A startup faces challenges at its inception, and raising capital may be the biggest hurdle. According to the Federal Reserve’s 2019 Small Business Credit Survey, less than half of firms received all the business financing for which they had applied. Over two-thirds of the businesses reported they made up for the shortfall by using personal loans.
Low-cost business loans are usually for established companies. So, what are the best startup business loans for a company with limited business credit scores and less than a couple of years of financial history?
The following startup business loans were selected to address a new company’s unique situation. We chose options with less restrictive qualification requirements to improve the odds of approval. Not all the selections are traditional bank loans—some are business startup loan alternatives when traditional borrowing isn’t feasible.
Best startup business loans
Startups have particular needs that differ from those of established businesses. Examine the pros and cons of the following business startup financing options to fund your new company.
1. SBA startup business loans
SBA loans should be at the top of your list of business loan options. The Small Business Administration (SBA) offers small business startup loan programs such as the Community Advantage Program for “under-served markets” and the Microloan Program. Both plans target companies that don’t qualify for traditional financing and are available through participating lenders.
Community Advantage Program
To qualify: You must meet the small businesses requirement of being privately owned, with a maximum of 250 or 1,500 employees, depending on the industry.
Costs: Prime + 6% for a loan amount maximum of $250,000 and loan terms up to 25 years.
Pros: Can be used for working capital, equipment financing, and real estate. Approval is “not limited by the size of the borrower’s balance sheet, or the amount of collateral.”
Cons: Cannot be used for revolving lines of credit.
To qualify: You must meet the small businesses requirement of being privately owned, with a maximum of 250 or 1,500 employees, depending on the industry. Many are for female, minority, or military veteran new business owners.
Costs: SBA microloans cost 6.5% to 13% for a loan maximum of $50,000, with loan terms of up to 6 years.
Pros: Available for startups and small business owners with lower credit scores.
Cons: Limited to $50,000 of capital. SBA microloans can’t be used for debt refinancing or real estate purchases.
2. Small business credit cards
The Fed’s Small Business Credit Survey reports that more than half (52%) of small businesses use credit cards as capital funding. Personal credit cards can be a cost-effective way to finance startup costs, but you miss out on the opportunity to build business credit. Business or corporate credit cards are a better option.
To qualify: While consumer credit cards require an excellent personal credit score, the Brex corporate card for startups doesn’t require personal assets as a guarantee, credit score checks, or security deposits from new business owners.
Your company must have $50,000 in a U.S. bank with professional investors, or $100,000 (professional investors not required). As you start growing or fundraising, you can apply for a Brex corporate card.
Costs: The Brex card doesn’t charge fees or interest. Other cards may charge annual fees between $50 and $450 plus variable interest rates, which average at 17.37% APR.
Pros: You can tap into credit at any time and may access expense management tracking that saves time. Using a business card helps a company build a good credit history.
Cons: Credit limits are usually lower than most business loans. In the case of a personal credit card, founders miss out on the opportunity to build business credit.
3. Rollover for business startups (ROBS)
This strategy allows you to invest personal retirement account funds into your startup tax-free and without penalization for early withdrawal. ROBS isn’t a way of cashing out your 401(k), nor is it a loan against it. It’s a way of capitalizing your business by rolling over your personal retirement funds to your existing business to cover startup costs.
Here are the steps to follow:
- Structure the business as a C corporation
- Set up a 401(k) plan for your C corp
- Roll over your personal deferred retirement account(s) into the company’s 401(k)
- Purchase stock as an employer qualified security (QES) transaction
- Use the funds as operating capital
To qualify: You must be a legitimate employee of the business with enough personal 401(k) funds to make the transfer worth the expense.
Costs: The average cost of a ROBS is $4,995 to complete the transaction.
Pros: No loans to pay back, and you’re not penalized for the rollover.
Cons: ROBS are currently under scrutiny by the IRS. Consult with a professional for guidance and to avoid non-compliance issues with the IRS.
4. Equipment financing
If a startup needs to make a sizable investment in machinery, vehicles, or equipment, small business owners can take advantage of equipment financing. This type of startup funding is available directly from equipment dealers and financial institutions such as banks or credit unions. Equipment financing is one of the most accessible term loans a startup can qualify for because it’s collateralized by the equipment itself and doesn’t require a personal guarantee.
To qualify: Most lenders require a down payment of 10% or more. Some may require a personal credit score of at least average.
Costs: As low as 5%, depending on the lender, with average terms of 1 to 7 years.
Pros: Financing business equipment frees up cash flow so a startup can use its capital elsewhere.
Cons: If you’re financing your equipment costs through several lenders, staying on top of different monthly payments takes more effort.
5. Angel investors
Angel investors are wealthy people who provide funding for a small business in exchange for an ownership stake. Angel investors are similar to venture capitalists, but generally invest less money and aren’t as likely to want an active role in your startup.
When partnering with an angel investor, structuring their investment as a convertible note is advisable. Convertible notes are short-term debt that can convert into stock, making it easier for startups to give different prices to different investors and limit an investor’s control.
To qualify: Networking is vital to find an angel investor. AngelList is a good startup company resource for finding investors.
Costs: Angel investors may require between 5% and 50% of your startup’s equity.
Pros: An angel investor is a viable way to fund your business without taking on debt from a small business loan.
Cons: Accepting angel investment funding will cost you a percentage of the ownership of your business unless you can structure it as a convertible note.
Oculus launched its virtual headsets on Kickstarter in 2012. Two years later, Facebook purchased the startup for $2 billion, making it one of the biggest crowdfunding campaign success stories so far. While there’s no guaranteed outcome, if your company sells a product, crowdfunding may be a viable option for raising capital.
Costs: Online platforms typically charge a flat fee of 5% to 10% of the total funding raised.
Pros: Small business owners use crowdfunding to launch new products, gauge interest, gain exposure, and raise capital through pre-sales or by offering company equity.
Cons: Successful crowdfunding takes a big marketing push. Negative feedback can affect a company’s reputation.
Diversifying startup capital funding
Your startup may initially need to use a combination of alternative funding to meet expenses and fund growth. Creativity and flexibility are helpful when growing your business. Products like Brex Cash can work in conjunction with your funding to replace your bank account.
Regardless of what type of startup business loans or funding you choose, you can increase your chances of getting financing by planning. Prepare a business plan, focus on improving your business credit, and network to meet potential investors. As your business grows, it will become easier to qualify for other startup business loans.