-to-day operations can be covered by lines of credit or term loans designed for new businesses. There are also some short-term options, like merchant cash advances or invoice factoring, that may be useful. Just keep in mind that these tend to come with much higher costs.
• 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, making these less expensive on average and more accessible to startups. Depending on the type of equipment your business needs, you may be able to finance directly through the seller.
• Building credit. Small business startup loans can be used to build business credit and increase your chances for future financing and qualifying for lower rates. However, a business loan won’t help build your score if the lender does not report payment information to credit bureaus, like Dun & Bradstreet (D&B), Experian and Equifax.
• Inventory. Almost every type of business loan will cover the cost of inventory, including startup loans. Ask if your seller offers a discount for buying in bulk. For startups that need a significant amount of inventory, this can help cut down on costs. Similarly, discuss a discount if you can pay the invoice on your inventory purchase ahead of schedule.
• Real estate. Qualifying for a commercial real estate loan may be difficult for a startup, but not impossible. If your business needs space to grow and you have the revenue to afford it, 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, and like all real estate loans, the process may take longer than other forms of financing — especially if you apply for an SBA 504 loan.
• Debt consolidation. If you are beginning a new venture but have taken on debt in the past, you may be able to 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, and 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. But if you’re receiving loan offers with APRs of 40 percent or more, a business credit card may be a better option.

Invoice factoring

Invoice factoring is another short-term solution. Instead of a loan, you sell your invoices to an invoice factoring company and receive a percentage of the total invoice amount. The remaining invoice amount, minus fees, will be sent to you once the loan is repaid.

Like invoice financing, factoring is an accessible option open to startups and business owners with bad credit.

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.

Funding is typically fast, but with the high interest rate and short repayment terms, this option makes the most sense for businesses that need short-term financing that can be repaid quickly.

Special purpose credit programs

Special purpose credit programs are designed to make borrowing possible for business owners of economically disadvantaged groups. According to the American Bankers Association, 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, making it easier for business owners to qualify for a loan.

In 2022, JPMorgan Chase made a $30 million 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

Not all types of business loans are a good fit for someone just launching a small business. When you have little-to-no credit, low annual revenue and less than a year in business, a startup loan may be the perfect funding option. Many lenders offer startup business loans with flexible lending requirements, so you have a better chance of approval with this option than you would with traditional bank loans.

Frequently asked questions about small business startup loans

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

  To start a business, you need a loan with flexible eligibility requirements. This can include six months or less in business, as well as low annual revenue and credit score requirements. A viable loan option is a startup loan, which is available through various types of lenders, including the SBA, banks and online lenders.

• 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.