Types of small-business loans
If you thought business financing begins and ends with term loans, then boy do we have news for you. Terms loans are just one of the many types of funding you can get for your small business.
In this section, we’ll look at the various loan choices available to you and discuss why you may or may not want them.
You probably already know something about term loans, but let’s refresh: a term loan gives you an up-front lump sum of cash. You pay back the loan, plus interest, over a length of time known as your term. For short-term loans, your term could be as short as a few months. Most term loans, however, have a term between one and five years.
Term loans often have low interest rates and lengthy terms that make them desirable for business owners. That being said, these loans usually have early repayment penalties, and some people won’t like the idea of making a years-long financial commitment. And to get the best deals, you’ll need a strong credit history, so startups or people with bad credit might want to look at other options.
Large loan amounts
Competitive interest rates
Long repayment terms
A business line of credit (LOC) provides a form of revolving credit, so you can use only the money you need. As you repay what you use, plus interest, those funds come available for you to borrow again. You get a constant source of working capital, with no need to reapply. This makes lines of credit a great way to cover short-term cash flow problems and to anticipate future financial hiccups.
LOCs tend to have lower APR than credit cards and even some loans; however, they often have stricter credit history requirements. Plus, most lines of credit will require a personal guarantee, which leaves you responsible for the debt if you default. And if business slows, some lenders will lower your credit limit.
Fast access to capital
No or low cash advance fees
Higher credit requirements
Threat of decreased credit limit
Personal guarantee requirement
As another form of revolving credit, business credit cards let you use the money you need, pay it back, and use it again. Credit cards have the advantage of being accepted just about anywhere—whether you take the office out to a business lunch or make a run to buy more staples—so you don’t need to plan ahead with this form of funding.
Business credit cards generally come with lower credit limits and higher APRs than lines of credit, which makes credit cards best suited to smaller expenses that you can quickly repay. Not only will this save you on interest, but it will help you build good credit through your small, everyday purchases.
Higher APR than lines of credit
Big cash advance fees
Low credit limits
There are several types of SBA loans, and they all come backed by the US Small Business Administration, which means they have low interest rates, small down payments, and long terms. Sounds like a good deal, right?
Yes, but there’s a but. You have to meet some pretty specific qualifications to qualify for an SBA loan, like getting rejected for private funding and fitting the SBA’s definition of a small business—and that’s in addition to meeting any other lender requirements. Also note that getting funding from SBA loans can take a while. Still, it’s often worth the wait.
Low interest rates
Small down payments
Long repayment terms
Long funding wait times
Very specific qualifications
As you might guess, equipment financing gives you funding to purchase or lease equipment for your business. In this case, the word “equipment” applies more broadly than you might think—it applies to big construction equipment, yes, but it can also refer to desks for your office, couches for a waiting area, breakroom coffee machines, or even software.
Because your equipment serves as collateral for the loan, even people with bad credit can qualify for equipment financing (though you’ll get better rates with good credit). Just make sure you use it to get durable equipment that won’t soon become obsolete; otherwise, you might find yourself paying off a broken, out-of-date piece of junk.
Workable option for bad credit
Potential to owe on obsolete equipment
Limited uses for funds
Higher cost than outright purchases
Commercial real estate loans
Commercial real estate loans provide funding to purchase real estate for your business. Many versions of real estate loans exist, but most come with long terms (think 15 to 30 years long) and low fixed interest rates.
With a commercial real estate loan, the real estate you purchase serves as collateral, so things like the location and the usability of the property can affect the kind of deal you get. Also, commercial real estate loans have some of the longest funding wait times, and they often have pretty strict credit requirements.
Low fixed interest rates
Many loan options
Strict loan qualifications
Lengthy loan-processing time
Large down payments
Cash flow loans include several types of loans designed to help with short-term cash flow needs. If, for example, you’re waiting on clients to pay their invoices but the bills are due, these loans can get you quick cash when you need it. Cash flow loans include lines of credit, merchant cash advances, invoice financing, and short-term loans.
These cash flow loans carry higher fees than traditional term loans, but they also have looser application requirements, so they work well for people who don’t have the time or the credit to get a term loan through a bank. Borrow carefully, however: businesses usually get cash flow loans in expectation of a cash influx (from invoices, for example); if that influx doesn’t come, you could find yourself in a financial bind.
Low application requirements
Help for cash flow
Potential for debt cycle
Risk of future forecasting
A merchant cash advance (MCA) gives you an upfront sum of cash, which you repay with a fixed percentage of future credit card and debit card sales. People with bad credit often turn to MCAs because they have virtually no requirements aside from you having plenty of credit card sales, and these loans get funded in just one or two days.
Merchant cash advances don’t accrue interest; instead, a factor rate determines your fees, which usually amounts to 20%–50% of the advance amount. This fee method can make MCAs look like a good deal, but if you do the math, you’ll see they come with super-high APRs when compared to pretty much any other kind of funding.
High approval rates
Fast access to funds
High APRs and rates
Little industry regulation
Possible debt trap
Invoice factoring and financing
With invoice factoring, you sell unpaid invoices to a factoring company; in exchange, you get a percentage of the invoice as upfront cash, with the remaining percentage following after the invoice gets paid. Invoice financing, on the other hand, gives you a loan for the amount of an invoice. You pay back the loan plus fees over a short term.
Factoring and financing provide another way for businesses with poor credit to get funds quickly, though these methods have relatively high fees and (often) low maximum loan amounts. Plus, invoice factoring could hurt your company’s reputation, as the factoring company contacts your customers to collect on invoices. If you don’t want to risk your customers knowing about your financial woes, use financing instead.
Fast application and funding
High approval rates
Minimal credit requirements
High rates and fees
Low funding amounts
Potential to damage your reputation
Trade credit, also known as mercantile credit, allows a buyer business to purchase goods from a supplier business on credit in exchange for promised future payment. The supplier generally sets the precise terms, which can vary from one week to several months, but a 30-day term is pretty standard.
In most cases, trade credit doesn’t accrue interest, and some suppliers even offer discounts for buyers who repay early. This makes it great for businesses that need to delay payment just a little to smooth over cash flow issues. Plus, many suppliers report to credit bureaus, so you can build business credit through trade credit. Not all suppliers will do this, though, so ask your suppliers to find out if they do.
No or low interest rates
Early payment discounts
Potential to build credit
Fees for late payment
Inconsistent credit reporting
As the name suggests, microloans are like term loans, but smaller. Generally, microloans come in amounts of $50,000 and less. (For reference, the average SBA microloan is $13,000.)3 These small amounts make microloans easier to get than large term loans, but microloans usually have higher interest rates than their larger cousins.
Of course, microloans might be too small for some funding needs; however, microloans allow you to borrow smaller amounts than traditional banks, so you don’t have to pay for money you don’t actually need. And if the funds fit, microloans provide a good option for building your business credit, and you can usually get funded within about two weeks.
Lower application requirements
Smaller possible loan amounts
Higher interest rates than bank loans
Small maximum loan size
Moderate wait time for funds
According to a recent study conducted by Finder.com, the average amount borrowed for business was $7,176, with the most popular means being a personal loan (47.1%), the second-most popular being both a credit card (17.7%) and borrowing from friends and family (17.7%), followed by a short-term or payday loan (11.8%) and a peer-to-peer lender (5.9%).