Small business loans are common. They are frequently used to get a fledgling business up and running, they can also be taken out when a business wants to expand, purchase more inventory, or increase its marketing.
Just like there are various reasons a business would need a loan, there are many different types of small business loans available.
Understanding the types of loans will help you decide which one is best for you.
Five Types of Small Business Loans
SBA Loan
SBA stands for Small Business Administration, it is a US Federal Agency that works to connect small businesses with the funding and resources they need. They can grant loans ranging from $50,000 to $5,000,000. There are various types of SBA loans.
Because they are backed by a federal agency, the terms may be more flexible than other lenders. Additionally, SBA loans can sometimes have lower interest rates.
However, the SBA is not the sole lender. They partner with a lending institution, usually a bank, and guarantee the lender repayment up to a certain percentage if you default on the loan. If your business can't make payments, your personal assets may be at risk. This is because the SBA requires every owner with at least a 20% stake in the company to make an unconditional personal guarantee.
While SBA loans may sound great, they can be difficult to get approved and not everyone is eligible. The application process can be lengthy, sometimes taking months, and requires a lot of paperwork.
Short Term Loan
A short term loan is a much quicker process than an SBA loan. A short term business loan involves applying with a lender. Once you're approved the cash amount is given to you in a lump sum. The repayment period for the loan can vary, ranging from three months to three years.
Because of the short repayment period, the maximum loan amount is typically less than $500,000. These loans are often sought when emergency funds are needed, such as to cover a sales slump or pay for unexpected expenses. From application to cash in hand can take as little as 24 hours.
Short term loans may not be for everyone as their maximum loan amounts generally don't exceed $500,000. While some rates may be as low as 8%, this isn't always the case. While eligibility requirements aren't very strict, you must have good credit and have been in business for a few years, some lenders require collateral.
Merchant Cash Advance
A merchant cash advance is much like a payday loan, only it is solely for businesses. The advances work a bit differently than traditional small business loans. A lender provides you with a lump sum of cash upfront. This can be as much as $1,000,000. This amount is paid back over time using one of two payment plans. You can either transfer fixed daily or weekly debits from your bank account, or offer a piece of your future credit and debit card sales as collateral.
What is nice about a merchant cash advance is that you can have the money rather quickly. Similarly to payday loans where you normally get the money the next business day, it often takes just a few days to receive the money when you apply for a merchant cash advance. Additionally, approval is typically painless and you don't have to worry about offering up physical collateral.
Also, because the pay scale is usually based on your credit and debit card sales, there is a chance that your payments will reflect your sales. This means when business is slow for you, your payments may slow down as well.
However, when sales pick up for your business, your APR may increase too. When all fees and interest is taken into account, the APR may be high. There is also no benefit to repaying your loan early and not a lot of federal oversight as merchant cash advances are not structured as loans but as commercial transactions. However, this means that applying usually doesn't require a hard credit check and therefore won't depend on your credit score or affect it.
Business Credit Card
Obtaining a line of credit for your business is very similar to getting a personal credit card. Credit limits for a business can extend up to $500,000. You then pay down your credit like you would with a traditional credit card. Interest rates can be as low as 8% and as high as 24%, though many times you can find a 0% introductory rate.
Securing a business credit card isn't as difficult as getting approved for other types of small business loans. The process can be relatively quick and will provide you access to cash quickly. Additionally, most lenders offer rewards programs. A business credit card can help you build your credit so you can apply for a business loan in the future.
However, beware of hidden fees. Sometimes there is an annual fee just for having the card, in addition to late fees and occasionally high-interest rates. A business credit card can also be linked to your personal credit as they require a personal guarantee. Your business credit activity and history will appear on your personal credit and you may become liable for late payments or over-extended credit.
Business Term Loan
A business term loan can provide you money relatively quickly, have a longer repayment schedule, and a greater maximum amount. Business term loans provide you with all of the funds upfront, in a lump sum.
The amount can be as much as $2,000,000. Payments are then made to the lender on a schedule, either weekly, monthly, or bi-monthly. The repayment plan may be short-term (12 months or less), intermediate-term (1-5 years), or long-term (6 to 20 years). The interest rates are generally fixed but some may be variable over the lifetime of the loan. They can be as low as 6% or as high as 30%.
Business loan lenders are usually banks, the SBA, or other financial institutions. Therefore, they usually require that you have a good credit history. Additionally, most lenders will only loan to businesses that have been operating for at least two years. Some may require collateral and can have strict rules and restrictions, like maintaining a certain debt-to-equity ratio.
Which Small Business Loan is Right For You?
When it comes to finding the perfect small business loan, there are many factors to consider. Approval and eligibility can vary depending on your credit history, years in operation, and what collateral you can offer. You should also think about the repayment plans, interest rates, and fees. Ultimately, you know your company best, including which lender and loan are best suited to your business.