The Many Types of Business Loans Explained: Get To Know Your Options
Practically every small business has faced the challenge of selecting a business loan. You certainly don’t lack for choices, but finding the right one to match your business needs without costing you an arm and a leg in the long run is often tough. So, let's break down what types of business loans exist and the parameters you should use to decide which one is right for your company.
What Loan Types Should You Consider?
Back in the day, businesses and people looking for a loan didn't have as many options as we have today. Nowadays, however, the multitude of loans and vendors available makes finding the right loan much more likely, but the search is still quite difficult.
Of course, heading to your bank of choice is still an excellent option, as they tend to give better terms for their business-loan options. The requirement standards will be the steepest here. You're more likely to get approved for a loan by alternative lenders, even though the terms might not be as generous as you'd like them to be.
Below, we’ll go through the most common kinds of business loans you can get.
A Business Line of Credit
A business line of credit is an excellent solution if you need plenty of leeway in your business finances. If your income and expenses are often playing cat and mouse, starting a line of credit is probably one of the best types of business-loan options you could use. It essentially works like a credit card for your business and, provided you do not exceed your limit, it could be the solution you need to manage your business much more effectively.
A business line of credit can help out on a day-to-day basis for covering unexpected expenses, but it won't be of much help if you need a loan for more significant projects. Lines of credit cover smaller amounts - above $1,000 and under $250,000 - so if you need to make a more substantial investment, this type of business loan probably won’t be your top pick. However, finding the right business line of credit can be just the thing for managing your company’s cash flow.
As we've mentioned before, online lenders usually have lower requirements than banks. You'll probably be able to get a line of credit if you've been in business for at least six months, have a credit score of 500 and up, and at least $25,000 in annual revenue. Banks will require at least one to three years of positive history and a much higher income. To open this kind of business loan for a small business at a bank, you’ll need to submit business and personal tax returns, bank account information, and your company’s financial statements.
Working Capital Loan
A working capital loan is a short-term loan used to cover unexpected or day-to-day expenses, but also for expanding your business.
Getting one is a complex matter, as you need to find a large national bank, local credit union, or third-party direct lender that will approve this type of loan. You'll also need to provide a mountain of paperwork, which is a common case with these types of business loans, whether they’re offered by banks or private lenders.
The critical thing to keep in mind is that the optimal amount for a working capital loan is around 10% of your company's revenue.
Many lenders will only work with your business if it gets at least $9,000 in revenue each month. You’ll need to submit documentation to prove this income, and you will likely need to provide collateral. If you decide to go with a working capital loan, consider a bank you are already cooperating with: It will already be in possession of your business history records, so you might get approved for a loan for your business a lot quicker.
Business Term Loan
A business term loan is the one to rely on if you need to finance large projects. A business term loan is a fixed sum of money to be paid off at a fixed interest rate over a fixed period - usually between one and five years. Unlike the previous solution, this business loan is not that hard to get - as long as you have good credit and generate revenue, the odds are in your favor.
The loan amount usually ranges from $25,000 to $500,000, and you pay it back in pre-set increments throughout the specified term. Unfortunately, you can often expect high business-loan interest rates to go with that, from 7% to 30%.
Your best bet for applying and receiving this kind of credit is a bank. This is not a quick solution, however - application processing can be tedious and time-consuming, although things speed up somewhat if the bank lets you apply online. You will need to prepare your bank statements, balance sheets, tax returns, profit and loss statements, and your credit score report before starting the process.
Small Business Administration Loan
SBA loans are actually three different types of loans that come from private lenders. You will also need to provide collateral. The first type, a 7(a) loan, is perfect for acquiring an existing business or financing major projects. Microloans are a good solution for startups looking for finances to expand their businesses, and the 504 loan program is commonly used for purchasing real estate or significant amounts of equipment.
SBA loans range from $10,000 to $5 million, and the maximum term allowed for these loans is six years. Interest rates can vary between 8% and 13%.
Each of these different types of small-business loans has its own set of requirements and eligibility criteria, and they vary by lender. If you are looking to apply for a specific type of SBA loan, you will want to visit the lender’s website to find out if you’re eligible for approval.
Accounts Receivable Financing
Accounts receivable financing or factoring is a fancy name used to describe selling your uncollected invoices to a third party for an advance payment. The third party is then responsible for making good on the invoice from the customer. This is not the best option out there, as you will never get the full value of your outstanding invoices, but it can be an excellent match if you’re in a pinch. Such loans for small businesses often work for companies that have yet to establish a sustainable source of financing or struggle to make customers pay up.
Unfortunately, these loans are often very costly, as they usually have extremely high interest rates, which can end up being a lot more trouble than it was initially worth. The biggest problem with this kind of financing is that you don’t control your own cash flow - instead, it depends mostly on your customers’ financial strength.
Not many banks offer this business loan for a small business, so you'll likely have more luck with commercial lenders. The paperwork is tough with this one, too, and you should be prepared to provide the lender with an example of your typical invoice, a master list of customers, and your company's most recent accounts receivable and payable records.
Merchant Cash Advance
Similar to accounts receivable financing, a merchant cash advance allows you to take a loan based on your future sales. While used mainly by businesses that rely heavily on credit and debit card sales, these types of loans for a small business can also serve other customers. They are usually approved within 24 hours: Perfect in case of an emergency, as they require little to no paperwork, no collateral, and the lender can modify the repayments based on how well your business is doing.
Of course, nothing is ideal, so these also carry certain expenses. Considering that they typically come with a high APR, they might not be a great idea if your business is not financially stable. The interest can get out of hand and drive your business into the ground instead.
As mentioned before, there are no special requirements for setting up this type of business loan. Even if your business has bad credit, but you need a loan, you’ll be able to apply for it. The only paperwork lenders might ask for is three months of financial statements, which the lender will use to determine risk factors.
How To Choose the Correct Loan
Choosing the right loan is essential. After all, the loan you're getting is meant to help your business, not get it into more trouble.
With such high stakes, it’s no surprise that 27% of small businesses have found choosing the adequate one among the various types of financial loans for business difficult, according to a 2017 study. To help with that, here are some things to pay attention to when picking your next loan.
Do You Need the Loan, and Why?
If your business needs money to cover many different expenses, you might want to think twice about getting a single loan or multiple ones.
First, pinpoint why you need financial help in the first place. What will you use it for, and how can a loan help your business? Answering this will help streamline the selection process and help you find the right one among the many types of business loans that can help your business grow.
You should always double-check your reasoning: If you want to take on a loan to expand or grow your business, you should find the right loan and do it. However, if you are looking at borrowing money as a lifeline for your business, you might want to consider some other, maybe even unpleasant, options.
Often, a loan is nothing more than a band-aid. In some situations, it is better to reevaluate your business budget and spend money you already have instead of looking for business-loan options. You will find the funds you need, or you will realize that, if you can’t pay for what you need, you probably can’t afford to be in debt, either.
Keep in mind, if getting a loan isn’t the best fit, there are always other options. You can try applying for business grants, finding investors, or even start a crowdfunding campaign.
Find Out How Much You Need and How Much You Can Afford
Business loans come in all shapes and sizes, and there are maybe even one too many types of loans available. It is crucial to keep that in mind when you decide to borrow.
For example, getting a loan that you can't possibly pay off, or one that’s insufficient for what you need is the biggest mistake businesses make when taking on a loan. You want to do the math carefully to ensure that the loan is of the appropriate size. You should also keep in mind unavoidable fees and interest. Calculate these in, too, and know that getting a slightly bigger loan to cover these expenses can also sometimes be a good idea.
Keep Track of Your Credit Score
Before applying for different types of business loans, take a good look at your business's creditworthiness. Your needs may be large, but the loans you’re eligible for don’t necessarily have to be. Make sure that you can meet lenders' business loan requirements first so that you don't have to waste time applying for loans you have no chance of getting.
Additionally, lenders may refuse you for a loan for a multitude of reasons. Even if a bank or a third-party lender has many types of business loans available, you need to ensure it doesn’t have a problem issuing loans to women-led businesses, minority-led ones, or those who are just starting out and therefore have trouble proving their creditworthiness.
You need to check your credit score, business credit, annual revenue, whether you have declared bankruptcy in the past, and much more. Of course, different lenders will have other requirements, so get familiar with those in detail before you apply.
Choosing a Lender
Now that you’re hopefully no longer wondering: “What are the types of business loans?” it’s time to compare your lending options. Every lender will have their set of loan features which you need to consider carefully. From APR, minimum and maximum loan amounts, terms, fees, and others, you should take your time and compare every offer in detail, keeping in mind your own set of priorities.
It would be best to apply for loans whose requirements you can match and gather all the paperwork in advance. Submitting your application with more than one lender is also a good idea, especially when you take into consideration that there are plenty of lenders out there that allow submitting for online business loans.
For such a big loan, you might want to consider applying for an SBA loan. You can check the requirements on the official site of the lender of your choosing.
The quickest solution is a merchant cash advance, as it doesn't require a lot of paperwork, but it might not work with your business. If the amount you can get this way is too low, you can rely on the fact that there are now many types of alternative business loans you could consider, some of which have lax requirements for issuing a loan.
You can apply for many loans, starting from SBA-approved banks and non-profit organizations, through credit unions and Certified Development Companies. You should look for lenders that do not have overly strict approval requirements.
This question is difficult to answer; each of the several types of business loans you can apply for with the SBA carries its own set of requirements. Check out the official SBA website to determine if you qualify for one of the three kinds of loans this organization provides.
Albert Einstein is said to have identified compound interest as mankind’s greatest invention. That story’s probably apocryphal, but it conveys a deep truth about the power of fiscal policy to change the world along with our daily lives. Civilization became possible only when Sumerians of the Bronze Age invented money. Today, economic issues influence every aspect of daily life. My job at Fortunly is an opportunity to analyze government policies and banking practices, sharing the results of my research in articles that can help you make better, smarter decisions for yourself and your family.
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