Funding
How Business Lending Actually Works
Businesses rarely fail because they could not get money. They fail because they took the wrong money, at the wrong price, at the wrong moment. Understanding how lenders think is most of the defence.
Key points
- Match the term of the borrowing to the life of the thing it funds. Short-term money against a long-term asset is how businesses get squeezed.
- Lenders assess capacity to repay from cash flow first, and collateral second. Collateral is their fallback, not their reason to lend.
- Nearly all small business borrowing requires a personal guarantee, which puts your own assets behind the debt.
- The SBA does not lend. It guarantees part of a loan made by a bank, which lets the bank accept a borrower it would otherwise decline.
- A “factor rate” is not an interest rate. Convert every offer to an annualised cost before comparing anything.
The main forms of business borrowing
Each product exists to solve a different problem. Using the wrong one is expensive even when the rate looks fine.
| Product | What it suits | Typical shape |
|---|---|---|
| Term loan | A defined one-off need — expansion, a large purchase, refinancing | Lump sum, fixed repayments over a set period |
| Line of credit | Working capital, seasonal gaps, timing mismatches | Revolving limit; draw, repay, redraw. Interest on what you use |
| SBA 7(a) | General purposes where conventional terms are out of reach | Bank loan, partial government guarantee, longer terms |
| SBA 504 | Owner-occupied real estate and major fixed assets | Bank + certified development company structure, long fixed term |
| Equipment financing | Machinery and vehicles | The equipment itself is the collateral |
| Invoice financing | Cash tied up in unpaid B2B invoices | Advance against receivables, fee based on time outstanding |
| Merchant cash advance | Rarely the right answer — see below | Lump sum repaid as a share of daily card sales |
Fund long-lived assets with long-term borrowing and short-term needs with short-term facilities. Buying a five-year asset with a nine-month facility creates a repayment burden far heavier than the asset generates, and that mismatch — not the interest rate — is what usually causes the damage.
What an underwriter is actually assessing
Lending decisions are conventionally framed around five factors, and understanding them tells you exactly what to prepare.
Capacity. The central question: does cash flow service the debt? Lenders commonly compute a debt service coverage ratio — cash available for debt service divided by total debt payments. A ratio of 1.0 means every available dollar goes to the loan; lenders want a clear margin above that, with the required cushion varying by lender and loan type.
Credit. For small business the owner's personal credit score usually matters as much as the business's, because the owner is guaranteeing the debt. Business credit history matters too, and is covered in the business credit guide.
Capital. How much of your own money is committed. A lender funding an acquisition or a property purchase expects the borrower to have meaningful equity at risk.
Collateral. Assets pledged as a secondary source of repayment — property, equipment, receivables, or a blanket lien over business assets. Collateral improves terms; it does not substitute for cash flow.
Conditions. The purpose of the loan, your industry, and the broader economic environment. Some sectors face restrictions regardless of individual performance.
Time in business and revenue
Most conventional lenders want at least two years of trading history and a revenue floor. Below that you are looking at SBA microloans, community lenders, equipment finance secured on the asset, or personal credit. Being newly established is not a defect — it simply narrows the field.
The personal guarantee
Forming an LLC separates your personal assets from business liabilities. A personal guarantee deliberately reverses that for a specific debt: if the business cannot pay, the lender pursues you.
Nearly every small business lender requires one. Its absence generally signals either a very well-established borrower or strong asset backing. This is not something you can usually negotiate away, but you can sometimes negotiate its scope:
- Limited guarantees capping exposure at a set amount or percentage rather than the full balance
- Several rather than joint liability where there are multiple owners, so each guarantees their own share instead of all being liable for the whole
- Release provisions that drop the guarantee once the business hits agreed performance or the balance falls below a threshold
Whether these are available depends on your leverage. What matters is that you understand you are signing them. Read what the guarantee covers, and if you are married, understand how it interacts with jointly held assets in your state.
How SBA loans really work
The most common misunderstanding: the Small Business Administration does not lend money. You apply to a bank or approved lender. The SBA guarantees a portion of the loan, reducing the lender's downside, which allows them to approve borrowers or terms they would otherwise decline.
The two principal programmes:
7(a) is the general-purpose programme — working capital, equipment, refinancing, business acquisition, sometimes property. Flexible, and the most widely used.
504 funds owner-occupied commercial real estate and major fixed assets through a structure combining a bank loan, a certified development company debenture and a borrower contribution, typically at a long fixed rate.
Maximum loan sizes, guarantee percentages, maturities and fee schedules are set by programme rules and are periodically revised [VERIFY: current SBA 7(a) and 504 maximum loan amounts, guarantee percentages, fee structure and rate caps, sba.gov]. Interest rates on 7(a) loans are typically tied to a base rate plus a spread subject to a regulated maximum.
What to expect from the process
SBA lending trades speed for terms. Longer maturities and lower down payments come with a heavier process: extensive documentation, business and personal financial statements, tax returns, a business plan or projections, and weeks rather than days to close. Lenders differ enormously in how efficiently they run it — some are designated preferred lenders with delegated authority and move considerably faster. If you are pursuing SBA finance, ask about that designation before you start.
Merchant cash advances and why the cost is disguised
A merchant cash advance is not technically a loan. The provider buys a share of your future card receipts at a discount, and collects by taking a fixed percentage of daily sales, or a fixed daily debit, until a set total is repaid.
Approval is fast and requirements are minimal, which is why struggling businesses reach for them. The problem is the pricing structure.
MCAs are quoted as a factor rate — borrow $50,000 at a factor of 1.4 and you repay $70,000. That $20,000 looks like “40%”. It is not. Interest rates are annualised; a factor rate is not. If that $70,000 is collected over roughly eight months, the annualised cost is far higher than 40% — frequently in triple digits. Repaying early does not reduce the total owed, because the amount is fixed at the outset rather than accruing over time.
Two further features compound the risk. Repayment is taken daily, straight from receipts, so it hits cash flow before you can prioritise anything else. And because approval is easy, businesses under pressure often take a second advance to service the first — a stacking pattern that is difficult to escape.
There are narrow cases where a short, expensive advance is rational: a genuinely time-limited opportunity with a clear and rapid return. Covering a shortfall of unclear cause is not one of them. Before signing, calculate the annualised cost and compare it against a line of credit or an SBA microloan, even if those take longer to arrange.
Comparing offers on the same basis
Lenders present cost in ways that are not directly comparable. Normalise everything before deciding.
- Ask for the APR, not the interest rate or factor rate. APR incorporates fees and reflects the repayment schedule.
- Add every fee — origination, packaging, closing, servicing, and any prepayment penalty.
- Check the payment frequency. Daily or weekly debits affect working capital very differently from monthly ones, even at identical APR.
- Ask about prepayment. Can you repay early and save interest, or is the total fixed?
- Read the covenants. Financial covenants can trigger default on a loan you are paying perfectly well.
- Identify the collateral and any blanket lien, which can prevent later borrowing against the same assets.
Preparing an application
Have ready: two to three years of business tax returns, year-to-date profit and loss and balance sheet, business bank statements, personal tax returns and a personal financial statement for each significant owner, a debt schedule, entity documents, and a clear written statement of how much you need, what it is for and how it will be repaid.
That last item carries more weight than owners expect. A specific, quantified case — this equipment produces this additional output, generating this margin, which services the debt with this cushion — presents very differently from a general request for growth capital.
Educational information only. This guide explains how US business finance generally works. It is not financial, tax, investment or legal advice, and it does not account for your circumstances. Tax figures change annually and rules vary by state — anything highlighted for verification must be confirmed against current IRS or state guidance. Consult a qualified professional before acting. See the full disclaimer.