Starting a small business can be daunting, especially when thinking about the financial aspect of it. Without the right funding, businesses can struggle to get past the initial stages, let alone grow and develop over time. Fortunately, there are many types of small business loans available to help entrepreneurs get their businesses up and running. In this blog, we will be covering 9 distinct types of loans ranging from term loans, SBA loans, lines of credit, equipment loans, invoice factoring, invoice financing, merchant cash advances, personal loans, and business credit cards. We’ll discuss the pros and cons of each type of loan, how they work, and what you should consider before applying. So, whether you are starting a new venture or looking to expand, keep reading to zero in on the right type of small business loan for you.
How much do you need?
When it comes to small business loans, there are various options to choose from. Microloans are a popular choice for small businesses, with funding up to $50,000. These loans are typically offered by government and nonprofit organizations. However, microloans may come with higher interest rates and require collateral. They can still help businesses cover operational costs and working capital.
Microlenders tend to focus on underserved small business owners, such as women or minority-owned businesses. They often provide support and resources in addition to loans. Before applying for a microloan or any small business loan, determine how much you need to borrow to achieve your business goals.
1. Term loans
Term loans are a popular type of small business loans that are commonly used by startups and small businesses. These loans require fixed monthly payments, which typically include interest on the principal balance. Small businesses can borrow up to $500,000 or more with repayment terms of up to 10 years. These loans can be utilized for a variety of purposes, such as purchasing new equipment or expanding the business. Banks and online lenders offer different rates and terms for term loans, so businesses can choose the one that best suits their needs.
2. SBA loans
SBA loans or Small Business Administration loans are government-backed loans that guarantee loans made by private lenders. Three popular SBA loan programs include the 7(a) loan program, microloan program, and CDC/504 loan program. SBA loans are available for various business purposes such as working capital, equipment, real estate purchases, or business expansion. The loan amount can vary from $10,000 to $5 million depending on the loan program. The loan repayment terms are quite flexible and extend up to 25 years. Interest rates for SBA loans can vary between 2.8% and 13%. These loans are very beneficial for small businesses to access the necessary financial resources to expand and grow their business.
3. Business lines of credit
A business line of credit is a type of financing that provides access to funds on a revolving credit limit. Unlike term loans, borrowers only incur interest charges on the amount withdrawn. This type of loan can be helpful to businesses that have short-term working capital needs, as they can draw on the credit line as needed. Business lines of credit can be unsecured, meaning they do not require collateral. Banks offer the best interest rates and the longest time between renewals for lines of credit. Just like a credit card, business lines of credit have a draw period and may expire after 12-24 months.
4. Equipment loans
Equipment loans are a type of financing that helps small businesses finance machinery or equipment purchases without having to expend a significant portion of their working capital. These loans have a longer repayment period and lower interest rates than other types of loans. The interest rates for equipment loans range from 8% to 30%. Equipment loans are usually secured, which means that the equipment being purchased serves as collateral in case of loan repayment failure.
Equipment loans are available to both established and new businesses. However, lenders usually require established businesses to submit financial statements, which can include business tax returns and balance sheets, to obtain lenders’ confidence. The equipment being purchased must have a clear and measurable value to be eligible for financing. Once the loan is sanctioned, the business can use the equipment for any related purposes, be it repair, maintenance, or replacement.
5. Invoice factoring
Invoice factoring is a type of small business loan that uses outstanding invoices as collateral to get cash. This lending method is a great way for businesses struggling with on-time payments. In simple terms, invoice factoring allows you to sell your accounts receivable to a factoring company. The factor, in return, advances a percentage of the total invoice amount. This is usually about 85%-90%. Invoice factoring essentially gives the buyer control over collecting payments, while invoice financing requires businesses to collect payments themselves. It is worth noting that invoice financing and factoring can be expensive and should be read carefully before signing.
6. Invoice financing
Invoice financing is a form of debt financing that turns accounts receivable (invoices) into cash through a lender. It allows businesses to use outstanding invoices as collateral for a cash advance, which can then be used to cover operational costs or invest in growth opportunities. Invoice financing can be a good option for businesses that struggle with cash flow due to unpaid invoices. However, it may be more expensive than other small business loans. Another type of small business loan is a microloan, which is unsecured and covers operational costs such as inventory, supplies, and payroll.
7. Merchant cash advances
Merchant cash advances (MCA) are not loans, but cash advances based on credit card sales. Repayment is made through a percentage of daily credit card deposits. This feature allows for flexibility in repayment, as you pay more on good days and less on slow days. Merchant cash advances are usually the most expensive type of business financing, with annual percentage rates (APRs) approaching 100%. The MCA lender uses credit card sales as collateral instead of unpaid invoices. This makes cash advances easier to qualify for than other types of small business loans. However, borrowing costs can quickly add up, and it is important to understand the terms and APRs before taking out a merchant cash advance.
8. Personal loans
Personal loans are another option for small business loans. This type of loan is typically used for urgent business needs and is often based on the borrower’s personal creditworthiness. Personal loans are unsecured loans, which means that they do not require collateral. However, they typically have higher interest rates than other types of loans. Personal loans are a suitable option for entrepreneurs with good credit. This type of loan ranges in the low thousands of dollars and can be used for a variety of business expenses.
9. Business credit cards
Business credit cards are a popular financing option for small business owners. They offer a low paperwork and user-friendly financing method with fast access to cash when needed. Business credit cards are used as cash management tools and offer perks such as cashback offers, travel rewards, statement credits, and more. In addition to using business credit cards, business owners may also consider business lines of credit as a source of financing. These provide a revolving credit limit with interest only on the amount withdrawn. Business finance can be divided into two main categories: debt and equity financing, which can be combined for optimal results. Utilizing business credit cards can provide a convenient financial resource for any small business.
Microloans are a specific type of loan that offer smaller amounts, ranging from $2000-$35,000, with interest rates usually higher than traditional loans. However, they are aimed at start-ups that lack established credit history and collateral. Microloans can serve as a lifeline for small businesses by providing funding for equipment, furniture, and other operational costs. These loans are administered by nonprofit organizations like the SBA and micro-lenders, which focus on helping underserved small business owners. The qualification criteria for microloans tend to be less strict than traditional bank loans, and the interest rates may be lower too. However, it’s essential to make sure you can repay the loan and understand the terms and conditions before applying for microloans.
In conclusion, there are various small business loan options accessible, which can be confusing to decide. Your needs, credit score, business plan, and revenue streams come into play when you’re looking for a loan option. It’s essential to educate yourself about the choices to make an informed decision. Getting a small business loan should not be the only option for raising capital, but it should be considered a viable one for stable and diligent companies looking to make a push. For more detailed information on each type of small business loan, check out our comprehensive guide on the 9 types of small business loans available in the market.