If you're planning on opening a restaurant, a retail shop, or any type of small business, it's likely you're going to need a loan. Even if your business is established, a small business loan can help you expand, hire new staff, and grow your product line. While no one likes to ask for money, knowing what to expect from the loan process can help it go more smoothly and increase your odds of success.

What Is a Small Business Loan?

A small business loan, as the name implies, is a way of getting funding for your business operation. This might be a lump sum loan or a line of credit that you can draw on for inventory, materials, and other purchases. A small business loan must be used for the business, not for personal expenses. Some business-related expenses include buying inventory, purchasing real estate, tiding your business over a seasonal slump, or opening a new location.

How Small Business Loans Work

Small business loans work differently, depending on what type you choose. Most loans work similarly to how your personal home mortgage works. You find a lender, agree on terms, apply for the loan, submit paperwork, wait for the lender to decide if your business is a good risk for them, and receive funding, if approved. Some types of small business loans are secured while others are not. There are also loans guaranteed by the US government. Some loans give you all your funds upfront; others allow you to access funds as you need them.

Determine What Type of Loan You Need

The first step to getting a small business loan is to decide what type of loan is best suited for your situation. There are different types of loans, designed for different business needs. Some of these include:

Term loan

This is a traditional bank loan, where the borrower gets a lump sum from the bank and the business owner pays the money back with interest at intervals set out in the repayment plan. According to "Forbes" magazine, term loans are typically available in amounts up to $500,000, depending on the creditworthiness of the business and its owner. You can expect to pay an interest rate of at least 9% for a term loan.

Line of credit

A line of credit is a pre-approved loan that the business owner can draw on when needed. This type of loan is often used by contractors, so they can buy materials before they are paid by the client. The loan term for these types of loans is generally 24 to 60 months.

Merchant cash advance

This type of funding gets your business the money it needs for expansions, to buy inventory, or carry you through a period of low cash flow. These vary from other types of loans in its repayment structure. Instead of following a strict payment schedule, an agreed-upon repayment percentage is deducted from your daily credit card deposits. This has the advantage that you get to make a lower payment when your receipts are low.

Equipment financing

This type of business loan is similar to your personal car loan. It is designed to make it easy for businesses to purchase expensive equipment, such as vehicles, manufacturing equipment, or computer systems. The common thread is that these loans are secured by the value of the equipment. If you fail to make your loan payments as required, the lender will take possession of the equipment.

Startup loan

Startup loans are designed to help businesses that are still in the planning stages receive the funds they need to create their business. Since this type of loan is riskier for the lender, the lender will look more carefully at the credit worthiness of the owner. Generally, you'll need a credit score of at least 680 to qualify for this type of loan. The lender may also require that the loan be secured by a house or vehicle.

Accounts receivable financing

An accounts receivable loan helps a business get by those periods when clients just won't pay them on time. You know the money is coming, but you need it now, not in two weeks or a month. With an accounts receivable loan, you sell your receivables to a third party for a percentage of what they are worth, usually 80 percent. You get your funds in as little as three days. One of the advantages to this type of funding is that the lender isn't as interested in your credit worthiness as it is in the ability of your creditors to pay.

Determine Your Eligibility

For most of the loans mentioned above, you'll need to submit an application and have the lender's underwriting department evaluate whether you and your company are a good risk for their lending business. You can get a good idea of your eligibility by considering the following:

Anticipate how lenders will view your credit and risk profile

Business lenders will look at both the owner's and the company's credit profiles. Have you looked at your personal credit report lately? That's something you'll want to do before you submit the loan application. Many reports contain errors or obsolete information, so it is important to fix those issues before you complete your application. What about your business' payment history? Are you paying your bills on time? Step back and think about how your combined histories will look to the loan officer.

Know what creditors look for

Underwriters of small business loans look for your ability to repay the loan. In addition, they want to see a thriving business with a good business plan and steady revenue potential.

Credit score

Your lender will look at both your credit score and that of your business. Most loans will require you to have a personal score of 680 or better.

Business revenue 

If you have steady money coming into the business over a period of time, you're more likely to get a loan, since the lender can easily project your future revenue.

Other factors that determine eligibility

Other factors that will help the loan officer decide in your favor include a good business plan, proof (two-plus years) of success, and a solid plan for the use for the loan funds and your business assets.

Research Available Lenders and Loan Products

Just like a home loan, there are a number of different institutions and government agencies that offer small business loans. These include:

US Small Business Administration (SBA)

The SBA helps small businesses get loans by guaranteeing the loans and thus reducing the risk to lenders. These loans are funded by your local bank or other financial institution, and you apply for this loan product directly from your bank. The SBA functions for small business loans similar to the Federal Housing Administration (FHA) for home mortgage loans.

Traditional banks

Often the best place to get a small business loan is from the bank you already have a relationship with., since they already know you and your credit history, and the banker may even be a customer of yours.

Credit unions

Credit unions are another good source of small business financing. Credit unions are member-owned, non-profit financial institutions. Credit unions exist for members of the US military, for teachers in many districts, for union members, and for a number of other groups.

Online lenders

There are also companies that specialize in small business loans. Today, such companies are usually found online and not in a brick-and-mortar office. Because they specialize in this type of loan and generally have lower overhead costs than traditional banks, loans from online lenders often cost less than a traditional bank loan.

Accounts receivable lender

Traditional banks and credit unions don't usually make accounts receivable loans. Those types of loans are made by separate companies that concentrate on that specific sector of the small business loan industry. Look for these types of companies online or via your local Better Business Bureau.

Gather Detailed Information for Your Small Business Loan Application

Once you've chosen a lender, it's time to get together the documentation you'll need to submit your loan application. While the exact documents will vary slightly depending on how your business is set up and your individual circumstances, you'll usually need the following paperwork:

• Business and personal tax returns for the past two years
• Business bank statements, generally from the past two years
• Your business credit and personal credit score
• Your business plan for the next 12 months
• P & L statements for your business for the past two years
• Other financial statements, such as your revenue reports, income statements, and financial projections for the future
• Legal documents relating to your business, such as your business license, franchise agreement, articles of incorporation, and commercial lease agreement
• A copy of your driver's license or government ID

For startup loans, the lender may also require information about the management team and what other investors—if any—are participating in the new business, as well as the personal assets of the owner or owners.

In addition to paperwork, the lender will want to know the purpose of the loan, how you intend to use the funds, how you intend to repay the loan, and what collateral you have as insurance to the lender that you'll repay the funds they give you.

Complete the Loan Application

Armed with all your documents and information, you're ready to complete and submit your loan application. Accuracy and clarity are important here, so it's a good idea to give yourself enough time so that you're not hurried and inclined to make a mistake. Avoid attaching more information about your business than the lender requests. This can slow down the approval process.

After your loan application is submitted, you'll generally need to wait for 7 to 10 days to get an answer from the lender. This may vary somewhat depending on the loan product you choose. Once your application is approved, you'll get your funds generally within a week. With some loan products, such as accounts receivable financing, you'll get your funds in just a day or two.

Earning Your Degree from Johnson & Wales

Johnson & Wales University offers degree programs to get the training you need to be a successful small business owner, including a Bachelor of Science in Business Administration—Entrepreneurship. This unique, four-year degree program focuses on topics including writing a successful business plan, improving business communication skills, leading change within your organization, identifying capital funding sources for startups and existing businesses, and ethical business practices.

To further your business education, Johnson & Wales also offers several Master of Business Administration (MBA) programs, some of which can be completed in as little as one year.

Johnson & Wales University, founded in 1914, has campuses in Providence, RI, and Charlotte, NC. Many of the university's degree programs can also be completed via online learning. Johnson & Wales has a current enrollment of 8,800 undergraduate,  graduate, and online students.

Get the educational foundation you need to start your small business when you earn your bachelor’s degree in entrepreneurship from Johnson & Wales University. For more information about completing your degree online or on-campus, complete the Request Info form, call 855-JWU-1881, or email onlineadmissions@jwu.edu.