If you’re wondering which type of business loan is best, you aren’t alone.
Small business owners who need extra capital may not know how to find the right financing based on their business needs. The search for capital can get complicated as you explore different types of loans and business lines of credit. For example, some business loans help with short-term expenses, while others make sense for long-term investments.
Understanding the available choices will help you make better financing decisions for your company so that you can maintain and expand operations. Our guide will walk you through the different types of business loans so you can determine which one is the best for you.
What Is a Business Loan and How Does it Work?
If you need to buy equipment or commercial properties for your business but don’t have the financial means to do it, you have two choices. You can save, potentially for years, until you accumulate enough cash to make the needed purchase. Or you can take out a business loan to acquire additional capital now and make the purchase you need to grow your company.
A business loan is a common way for small business owners to buy or expand a business. You can apply for a lump sum loan or a business line of credit from a traditional bank or online lender.
In the process of getting approved for and accepting a loan, you and the lender will agree upon repayment terms. These terms can affect your payment interval and interest rate.
Business owners can structure loans for quick or long-term repayment, depending on their preferences and the type of loan. A quicker repayment gets you out of debt sooner, but the monthly payments are higher. A lengthier loan has lower monthly payments, but you stay in debt longer and pay more interest over the term of the loan.
You can use a loan’s funds for various investments, including buying equipment or other business assets, advertising and marketing, expanding your product line, purchasing commercial real estate, paying off debts, or improving your cash flow.
Types of Business Loans
There is a different type of business loans for virtually every business need. Here are some of the common types of business loans you can use for your company.
Business Term Loans
Business term loans are some of the most common small business loans. You borrow a lump sum from an online lender or traditional financial institution like a bank or credit union and pay back the loan over an agreed-upon timeframe and fixed interest rate. Having an established business and a good personal credit score will help you secure more favorable rates and loan terms. Some lenders will only accept your business credit score, but a good personal credit score may be enough to qualify you for a term loan.
Some lenders require that you have been in business for at least two years and have proven annual revenue to be eligible for a business term loan. In addition, you may need to submit a business plan. If you need funding fast, the approval process may be quicker with an online lender than with a bank or credit union. Some online lenders can provide same-day approval, while financial institutions can take several weeks to approve your application and provide funds.
SBA Loan
SBA loans are harder to qualify for, but they have some of the most attractive rates and terms in the industry.
The U.S. Small Business Administration guarantees SBA loans. It’s worth noting that the funds do not come from the government but rather from lenders approved to offer SBA loans. An SBA loan can help with the following objectives:
- Expand your business with additional funds and cash flow
- Acquire an existing company
- Purchase valuable equipment or commercial real estate for your company
Not every business owner needs a large loan. Companies can get SBA microloans for smaller amounts of working capital. Interest rates and other loan terms may be more attractive for SBA loans, but the SBA has more challenging qualification requirements. For example, you will need a business plan and financial documents for this financing option. You will also need a good credit score. Because the application process for this program is more difficult than other common types of business loans, you may wait months for approval.
The SBA loan isn’t the best path for business owners who need quick financing or who don’t have the best credit scores. SBA bridge loans can alleviate the pain of waiting for capital while your SBA loan application gets approved. These smaller loans go through faster and provide funding to use in the interim. If your loan application gets rejected, you can continue using funds from the SBA bridge loan, but you must pay it back within a year.
Business Line of Credit
A business line of credit is similar in many ways to a business credit card. Banks, credit unions, or online lenders offer these financial products.
Each business line of credit has a credit limit, and you can borrow as much capital as needed up to that limit. Repaying the credit early minimizes your interest, and you only pay interest when you borrow against the line of credit.
If you need more money for business purposes, you can continue to draw against the business line of credit until the term expires. That means you can avoid the hassle of applying for additional loans.
A business line of credit may be the type of business financing you need, especially if you’re not sure how much you will spend on business investments. You pay interest only on the funds you draw versus a term loan or SBA loan, where you pay interest on the full amount of the loan, regardless of how much of the capital you use.
You will owe interest as soon as you withdraw funds. Lines of credit often have variable rates, which create more uncertainty with your payments. If you quickly pay down what you owe, the variable rate won’t be much of an issue.
Equipment Financing
Equipment financing is funding specifically for the equipment you may need for your small business. An equipment loan can help pay for vehicles, machinery, computers, office furniture, and other business assets.
Most of the time, the equipment you are financing can serve as collateral for the loan amount. The lender can seize the equipment as compensation if you cannot make your loan payments and have to default on the debt. Although collateral increases your risk, it can help you get better loan terms and higher loan amounts. Banks feel more confident working with borrowers when they can shift some of the risks to them.
Your personal credit score and other factors can help you qualify for favorable terms, such as a lower interest rate or a more extended repayment period, as well.
Merchant Cash Advance
A merchant cash advance is a loan based on future credit and debit card sales. The lender provides cash in a lump sum that you repay with regular transfers from your business bank account or a portion of your credit card sales. To qualify for a merchant cash advance, the lender will consider your daily or weekly sales figures to determine whether your business is a good risk. Fees vary depending on the lender, but it’s more expensive than most small business financing options. If your business has significant credit and debit card sales and you need cash fast to cover business expenses, a merchant cash advance may be an option to consider.
Inventory Financing
Inventory financing is a short-term loan you use to buy products you will sell at a later date. If you pay suppliers for your business’s products, inventory financing may be what you need. The inventory serves as collateral, and the capital gives you time to fulfill the demand for your products. As a result, you can use inventory financing to meet customer demand and update product lines while maintaining a steady cash flow. Newer businesses without a solid credit history can qualify for this type of financing, but fees and higher interest rates may apply.
Invoice Factoring
With invoice factoring, your business sells unpaid invoices to a third-party lender in exchange for cash. Then, your customers pay that lender directly for the products or services you have provided. Invoice factoring can be a quick way to get cash for your business on invoices before they are due. It’s easy to qualify for this type of financing, but the invoice financing company may review the credit history of your customers to determine suitability. The lender also won’t pay you the full face value of your invoices.
Selling unpaid invoices to an invoice factoring company is the only way on this list to obtain capital without going into debt. You don’t need the strongest finances to qualify for invoice factoring as long as your customers have good credit and reliable payment history.
Commercial Real Estate Loan
Business owners use commercial real estate loans to finance the purchase of a new or existing property, such as retail space, warehouses, or office buildings. Also called commercial mortgages, a commercial real estate loan can help you expand your business to a new location or even refinance an existing loan amount. The building or other property you are buying can serve as collateral for the loan. The lender can take possession of your property if you default on the loan and sell it to recoup their losses.
The terms of a commercial real estate loan will depend on the value of the property, your credit history, the size of your down payment, and your business cash flow and other debts, among other factors. Also, be aware the lender may charge prepayment penalties or use balloon payments.
Microloan
If you only need to borrow a small amount for a short period of time, a microloan may be a good fit. Another feature of microloans is that their interest rates are low or even zero in certain circumstances.
The application process for microloans is streamlined, and there may be fewer qualifications as well. Many microloans are offered through nonprofit organizations or government-guaranteed SBA loans. Collateral may be required, depending on the lender and funding needs.
Working Capital Loan
Consider a working capital loan if you operate a seasonal business with unpredictable cash flow. A working capital loan can cover expenses or purchase equipment that you can pay off quickly once sales increase. Working capital loans are usually short-term loans from online lenders, traditional banks, or credit unions. Interest rates can vary depending on the type of working capital loan program you choose.
Business Credit Card
Use a business credit card as you would a personal credit card. Whether you have a new or established business, a business credit card can help you build a business credit history. That, in turn, can help you qualify for small business loans in the future. A business credit card can improve your business credit score, and some cards also come with rewards programs.
Startup Business Loans
A startup business loan may be the answer if your business is too new to qualify for more traditional small business loans. You can usually qualify for a startup business loan without an established credit history or business track record, and it’s a way to build up your credit for future business growth.
