What Type of Loan Is Best for Your Small Business?
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March 19, 2020
13 min read
When you need financing for your business, finding the right lender is critical. But more importantly, you need to make sure you’re choosing the right type of loan.
Business financing isn’t one-size-fits-all, and what works for one business may not be the best choice for another. As you compare various loan and credit options, here are a few tips that can help you find your ideal financing match.
Ask the right questions
You may think you’re ready to start reaching out to lenders. But before you do, take a step back and consider these questions:
- Why do you need small-business financing?
- What are your goals or objectives for getting financing?
- How much do you need to borrow?
- How long do you estimate it will take you to repay financing?
- What kind of periodic payment best fits your cash flow?
- Are you looking for a secured or unsecured loan?
Asking yourself these questions can help you narrow down what kind of financing best meets your needs. It can also help you avoid a loan mismatch.
For example, say you want to open a second location for your business. While planning for the expansion, you create a detailed budget of the costs and a timeline for when the new location will be profitable. You also work up an estimate of your return on investment in terms of increased revenue.
Having those details nailed down can give you a better idea of what type of loan and loan terms will be realistic.
Compare small-business loans
There are many ways you can borrow money for your business. The more you know about how they work, the easier it is to choose the appropriate loan option.
For example, you may choose to finance your business with these:
1. Term loans
A term loan allows you to borrow a lump sum of money. You then repay the loan over a set term. Your interest rate may be fixed or variable, depending on the loan. Term loans can be short-term, with repayment extending 3 to 18 months, or long-term, with terms up to 5 years.
2. U.S. Small Business Administration loans
The U.S. Small Business Administration (SBA) doesn’t make loans to businesses. Instead, it guarantees loans made by partner lenders. An SBA 7(a) loan lets you borrow up to $5.5 million, and these loans can offer low interest rates for qualified businesses.
3. Inventory financing
Inventory loans allow you to borrow money for your business using the inventory you plan to buy as collateral. You then repay the loan from your cash flow as you sell the inventory.
4. Accounts receivable financing
Accounts receivable financing or invoice financing is a method of borrowing against your outstanding invoices. You can use your invoices as collateral for a loan or sell them outright to the invoice financing company.
5. Equipment financing
If you need equipment for your business, you might look at equipment financing. The equipment itself serves as collateral, and you may be able to finance 100% of the purchase, depending on the lender.
6. Business lines of credit
A business line of credit can offer flexibility if you need financing you can draw over time instead of a lump sum. Your line of credit may be secured or unsecured and have a fixed or variable interest rate. You only pay interest on the portion of the credit line you use.
7. Business credit cards
A business credit card is a way to cover business expenses while potentially earning rewards on purchases. A business credit card may offer a lower credit line compared to other financing options, but it’s a flexible way to pay for business needs.
8. Merchant cash advances
A merchant cash advance leverages your credit and debit card receipts for financing. The merchant cash advance provider offers you a set amount of money based on your credit and debit card sales. You then repay the advance from your future sales on a daily basis.
Things to consider
As you compare business financing and loan options, remember to focus on what’s most important:
- Borrowing limits (minimum and maximum)
- Loan terms
- Interest rates and whether they’re fixed or variable
- Collateral requirements
- Loan fees, if any
Also, make sure you’re aware of whether a loan requires a personal guarantee or a Uniform Commercial Code (UCC) lien. A personal guarantee makes you personally responsible for the debt you incur on your business’s behalf. A UCC lien gives a lender a blanket right to your business assets if you default on a loan. But be aware, most lenders, including traditional lenders like banks and credit unions, will usually require a personal guarantee on most loans.
Want more options? Fund your business with a personal loan.
Check the qualification requirements
The last step in deciding what type of loan is best for your small business is one you can’t skip. Before applying for any business loan, you should be aware of how likely you are to be approved.
Each of the loan options listed earlier has its own requirements when it comes to things like minimum credit scores, time in business, and annual revenues. Lenders want to see that you’re a creditworthy borrower and that you’re likely to repay a loan.
If you have an idea of which kind of loan you’re interested in, check the qualification requirements before you apply. Take time to review your business and personal credit, as well as your business financials. Create key documents, such as a financial statement, cash flow statement, and profit and loss statement to see where you stand. Your lender may ask to see these during the application process, so having them prepared can speed things along.
Once your loan application is approved, go over the fine print before agreeing to the loan terms. Take note of how much the loan will cost you in interest and fees. Review your cash flow to make sure you can sustain the estimated monthly payment obligation. Check for a personal guarantee or lien requirement. The better you understand your loan terms, the smoother the business financing process is likely to be.
Now that you know which type of loan is right for you, it’s time to find the right lender. Check out our guide to the top small business loan providers to get started.
Disclaimer
At Business.org, our research is meant to offer general product and service recommendations. We don’t guarantee that our suggestions will work best for each individual or business, so consider your unique needs when choosing products and services.
