When looking for a small business loan, you probably spend more time thinking about polishing your application and what type of loan you want than you about how long you’ll be repaying your lender. It’s easy to overlook the length of your loan when considering so many other things. But choosing the correct loan term is like judging the ripeness of the fruit before you buy it.
It can be hard to tell if the fruit you are buying is ripe. You can’t cut open a watermelon in the middle of the grocery store to check if it is sweet and juicy. But once you know that a perfect pineapple has dark green leaves, the best cantaloupe sounds like a bongo, and the sweetest kiwi has a slight squish, choosing ripe fruit is simple. You have to know what signs to look for and you know how long it will last.
A mismatch between your repayment schedule and your funding purpose is more important than buying good produce, but just as simple when you know what to look for. The key to choosing financing length is understanding your needs. Long-, medium-, and short-term business loans all support different objectives and have different costs. Your business goals are the guide to picking the financing term that is right for you.
Evaluate Your Business Goals
You have a plan for your borrowed funds, whether fixing broken equipment, expanding your services, or acquiring a local competitor. Choosing a matching loan term starts with understanding your business goals and their financial impact. Consider questions, like:
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- How expensive is your investment?
- How long will it take to complete your project?
- How soon will you see a return on your investment?
- How long will you benefit from your plan?
- How risky is the investment?
- How much of your current resources can you give to your project?
Your answers will determine which loan length is right for you. Each term offers different monthly payment amounts, total interest cost, and flexibility. The goal is to match the timing of your investment to your repayment schedule.
When to Choose a Short-Term Loan
Short-term business loans are all about speed and flexibility. Repayment typically runs from three to 18 months. Lenders often approve and provide funding within days and offer daily, weekly, or revenue-based payment schedules. Products like working capital loans, merchant cash advances, bridge loans, and invoice financing are examples of short-term funding.
A short-term loan is best for immediate needs with fast payoff potential, like working capital gaps, emergency repairs, seasonal inventory, or small marketing pushes.
Let’s say you own a retail store and need $20,000 to stock up on inventory before the holiday season. You need funding quickly and could repay the loan in six months or less. A merchant cash advance for retail shops allows you to build your inventory this week and make repayments as sales roll in.
Keep in mind that short-term loans can be risky. Lenders typically offer smaller amounts, under $100,000, and charge higher interest rates. They may also issue prepayment penalties for repaying the loan early. You’ll need strong cash flow or a significant return on your investment to handle the risks of short-term loans.
When to Consider a Medium-Term Loan
Medium-term loans balance affordability and flexibility. The repayment schedule ranges from one to three years for term and small business administration (SBA) loans, while equipment financing options can be slightly longer. These loans are well-suited for business investments that need more time to deliver returns.
Consider medium-length financing when your business is growing steadily but needs room to breathe.
For example, your commercial cleaning company invests $95,000 in new eco-friendly equipment using a two-year business equipment loan. You can spread out payments and maintain your cash flow while using the equipment to generate new revenue. By the end of the term, you’ll own equipment that will be useful and valuable for another couple of years and increase your profits.
Medium-term financing also offers a safe option from financing extremes. Say your cash flow can’t handle a short repayment period. A medium-term loan will protect your revenue with a lower monthly payment, but you’ll pay more interest. Or maybe you secure a commercial mortgage with a five-year repayment schedule. You will pay off the investment sooner, but are unlikely to secure the lowest interest rate. Overall, a medium-term loan is a moderate option.
When to Pick a Long-Term Loan
Long-term loans are significant financing options for major investments like real estate purchases, large-scale expansions, or buying out a business partner. The repayment periods stretch from five to 25 years, and the funding amounts are over $250,000. It may take decades to see a return on these projects.
These loans are best for businesses with stable income and extensive growth plans. Maybe you want to add a new facility across town to your multi-location dental practice. Between build-out, licensing, equipment, and staffing, your costs total $650,000. You can borrow at a low interest rate and pay affordable monthly amounts with a seven-year term, allowing you to grow into the new space.
Keep in mind that long-term loans can be limiting compared to medium-term loans. The requirements for long-term loans are often very strict. You must have significant business history and a good credit score to qualify. You commit to years of debt repayment, meaning many lenders won’t extend you additional funding. Over the years of the loan, you will also pay more in total interest than those with shorter terms.
Your Goals, Your Shopping Guide
The right loan term isn’t about which schedule is the shortest. Shopping for loans requires a nuanced approach, where your needs and knowledge of the products guide your decisions.
When you align the duration of your loan with your purpose, you reduce financial stress and set your business up for smarter, more sustainable growth. That’s more satisfying than a slice of watermelon on a hot summer day.
