Small businesses can fail without adequate financial resources. This is why many small business owners look to loans to scale up and keep their businesses running. The problem with taking out a loan is there are various types of loans with different requirements and characteristics.
There are many reasons small business owners may want to borrow money, and knowing what financing option best suits their needs is one crucial step in getting the best type of loan. To help you make the best financial decisions when taking out a loan here is all you need to know about the different types of loans for small businesses.
The Different Types Of Loans For Small Businesses
Getting a business loan sounds like a walk in the park, especially for low-risk small businesses. After all, small business owners simply need to walk up to any financial institution (like traditional banks and credit unions), fulfill due process, and walk right back out with a loan. Right?
Getting a small business loan is easily one of the trickiest processes small business owners will face. Many intricate mechanisms go into the process, each playing a significant role in the success or failure of loan accessibility. One includes figuring out which loan is best for your small business.
Choosing a suitable small business loan can be compared to selecting the right flooring material for your new home.
Imagine you drive out to the nearest Home Depot to find flooring materials. You get there without one specific option in mind. Now, you have to choose among the diverse options of cement concrete, bricks, marble, plastic, ceramic, glass, linoleum, wood, and even rubber flooring materials.
You are so overwhelmed that you have no clue what fits the initial flooring idea in your head. Although the end objective is to install flooring, there are many factors to consider, like the ease of installation, exposure conditions, floor function, maintenance needs, and aesthetic function, ease of installation, exposure conditions, floor function, maintenance needs, and aesthetic function.
While you might make a flooring material choice from Home Depot on the spot without proper preparation, there is a high probability that the choice you make won’t be the best for you. Small business loans come in different types or loan options. Each type serves different purposes and has different specific uses and repayment terms to meet business needs.
Not knowing what the different loans are before approaching the nearest financial institution for a loan will sabotage your financial plans and may even result in extreme results like business failure. Knowing how business loans work is not sufficient when you plan on applying for a loan.
Arming yourself with the knowledge needed to choose the right type of loan is essential in increasing your chance of success. The first step in securing a small business loan is identifying which loan to apply for. There are many types of loans that come with different amounts, repayment terms,
1. Business line of credit
Many small business owners may not consider a business line of credit a type of loan. This is because a small business line of credit operates more on the principles of a credit card than an actual loan. A small business line of credit is a predetermined amount of funds or unsecured debt that can be borrowed and paid back later.
This unsecured line of credit gives small businesses access to money that can be utilized for various business expenses, such as inventory and capital needs. A small business line of credit offers flexible yet consistent access to funds to cover business operations.
It gives small business owners access to a certain lump sum of money that they can borrow from, pay back, and borrow again. With this ‘loan’ type, the business owner decides where the funds go. Interest rates vary wildly and depend on the amount the business owner has access to.
Essentially, every line of credit comes with unique terms that business owners should be familiar with before settling with this mode of financial aid. There are many benefits of using a small business line of credit. Some include:
- You pay for what you use with a flexible payment plan
- Convenient option and easy access to short-term funding
- The application process is more flexible and accessible
- Negotiable interest rate.
However, there are equally many disadvantages. These include:
- An increase in interest rate can make repayment more difficult
- There may be a need for registration and application fees
- The availability of funds might make it easier to splurge and run into debt.
2. SBA Loans
SBA loans are undoubtedly the most popular kind of loan for small businesses. Also known as Small Business Administration loans, SBA loans are designed especially for small businesses to help small business owners solve financial problems such as startup costs, working capital needs, equipment purchases, expansions, and real estate purchases.
SBA loans are loans that the government partially guarantees through the Small Business Administration. However, it is essential to note that the government does not directly offer this loan but acts as a guarantor for small businesses to reduce the risks to the financial institutions offering the loan.
Although this might sound like a lot of business jargon, the bottom line is the SBA works with financial institutions like banks to offer small businesses loans by partially guaranteeing the loan. This way, if the small business cannot repay the loan, the Small Business Administration shoulders the agreed percentage and pays the lender bank.
There are nine different types of SBA loans. These include:
- SBA 7(A) loans: These loan types can be used for various business operations such as working capital, expansion, equipment, and property. It offers a maximum amount of $5 million with a repayment plan that can be spread over up to 25 years.
- SBA Express loans: This loan type is the best option for small businesses looking for fast financial solutions. SBA Express loans are approved faster than many other SBA loan types. However, they are often smaller and can amount to $350,000.
- SBA 504 loans: This loan type can only be accessed by businesses that need financial assistance to purchase fixed assets, like real estate or equipment.
- SBA Microloans: SBA microloans are usually used to settle capital and inventory. They are short-term, offer only small amounts, and are best for businesses with solid credit.
- SBA Community Advantage loans: This loan type favors small businesses in underserved markets. It can be utilized for working capital, equipment, expansion, and property.
- SBA Disaster loan: Physical disasters hurt businesses which is why SBA disaster loans are designed to assist small companies affected by natural disasters. This loan can be used as working capital, repairs, and replacements.
- SBA Export Working Capital loans: SBA Export Working Capital loans are designed for small businesses with international markets. It helps finance small business sales by offering financial assistance for inventory and other short-term working capital needs crucial to the business’s success in the global market.
- SBA Export Express loans: SBA Export Express offers up to $500,000 in financial assistance and a 12-month repayment term. These loans provide a swift financing solution to help businesses scale up by exporting goods or services.
- SBA International Trade loans: SBA International Trade loans are multipurpose loans that can be used as working capital, export financing, and purchase equipment and real estate. They are designed for businesses that engage in international trade.
Knowing what type of SBA loan you need will be the first step in your loan application process. Each SBA loan type has unique requirements, repayment terms, and processing times. Regardless, all SBA loans are typically known for low-interest rates (courtesy of the Small Business Administration), more extended repayment plans, no need for collateral, and flexible eligibility requirements.
3. Short-term Loans
If you need immediate financial assistance for your small business, short-term loans are one of your best options. Short-term loans are credit given to small businesses (individuals or entities) to support their temporary personal or business capital needs.
These loans are usually repaid in no more than a year and can be represented in the current liability section of a balance sheet. Short-term loans usually feature higher interest rates, low amounts eligible to be borrowed, are generally unsecured, and have a limited tenure.
Thanks to these features, short-term loans are usually unsuitable for long-term projects, especially volatile interest rates (Don’t know the difference between fixed and variable interest rates? Check out our guide here!) can cause the business owner to be penalized if they default on payment.
Regardless, there are some benefits to using short-term loans. Some of these benefits include:
- They are easily accessible for businesses, especially those with lower credit scores.
- The approval process is fast and simple
- The interest cost is lower than some other loan types in the market
- Being punctual with payments of short-term loans is an easy way for borrowers to increase their credit score and creditworthiness
- Unsecured, meaning small businesses do not need to submit collateral to borrow these loans.
There are different types of short-term loans. They are:
- Merchant Cash Advances: This short-term loan is only a cash advance to the business owner. However, the cash advance still operates like a loan. The borrower repays the merchant cash advance by giving the lender access to their (the borrower’s) credit facility. Whenever a customer purchases goods from the borrower’s company, the lender receives a percentage of the proceeds as repayment.
- Invoice Financing: This loan type uses a business’s accounts receivables. This means the lender uses the invoices yet to be paid by customers to measure how much to loan to the borrower and then charges interest based on the number of weeks that invoices remain unpaid. Any time an invoice is paid, the lender takes interest due and sends whatever is left of the proceeds to the borrower.
- Online Loans: Usually gotten from online lenders and repaid in installments, online loans involve a short application process.
- Payday Loans: These are short-term emergency loans that are usually accessed easily and can be gotten from many sources, including high street banks or lenders. The lender gets back the borrowed amount and interest by taking the money from the borrower’s bank account. Payday loans usually have high interest and must be paid in one sum when the borrower’s payday arrives.
Microloans is a type of business financing that offers small loan amounts with short repayment terms. This loan type usually has small interest rates, a less tedious application process, and requirements that are easier to meet than many other small business loans.
Admittedly, microloans may not serve every business, as borrowers are eligible for a maximum of $50,000. This loan is typically from nonprofit organizations to help underserved small business owners, such as businesses in third-world countries or women-owned businesses.
Borrowers often use microloans if they lack access to loans from other financial institutions due to poor credit or other factors. However, some microloan lenders may ask for a form of collateral. Microloans may be small to other businesses. However, to the lender, a microloan is all the lifeline they need to get their drowning business out of water.
5. Invoice Factoring
Invoice factoring works similarly to invoice financing. In fact, the significant differences between both loan methods are the invoice in invoice factoring is sold to a third party and the application process is a bit more stringent than invoice financing. This loan program is perfect for businesses that use invoices when dealing with goods or services.
In this small business loan method, the lender or factoring company buys your invoice with an advance of about 70% to 95% of their total value upfront. To collect the money lent and interest, the lender deducts a factor fee of typically 0.5 percent to 5 percent per month, per outstanding invoice. The proceeds not collected are then given to the borrower.
There are two types of invoice factoring. These include:
- Recourse Factoring: This type of invoice factoring mostly leaves businesses to buy back unpaid invoices.
- Non-recourse Factoring: The factoring company buying your invoices accepts liability for unpaid invoices.
6. Equipment Financing
Equipment financing, as its name suggests, is a type of small business loan used to purchase equipment for businesses that cannot bear the financial burden of purchasing the equipment themselves.
Because equipment is essential to the success of any business, equipment financing is one of the most sought-after small business loan types, especially by start-up and early-stage companies.Equipment financing is usually used to purchase costly equipment. It is split into two types that include:
- Obtaining a equipment loan or lease that the borrower uses to purchase the equipment
- Leasing the equipment directly.
In the former (where the lender obtains a loan to buy the equipment), the equipment typically serves as collateral. The financing company holds a lien on the equipment and can take the equipment back if the borrower defaults on loan payments.
In the former (leasing the equipment directly), the borrower leases the equipment instead of buying it outright. This is an excellent option for borrowers that do not qualify for a loan or only need the equipment short-term. Equipment financing comes with different terms that vary with the borrower.
The interest rates are often fixed (usually ranging between 2.00% to 20.00%), repayment terms can be between 1-25 years, funding or equipment can be accessed in as little as two business days, and credit score or operating history may be significant in the process.
7. Commercial Real Estate Loans
A Commercial Real Estate (CRE) loan is the perfect small business loan type for small businesses looking to buy commercial property. It functions similarly to equipment financing in the sense that the purchased property serves as collateral that the lender can foreclose in the event of a default in repayment.
Although foreclosing the property may put the lender at a loss, it allows them to cover a significant part of the risks associated with giving out the loan. Commercial Real loans usually range from 5 to 20 years, with loan-to-value ratios generally falling into the 65% to 80% range.
There are different types of CRE loans. This include:
- Permanent loans: These loans are first mortgages on commercial property. They have a term of at least five years written into the contract.
- SBA loans: There are different types of Small Business Administration loans, and some of them can be used to finance commercial real estate.
8. Startup Loan
Starting up is one problem that many business owners- or future owners- face. With inadequate or the absence of money to finance their business ideas, many people’s business plans have difficulty getting through the planning process into fruition. Startup loans are for new businesses.
They can range anywhere from $500 to $750,000 with varying interest rates between 0 to 17 per cent or more. There are multiple types of startup loans with terms for different business operations. There are loans that cover inventory, commercial building to lease office space, purchase equipment, or even hire and train staff.
Going For Best Loan For Your Business
Just because there are different types of loans and funding options does not mean all loans are fit for your business. Every loan program is unique to the financial institution offering them, and knowing the best loan for your business during a particular business cycle is key to making the most of your loan.
Regardless of what loan type you choose to apply for, it is essential to put in the work. This will increase your chance at a loan approval. Ensure you are eligible, gather the necessary documents, and remember to keep an open mind. However, for the best and most favorable results, work with financial entities that see your business goals and are willing to help you achieve them.
At Coastal Kapital, we are committed to providing businesses with the financial solutions they need to grow. We are your one-stop-shop for all financial needs, whether in the form of business loans, working capital, or equipment leasing. Our services are safe, easy, and tailored for your convenience.
Are you interested in getting a business loan? Contact us at [email protected] to begin your loan application process.If You Like Please Share It: