**Please note, this does not constitute legal or financial advice and is provided for educational purposes only**
Whether you’re starting up for the first time, trying to maintain the status quo, or taking your business in a new direction, you know that you need access to funds in order to move forward with your business venture. If you don't love the idea of giving away a part of your business with equity financing, you may consider debt financing.
If you're on this route, you've probably noticed there are more and more loan options available from a wide variety of sources. So, how do you decide what kind of business loan is the right choice for your needs? Let’s break down eight of the most common loan options favored by business owners:
1. Bank Loan
The absolute cheapest source of capital available to businesses is a traditional bank loan. Bank loans are usually multi-year term loans with monthly payments. With a term loan, you essentially borrow a fixed amount of money, usually for a specifically stated business purpose—and pay back the loan over a fixed term and typically at a fixed interest rate. You can apply for a business loan at big banks like Chase and Bank of America, or a community bank. However, bank loans are the hardest form of capital to secure, with around 82% of small business loan applications denied by the banks. If you're thinking of going this route, start with the community banks, as they have higher approval rates than big banks.
2. SBA Loan
Because of the risky nature of small business lending, many commercial lenders are hesitant to lend money to small business owners—especially newer businesses or those operating in riskier industries. As a solution, the Small Business Administration began guaranteeing a percentage of the loan principal for term loans through participating lending institutions.
Although the SBA itself does not directly lend funds, the agency will guarantee as much as 80% of the loan for qualifying borrowers in an effort to incentivize banks to lend money to small businesses. Because of this guarantee, banks can afford to offer lower down payments, longer payment terms, and more reasonable interest rates than they typically would.
There are several SBA loan programs available, many of which offer special considerations for women, minority business owners, and others who may struggle to qualify for traditional bank loans. The SBA 7(a) loan program is by far the most popular, as funds obtained through this program can be used for a variety of general business purposes. If you’re seeking seeking to purchase major fixed assets such as manufacturing equipment or commercial property, the Certified Development Company (CDC) 504 Loan Program may be a great choice.
Because SBA loans must be approved by both the Small Business Administration and the lending institution, these applications involve the most paperwork and longest approval times of any term loan. So if you need quick access to cash, and SBA loan is likely not the best choice for your business. But if you don’t mind waiting a few months to get the best interest rates available, an SBA loan may be worth the wait.
3. Online "Medium" Term Loan
Depending on your business needs, credit rating, and other factors, there are a wide variety of "medium" term loans available to many business owners online. The reason they're called medium term is the term length is often shorter than you would find with a bank loan or SBA loan. Term lengths range from 1 year to 5 years and everything in between.
A term loan may be a great fit if you’re looking for long term financing with a fixed interest rate, predictable monthly payments, and flexibility in the use of funds.
4. Equipment Financing
If your primary funding needs involve purchasing equipment for your small business, equipment financing may be a great choice. A small business equipment loan can be used for virtually any equipment need—from computers to production machinery, to vehicles, and more.
As a point of reference, compare equipment financing to a standard car loan: the amount you can borrow depends on the type of equipment, the price, and whether it is new or used.
Interest rates for equipment loans are generally fixed between 8% and 30%. However, newer startups or those with poor credit histories are typically subjected to higher rates.
Equipment loans are often a great choice for borrowers who can’t offer collateral, since the equipment itself acts as collateral for the loan.
5. Invoice Financing
Wouldn’t it be nice if every one of your customers paid their invoices on time? If accounts receivables converted right over to cash on hand at a steady rate, and you never had to worry about cash flow? But in reality, unpaid invoices can become a huge problem for businesses, with the resulting stalls in cash flow even threatening an otherwise healthy business’s very survival.
If you’re a B2B company, and cash flow issues from unpaid invoices are a primary reason that you’re interested in a business loan, invoice financing may be a great option for your business needs.
With invoice financing, accounts receivables companies advance you an amount based on your outstanding receivables. Typically, invoice financing companies will provide about 85% of the value of your invoices up front. The balance of the value, approximately 15%, will be returned to you at conclusion of the collection period, minus the fees retained by the company for its services.
Invoice financing fees usually include a processing fee for the privilege of the advance, and a second variable fee related to the speed in which the invoice is resolved—so the sooner your clients pay up, the more money you will retain.
These two fees can be a bitter pill for entrepreneurs to swallow. After all, you did the work for your client, and you’d like the full value of your invoices directed back into your business. But if you need a quick, reliable cash flow solution to maintain business operations in the short term, invoice financing may be your best available option.
6. Short-Term Loan
As the name implies, short-term loans are designed to meet a wide variety of short-term business financing needs. Business owners often use these loans to manage cash flow, deal with unexpected expenses, or take advantage of new business opportunities that may come along.
Unlike other loan types which may limit use of funds, short-term loans can be used for virtually any business purpose. And because the loan term is relatively shorter, you can limit how long the debt is on your books, impacting your bottom line of monthly profits. Short-term loans are usually 3 months to 18 months in length and often require daily payments instead of monthly payments.
There are some downsides to taking on a short-term loan. Typically, shorter term loans have higher annual percentage rates (APR), meaning you’ll be paying more in interest month to month than you would be with a longer term loan.
But if you need quick access to cash and don’t want to be told how to spend it, the flexibility, limited paperwork, and quick turnaround time may be worth any downsides.
If you have a relatively small or boutique business and need just a small amount of financing to get on your feet, the SBA microloan program may be a great fit for your needs. The microloan program funds loans for a maximum borrowing amount of $50,000, with average loan sizes of closer to $13,000.
Beyond the dollar amount, the primary difference between a microloan and a typical term loan is the source of the funding. Unlike with term loans or even SBA loans funded directly from traditional banks or other lenders, with a microloan, the Small Business Administration distributes funds to designated community-based nonprofit organizations with experience in business management and lending assistance who serve as the intermediary lenders.
Microloans may carry a maximum term of 6 years, with interest rates for microloans funded by the SBA falling between 8 and 13 percent. However, these rates can vary between intermediary lender and depend on costs from the U.S. Treasury.
8. Merchant Cash Advance
Unlike with a traditional loan, where the same minimum payment on principal and interest is due month to month, a merchant cash advance is repaid at irregular amounts and intervals.
Borrowers receive a lump sum payment of liquid capital in exchange for a percentage of the company’s future sales. When a borrower receives cash from a merchant capital provider, he agrees to pay back the cash advance, plus a fee, by allowing the provider to automatically deduct an agreed upon percentage of his company’s daily credit and debit card sales.
This setup is often ideal for seasonal businesses that don’t have regular cash flow, since it means borrowers have the flexibility to repay more when sales volume is high and less during slower sales periods.
However, keep in mind that most MCAs have significantly higher fees than most other loans. Borrowers also have less flexibility to change merchant service providers during the repayment period, and the daily deduction from credit card sales will limit a business’s cash flow. For these reasons, MCAs are not most business’s first financing choice.
Obviously, there are pros and cons to every business financing option, and many different factors about your business can impact which type of business loan will be the best choice for you. The best thing you can do is talk to a business loan expert or an independent financial advisor to help determine the best source of financing for your business needs.