For small businesses, financing is a vehicle to carry you toward your goals. But not just any vehicle will do. Imagine you just purchase a manual sports car. It purrs like a kitten, accelerates like a cheetah, and makes you feel like a million bucks. However, it doesn’t fit your family or your outdoor gear, and makes your insurance costs skyrocket. It’s a great car, but it fails to deliver what you need. An automatic minivan checks the boxes and leaves money in your bank account. Likewise, understanding and choosing the right business loan are the keys to a smooth ride.
Let’s walk through the factors to consider when your business needs financing. We’ll cover the six common types of small business loans and what makes them unique to help you find the financial car, truck, bus, or van for your business goals.
Making the Right Choice for Your Business
Choosing the correct type of loan is about how the structure fits your day-to-day operations and long-term plans. Consider the following questions when deciding if a small business loan is right for you:
- How fast do you need the funds?
- Is your need one-time or recurring?
- How long have you been in business?
- Can you handle fixed daily, weekly, or monthly payments?
- Do you have equipment, real estate, inventory, or invoices as assets?
- Are you using the funds for growth, operations, or asset purchase?
Each loan type provides a different kind of financing solution. When you know what matters most, selecting the right options becomes a matter of research. Consider each of the six small business loans to understand which could be a solution for you.
1. Term Loans
Term loans are the financing tool you are probably familiar with. Banks or alternative lenders provide a lump sum of capital upfront, which you repay over a year or more with regular daily, weekly, or monthly payments.
Predictability and structure are terms loan’s strengths. The repayment amount and terms never change, which is great for small businesses with regular cash flow and a consistent budget. Short-term loans typically have options for fast funding. Lenders can often offer this kind of financing to companies with bad credit if they show a reliable customer base and sufficient revenue.
A term loan might be a good fit if you’re renovating your offices, investing in marketing, or making a bulk inventory purchase. Projects to fund your business’s growth in the next one to five years, where consistent repayments won’t strain your business, are perfect for this structured financing option.
2. Business Lines of Credit
A business line of credit gives you access to a set amount of funds you can draw from when needed. It’s like a credit card for your business. You only owe interest on the funds you use. Once you repay what you’ve borrowed, that amount becomes available again.
A line of credit is a great option if your business has fluctuating expenses. For example, if you operate a seasonal business, a line of credit could allow you to draw $5,000 to handle payroll in the off-season and $20,000 to launch a new ad campaign before your busy season. During the busy season when you make more, you can pay down the line of credit. It gives you the agility to fund your needs and repay them in weekly or monthly payments.
A business line of credit offers strategic flexibility. You keep capital on standby. Be mindful of fees or rate changes that could increase the cost. Some lenders charge maintenance fees if you don’t draw funds, prepayment fees before you can withdraw an amount, or closure fees when you finish your line of credit.
3. SBA Loans
Small Business Administration (SBA) loans offer favorable interest rates and longer repayment terms. The federal government partially guarantees these loans, and there is a detailed application process and slows the funding timeline.
Small to medium enterprises (SMEs) can qualify for long-term loans with SBA 504 options and even relief after catastrophes with SBA disaster loans. But the SBA 7(a) loan is a short-term loan most commonly used with small businesses for working capital, purchasing equipment, acquiring real estate, or refinancing existing debt.
To qualify for any type of SBA loan, you’ll need to provide a complete financial picture of your business, including tax returns, credit history, and a solid business plan. You may even need to offer a personal guarantee. Any type of SBA loan isn’t ideal for fast funding.
If the time frame works for you and your business qualifies, SBA loans can offer the best combination of rates and repayment terms on the market. They’re ideal for up to 12-year investments, minimizing monthly costs, and securing stable financing for significant goals.
4. Equipment Financing
When your business growth depends on machinery or technology, equipment financing is a cost-effective option. Instead of paying for specialized tools upfront, this loan acts like a rent-to-own option, where you use the equipment, but the cost is spread out over monthly or quarterly payments.
Let’s say you operate a dental office and want to upgrade to the latest imaging technology. It could cost you $90,000 or more. You work with a lender for dental practices to structure an equipment financing agreement where you pay the total cost monthly over the next three years and legally own the asset at the end of the loan. Rather than depleting your cash reserves on the 3D imaging system, you maintain your cash flow and improve your business.
Business equipment financing typically uses the asset to secure the loan, which makes it easier to qualify than an unsecured loan. You can secure funding for your small business in a matter of days. The different types of equipment financing also offer different accounting benefits and tax breaks worth reviewing with an accountant or lender to get the most from your loan.
5. Working Capital Loans
Working capital loans are typically short-term and designed to help you bridge financial gaps quickly and flexibly. Nontraditional lenders, fintech providers, and private lenders offer funding within 24 hours of approval. Most SMEs qualify as streamlined applications that require bank statements and basic business information rather than an extensive history.
Another strength of working capital loans is flexible repayment terms. Lenders structure loans around your business model with daily, weekly, and monthly schedules or percentages of your revenue to repay the loan. If your business is seasonal, flexible repayments could make working capital loans the best option for you.
Working capital loans offer practical solutions for unexpected expenses like rising supply chain costs or covering day-to-day operations while waiting on receivables. It can also be helpful for fast-paced growth opportunities like purchasing real estate or buying inventory in bulk. You can secure funding when you need it with this financing option.
6. Invoice Financing and Factoring
You leverage your unpaid invoices to get immediate capital in this financing option. With invoice financing, you collect payment from your customers and then pay back the advanced amount and a fee to the lender. With factoring, the lender takes over collections in exchange for a percentage of the invoice amount.
If your small business struggles with slow-paying customers, has large accounts receivable, or is a business-to-business (B2B) company, invoice financing or factoring could stabilize your cash flow and protect your reserved funds.
For example, your construction company frequently contracts with government departments with 120-day payment terms. Your cash flow is all over the place, and you are waiting on those invoices. However, your operating expenses for their projects are consistent. Rather than drawing from your cash reserve, invoice financing would pull the funds from the unpaid invoices. Now you have the funds to finish the project without pulling from your revenue or your savings.
Driving Toward Your Goals
As a small business owner, you need the right kind of funding. Take time to assess your financial health, anticipate your upcoming needs, and choose a loan that aligns with your operations. Lenders offer solutions that will move with you and keep you on track financially. As long as you understand the different types of small business loans, you can confidently control your growth and manage challenges on the road to your goals.
Infographic
Choosing the right small business loan means aligning it with your daily operations and long-term goals. Each loan type serves a unique purpose, so understanding them is essential before committing. This infographic presents six types of small business loans.
