A Comprehensive Guide to Business Loans

For many small business owners, cash flow management problems are a commonly cited source of stress. Loans are one way you can invest in opportunities like expansion or covering your current expenses.

Deciding to take on business financing like a loan, line of credit or credit card can be daunting. From navigating the paperwork required and applying—or even knowing where to start—knowing what you don’t know can be overwhelming.

According to a survey by Equifax Canada, more than half of small business owners don’t feel supported by their banks, other lending institutions, or their government. Twenty-six percent of business owners are concerned with their ability to repay their current loans.

For many small business owners, cash flow management problems are a commonly cited source of stress. Loans are one way you can invest in opportunities like expansion or covering your current expenses.

Table of contents:

What is a business loan?

A business loan is an agreement between a business owner and a bank or private lender where money is received for future repayment of the principal with interest. Business loans are specifically intended for business purposes.

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What are the different types of business loans?

Business loans can either be secured or unsecured. A secured loan means that the borrower offers collateral if they default on the loan. An unsecured personal loan, on the other hand, does not require collateral. There are many types of affordable loans small businesses may apply for. Here are a few examples of the most common types of business loans:

  • Business line of credit: A business line of credit is flexible, revolving capital that gives you access to cash.

  • Business credit card: A business credit card is intended for business use rather than personal use and can help business owners build credit, which can translate into better loan rates.

  • Business term loan: This loan is a lump sum of capital to be paid back in fixed increments over a set amount of time (called a term).

  • Canada Small Business Financing: The Canada Small Business Financing Program offers several different loans geared toward small businesses, up to a limit of $1 million per borrower—of this amount, a cap of $350,000 can be used for purchasing or improving property or equipment.

  • Equipment loan: Equipment loans are loans specifically designed to enable owners to buy business equipment. A small business may look into an equipment loan to replace old equipment or update its current equipment.

  • Accounts receivable financing: Accounts receivable financing allows companies to receive early payment on outstanding invoices. Three common types of accounts receivable financing include traditional factoring, selective receivables financing, and asset-based lending.

  • Merchant cash advance: A merchant cash advance is a loan repaid through a percentage of your business’s future credit or debit card sales. This type of loan means you are borrowing against your business’s future earnings. This is less of a loan and more of a cash advance but an alternative to more traditional types of financing.

What do you need to apply for a business loan?

As a small business owner applying for a loan, you have several places you can look when seeking a small business loan. Online lenders, banks and peer-to-peer lending sites are just a few of the types of lenders that provide loans. If you are a Square seller or processing with Square, you might be eligible for a loan through Square Loans.

When you apply for any type of loan, here is some of the documentation a bank or other lender may want to see:

  • Information about how the loan will be used

  • Business plan: A plan that describes all facets of your business

  • Personal background and financial statement: While a lender will likely pull a business credit report, they may also take a look at a personal credit report if you have very little borrowing history.

  • Loan application history

  • Business financial statements, which might include a profit and loss statement, balance sheet, and projected financial statements, for example.

  • Income tax returns

  • Resumes: A loan application will include a professional resume as a way to give the lender context for the experience you have in the industry you are operating your business in.

  • Legal documents: These might include documents like a business certificate or license, commercial leases, and contracts you may have with third parties, for example.

Business Loan Eligibility

There are a few criteria that lenders consider when determining if applicants are eligible for a loan. Building a strong business credit score is one way to strengthen your case when applying for business credit and loans. Each lender has different minimum requirements and qualifications for what will make an applicant more or less eligible, but they typically include:

  • Credit: In this case, credit refers to the creditworthiness of a business.

  • Time in business: How many years the business has been operating (for example, if the business just started versus having been in operation several years).

  • Collateral: Tangible assets that could be used to secure a loan (only in the case of a secured loan).

  • Cash Flow: The amount of cash flowing in and out of a business.

  • Debt load: The amount of debt you have.

  • Industry: The industry of your business is composed of a set of businesses that process the same raw materials, goods, or services. For example, you could be operating a business in the food industry or healthcare industry.

Business loan sizing

Business loan sizing refers to the size or dollar amount of the loan, and it can be determined by several factors like debt-to-income ratio, credit score, and others. A lender determines the loan sizing that they might be able to provide a borrower, but this can be a tricky process, as borrowers may be counting on a larger loan than they may ultimately be qualified for.

Financing and refinancing business loans

The term “financing” refers to the process of providing funds for businesses. There are two different types of financing — debt or equity financing. Loans fall into the debt financing category, which means they must be paid back with interest. Loans have a range of terms, from as short as a few months to as long as 25 years. Microloans, for example, typically last only a few years.

Type of loan Average loan terms
Bank term loans 3-10 years
Business line of credit A few months to years
Merchant cash advance 3-18 months
Equipment loan 2-10 years

What is refinancing? Refinancing a loan means that you are replacing an existing loan with a new one. This is something an owner might consider not only for a business loan but a mortgage or an auto loan as well. You may consider refinancing if it allows you to reduce the interest rate or shorten the terms of the loan, and it can be applied to a mortgage or an auto loan as well.

Some business loan terms to know

Below is a glossary of financial terms and definitions that you should know to make informed choices around loans.

  • Accounts receivable: Accounts receivable is money due to a business by its customers. This refers to outstanding invoices a company has or, more broadly, the money clients owe the business.

  • Accounts payable: Accounts payable is money owed by a business to vendors or suppliers.

  • Amortization: Amortization refers to spreading payment over multiple periods. Amortization can refer to loans or assets. An amortized loan requires the borrower to make scheduled, periodic payments applied to both the principal and interest.

  • APR: APR, or annual percentage rate, refers to the interest rate typically applied to a loan or credit card. In another sense, it is the amount the borrower is charged for the loan expressed as an annual rate.

  • Assets: Tangible assets are any property of monetary value that can be used as collateral. Examples of this include real estate, equipment, or a vehicle.

  • Business credit: Business credit is any financial product (for example, a business loan or a business credit card) that allows a company to borrow money that can be used to purchase products or services.

  • Business credit score: A business credit score is used to evaluate a business’s creditworthiness. High business credit scores can allow business owners easier access to loans, lower interest rates, and better repayment terms.

  • Capital: Capital has several definitions. In finance, capital most commonly refers to financial assets in a bank or brokerage account.

  • Cash Flow: Cash flow refers to the amount of cash going in and out of a business.

  • Collateral: Collateral is an asset (usually tangible) a lender accepts as security for a loan should the borrower default on the loan payment. Not every loan requires collateral, but generally, loans of higher amounts will require it.

  • Debt: Debt is a liability or obligation to pay or render something. Under the terms of a loan, the borrower is required to repay the debt within a certain amount of time.

  • Hold rate: A hold rate is a percentage of daily sales used to repay a loan.

  • Interest rates: An interest rate is the percentage of principal charged by the lender for use of its money. APR and APY are two common ways to calculate interest on credit or loans.

  • Lien: A lien is a legal right or claim against assets that are used as collateral to satisfy a debt. Liens can take several forms depending on the type of asset: a bank lien, judgment lien, mechanic’s lien, real estate lien, and more.

  • Principal: Principal is the amount of money borrowed in a loan. This is the initial size of the loan, and it does not include the interest rate or other fees.

  • Refinancing: Refinancing is the replacement of an existing loan with a new loan with different, sometimes more favourable terms.

  • Term: The term of a loan is the amount of time in which you agree to repay the loan. These terms vary based on the type of financing.

  • Underwriting: Underwriting is the process through which an individual or institution takes on financial risk in exchange for a fee. Underwriting about a loan is when a lender assesses income, assets, debts, and other financial factors to decide how much risk they are taking on if they decide to offer you a loan.

  • Working Capital: Working capital is a financial metric that assesses a business’s ability to pay its current liabilities. In other words, it’s the amount of money a business has that isn’t allotted to already existing debt.