If you need start-up capital for a small business, you have three main options. Firstly, you can use your own money. Secondly, you can ask for investment (thus giving up a stake in your business). Thirdly, you can apply for a small business loan. Many business owners prefer to use small business loans as it eases the pressure on their own funds, but still gives them full control of their business.


Table Of Contents



What is a Small Business Loan?

In general terms, a small business loan is simply a loan made to a small business as distinct from a loan made either to an individual or a loan made to a larger enterprise. In Canada, however, the term “small business loan” can also be used to refer specifically to the Canada Small Business Financing Program which is backed by the Federal Government.

How Small Business Loans Work

In principle, small business loans work in much the same way as any other sort of loan. A lender will look at the amount requested, the purpose for which it is requested and the borrower’s financial standing. They will then make a decision on whether or not they are prepared to make a loan and, if so, at what interest rate.


There is, however, a bit of nuance with small business loans. Small businesses, particularly startups, are highly unlikely to have a credit history of their own. This fact has three main implications.

Greater emphasis on the purpose of the loan

If a loan is to buy assets, then the lender could potentially use the proceeds from the sale of those assets to recoup their money if the borrower defaults. If the loan is for another purpose, then the lender is potentially more at risk if the borrower defaults.

Greater emphasis on collateral

Similarly, if the borrower has assets that could be monetized in the event of a default, then the loan is less risky for the lender.

Greater emphasis on personal guarantees

With startups, business owners may choose to apply for a small business loan even if they, personally, have the liquid funds they need to finance their business. This is because using a small business loan allows the business to start building up its own credit history, independently of the owner. Effectively, the borrower is choosing to make interest payments to the lender in exchange for having their payments reported to the credit bureaus.

What Types of Loans are Available to Small Businesses in Ontario?

There are a variety of loans available to small businesses in Ontario. Here is a quick guide to the main ones.

Bank business loans

In theory, there are plenty of bank business loans available. There are, however, two potential problems with them. Firstly, products from mainstream banks may not really be suitable for startups and other young/small businesses. Secondly, even if they are, it may be very difficult for the average smaller business to qualify for them.


The key point to understand about traditional bank loans is that banks need to make a profit on them. Lending small amounts of money at low rates of interest does not generate a lot of profit. Lending large amounts of money at high rates of interest can generate a lot of profit, but it can also generate a lot of risk.


This means that mainstream lenders tend to be set up to lend either small amounts of money at higher interest rates or larger amounts of money at lower interest rates. Neither of these options is likely to be ideal for smaller businesses, especially startups.


The other main barrier is meeting the qualification criteria. Startups, by definition, won’t have a credit history. This means that they’ll almost certainly need to rely heavily on collateral and/or personal guarantees. Even then, they might struggle to get a small business loan for anything other than the purchase of assets which could be easily sold in the event of a default.

Canada Small Business Financing Program 

The Canada Small Business Financing Program is a cross between a regular small business loan and a government support program. It’s like a loan in that the money is repayable over a designated period with interest. It’s like a government support program because it’s backed by the Federal Government and hence can be made available to borrowers the banks might not usually consider.

Credit union business loans

Credit unions work on a non-profit basis. This has two implications. Firstly, their interest rates tend to be lower than bank rates. Secondly, they may be prepared to offer loans for amounts the banks would reject as unprofitable.  


There will obviously still be a limit to how low they can go as they will still need to cover their costs. They do not, however, need to make a profit to satisfy their shareholders the way the banks do.


As with bank business loans, however, you still have the issue of qualifying for a credit union business loan. Again, if you don’t have a credit history, which startups won’t, then you’ll probably need to be able to provide collateral and/or personal guarantees. Again, even with these, you may struggle to get a credit union business loan for anything other than buying assets that could be easily sold in the event of a default.

Online business loans

Online business loans work the same way as regular bank loans. The fact that the lender works purely online has both benefits and potential drawbacks.  


The obvious benefit is that it lowers the lender’s overheads and hence can result in lower-cost business loans. It can also mean that online lenders are more willing to offer business loans for amounts the banks would consider to be unprofitable. Last, but in some cases definitely not least, their application processes can be relatively speedy.


The potential drawback, however, is that you may find it much harder, if not impossible, to get any meaningful help from human staff if you find you need it. How much of a drawback it is probably depends on how comfortable you are with business administration.  


If you’re confident you know your way around filling in the necessary paperwork to get a small business loan, then you may be absolutely fine with this. If you’re not, however, then you might want to stick with lenders which can provide human assistance if you need it.

Private business loans

Private business loans come in many shapes and forms. It may be possible to get loans directly from private individuals (e.g. venture capitalists) or privately-owned companies. Alternatively, you could look at peer-to-peer lending platforms or crowdfunding platforms.

Other loans and grants

Depending on your personal status and history and the nature of your business, you may be eligible for non-standard funding, possibly even grants. The requirements for these are very variable and programs can change, so you always need to do your own research at the time.

Who Do Banks Typically Lend To?

Banks typically lend to any legal business which can show itself capable of making the necessary repayments. Some banks may steer clear of businesses in controversial business areas. In general, however, it’s a borrower’s (perceived) willingness and ability to make repayments which really matters.


This means that banks are typically looking for borrowers who/which

  • Have a solid credit rating
  • Have reliable income
  • Have assets

Banks are well aware that credit ratings take time to build (or rebuild). They may therefore be willing to stretch a point on that issue provided that the applicant can compensate for this in other ways. In the case of startups, this might mean having a very robust business planned backed by a personal guarantee.

How Much Can I Borrow for a Business Loan?

There are business loans available for anything from a few hundred dollars to several million dollars. The question is whether or not you would qualify for them. You can get a ballpark idea of how much you might be allowed to borrow by calculating your debt service coverage ratio.


Calculate your income minus your pre-tax expenses. This gives your pre-tax profit. That’s how much cash you have to use to make repayments on a loan. It is unlikely to be worth your while even to apply for a loan where the monthly repayments are greater than this amount.

The only exception to this is if you can offer really compelling evidence that your disposable income is likely to increase, e.g. as the result of getting the loan.


Be aware, however, that your DSCR is a starting point, rather than a hard-and-fast rule about how much you can borrow. The lender will also consider other factors. For example, they will look at how long you have been trading, to see how reliable your income is. They will also look at the length of the loan period to see how exposed they (and you) would be to changing circumstances.

What is the Average Interest Rate on a Business Loan?

Again, there is no standard answer to this. Firstly, interest rates on business loans depend on the prevailing rate in the market at the time you make your application. Secondly, interest rates depend on the perceived level of risk and this will depend not only on the borrower and the amount requested but also on the length of the loan term and the purpose of the loan.  


For example, the same customer requesting the same amount might pay a different rate of interest depending on whether the loan was to purchase assets or to lease them. This is because, in the former case, if the borrower defaults, the assets could be sold to pay back at least some of the capital.


You will therefore need to check the average interest rates in place when you want to apply for a business loan. It’s also advisable to check whether or not these rates are fixed. If they’re not, then you need to account for possible increases.

What is the Typical Loan Period for a Small Business Loan?

There is really no typical loan period for a small business loan. There are loans available for very short terms (3-18) months and loans available for very long terms (10+ years). As a rule of thumb, however, the shorter the term of the loan, the easier it is to be approved for it. This is because the lender is less exposed to the possibility of your circumstances taking a change for the worse.

How to Apply for a Business Loan

Before you apply for a business loan, you should make some time to think about the following points.

  • What exactly do you want to do with the loan?
  • How much can you really afford to pay each month?
  • What options do you have?

If you decide to go ahead with the loan application, then your lender will want answers to the first two questions. So by thinking about them in advance, you’re putting yourself ahead of the game.


Question three is for your benefit and it’s massively important. Remember to think about all your options, including alternatives to getting a business loan right now. For example, you may want to buy assets and hire staff. It may, however, be more pragmatic to lease assets and work with freelancers, at least in the early stages of your business.


As a rule of thumb, the longer you have been successfully trading, the easier it will be for you if you do want to apply for a business loan. You will have demonstrated that you can run a business over the long term. You will also have had a chance to build up a credit score for your business.

Always do your research

If you do decide to go ahead and apply for a business loan, research the market thoroughly. Make a list of business loans for which you have a reasonable chance of qualifying. Then rank them in order of preference. Then choose one lender and apply to them and them only.  


Resist any temptation to apply to multiple lenders at the same time. If you do, and there is an issue with your application, you’ll end up getting multiple rejections and may have to wait before you can apply again. If, however, you approach one lender and get rejected, you may have an opportunity to fix any issues before applying to another.

What are the Requirements for a Small Business Loan?

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Although each lender will have their own requirements, there are four criteria lenders are practically guaranteed to check. These are:

  • Your business’ legal status
  • Your credit score
  • Your business plan, including details of how you intend to use the loan
  • Your financial documents

"Financial documents" is a very broad category and can include anything from tax filings (or in the case of startups tax registration) to commercial leases to proof that you have a contract to accept payment cards.  


You can expect to need to show that you’ve thought through all elements of the cash-flow-management process. For example, if you’re taking payment in arrears, you can expect to be asked about your invoicing process and how you will handle your own credit control. If you’re taking payment in advance, you can expect to be asked about your expectations for returns and customer disputes.

What do I need to apply for a business loan?

Each lender will have their own set of requirements and these can vary greatly. It’s therefore advisable to make a detailed check of all the requirements for any business loan product before you make a final decision on whether or not to apply.

Applying for a business loan - what do banks look at?

When deciding how much (if anything) you could potentially borrow a lender will typically look at factors such as:

  • Your company’s legal status
  • The nature of your business and how long you have been trading
  • How much income you receive and how you receive it
  • Your liabilities/expenses
  • Why you want the loan

If you apply for a business loan, you should expect to have to go into a lot of detail about how you earn your money and how you take payments. For example, a lender might want to know if you use ewallets and/or accept payment cards or if your customers have trade accounts. This sort of information can help it to build up a picture of your finances.

How much collateral for a business loan?

How much collateral you will need for a business loan will depend partly on how the lender perceives you as a customer and partly on the purpose of the loan. For example, if you were looking for a loan to buy assets, then the lender might only request a small amount of collateral. If, however, you wanted a loan for the same amount to hire staff, the lender might increase the amount of collateral to reflect the fact that your staff could not be sold to pay back the loan.

How to Qualify for a Business Loan

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There is no formula that guarantees that you will qualify for a business loan. There are, however, two golden rules you should always follow. These are:

  • Maximize your credit score
  • Fill in the lender’s documentation completely and consistently

Maximize your credit score

The better your credit score, the better your chances of being approved for a business loan. This poses an obvious challenge for startups that don’t yet have one. In this case, it can be very helpful if the business owner has a solid personal credit score.

Fill in the lender’s documentation completely and consistently

Business loan applications can be very dense and very technical. All those questions are, however, there for a reason and you need to make sure that you answer them completely. Similarly, you need to ensure that you are totally consistent about everything, right down to the finest details.


Formatting matters


Pay close attention to the formatting. You need it to be consistent not just across the loan application form, but across all associated documents. This may require you to update your details elsewhere.


For example, if your commercial lease gives your business address as 1 A. N. Other Street, then that’s how it needs to appear on all documents related to your application. This means that if you have documents showing it in some other format, e.g. 1 A N Other St., then you need to update your details with the relevant company. 

 

This may be a tedious exercise, but you should only need to do it once. Then make sure you always enter your details absolutely correctly when you’re completing any business-related documentation.


The reason why this matters is that most business loan applications are scanned by a computer algorithm before being sent to a human. These algorithms can identify formatting issues as inconsistencies and penalize them.

How to Get a First Time Business Loan

If you’re applying for a first time business loan, then you need to be very aware of the fact that lenders will scrutinize both your business plan and your own personal history. This won’t necessarily be just your financial history. They may also want to know about your educational/work experience. In other words, is there anything in your past that might influence your success in the future?

How to Apply for a Startup Business Loan

Essentially the same comments apply as for a first time business loan. Be aware that your business plan will be scrutinized very thoroughly as will your personal history, financial and otherwise.

How to Get a Loan to Buy an Existing Business

There are basically two key factors that determine how likely you are to get a loan to buy a business. The first is how well the business is doing. You should already have received all the necessary data as part of your initial due diligence before the purchase. The second is how well-qualified you are to run it.


If you’re buying a successful business, you need to be able to demonstrate that you have a reasonable chance of keeping a business running to its current standard. Ideally, you will be able to demonstrate that you have a viable plan for improving it. If you’re buying a struggling business then you must be able to show the lender how you intend to turn it around.  

How to Get a Business Loan for a Franchise

If you are planning on taking over an existing outlet of a franchise business, then the process is essentially the same as the process for buying any other existing business. If, however, you are planning on opening up a new outlet of a franchise business, then you will also need to show the lender why that outlet can expect to succeed in that particular location.

How to Write a Business Loan Proposal

The key to writing an effective business loan proposal is to remember that it is basically a sales pitch to very experienced buyers. You, therefore, need to think about all the questions an experienced buyer might ask and make sure they are answered in your proposal. Here are some points to consider.

  • What is your business all about and why do you think it can succeed?
  • How are you going to market your brand and promote your products/services?
  • How are you going to make your product/provide your service?
  • Who are you and your management team? What are you bringing to the table?
  • What other talents will you need and how will you recruit and pay for it?
  • What financial data do you have? If you’re using forecasts, how can you justify them?

You must be able to back up forecasts and ideally, you should be able to back up any and every claim you make. For example, find statistics on your industry and its growth. Show you have established a presence on the internet and social media (or at least bought a domain and claimed the associated social media handles). Provide client testimonials.


Remember that your proposal is going to be read by humans, not computers, so make it as easy as you can for them. As a minimum, pay attention to proper spelling, grammar and punctuation. Make sure your sentences are clearly understandable and avoid jargon (or at least explain it). See if you can use graphics and images to make data easier to grasp.

How (and Where) to Get a Business Loan with Bad Credit

If your company has no credit or bad credit but your personal credit history is good, then you may be able to apply for standard business loans backed by a personal guarantee. If you personally do not have a positive credit history, then you may have to rely on collateral and/or a personal guarantee from someone else.


If you have an actively bad credit history, e.g. you’ve defaulted in the past, then your options will be much more limited. You may still be able to get a standard business loan if you can offer significant collateral or and/or a personal guarantee from someone who is very well-qualified.

If you can’t get a business loan with bad credit:

The better your credit score, the better your chances of being approved for a business loan. This poses an obvious challenge for startups that don’t yet have one. In this case, it can be very helpful if the business owner has a solid personal credit score.

  • Try the Canadian Small Business Financing Program
  • Try the Business Development Bank of Canada
  • Look at peer-to-peer lending, crowdfunding and grants
  • Wait and rebuild your personal credit history
  • Look specifically for a commercial lender that specializes in higher-risk loans.

How to Get a Small Business Loan Without Collateral

There are basically three ways to get a small business loan without collateral. The first is to borrow a small amount, preferably over a short period. This creates minimal risk to the lender, especially if the loan is being used to buy assets that could be sold in the event of a default.


The second is to build up a good credit score. Over the long term, you’ll want your business to develop a good credit history (assuming it's incorporated). In the startup period, however, lenders tend to work off the owner’s credit score. This means that anyone planning to open or buy a business should do everything they can to make their credit score as good as it can possibly be.


The third is to look at government-backed and alternative sources of funding. These can be less commercialized and therefore potentially a bit more relaxed about their requirements.

How to Apply for a Small Business Loan from the Government

The Canadian Government has a huge range of funding programs of which the Canadian Small Business Financing Program is probably the most widely recognized. This is administered through lenders, each of which will have its own application process.

How to Get a Small Business Loan for Women

The Canadian Federal Government has published a Women Entrepreneurship Strategy. Its homepage has up-to-date information on small business loans specifically for women entrepreneurs. In general, however, the Business Development Bank of Canada is often a good source of funds for businesses run by women entrepreneurs.

How to Get a Small Business Loan for an Aboriginal Person

There are currently three special loan programs available for Aboriginal and First Nations people. These are run by the Waubetek Business Development Corporation, the Nishnawbe Aski Development Fund and the Indian Agricultural Program of Ontario.

Common Mistakes to Avoid When Looking for a Small Business Loan

Here are some common mistakes to avoid when looking for small business loans.


  • Failing to research the market thoroughly. Be sure to look at all options before you apply for any.
  • Failing to be realistic about how much you can borrow. Take a close look at your finances and remember that lenders generally err on the side of caution.
  • Failing to create an effective application. Applying for a business loan can be a tedious and technical process, but you must take all the time you need to get it right

About the author 

Maurice

Maurice (Moe) Muise learned the ins-and-outs of government while an employee of the Government of Canada in Ottawa for 10 years. His current focus is helping small businesses in Ontario to identify and maximize government grants to grow their business.
Click here to learn more about Moe's background and how he can help your business.

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