Understanding Different Types of Small Business Loans

May 19, 2019

Understanding Different Types of Small Business Loans

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There are many different kinds of small business loans, making it essential to do your research before beginning any application process. Rushing the process is akin to walking into a paint store and telling the clerk you need a can of paint, any kind will do. You’d end up driving home with a new can of paint, but it’s unlikely you’d get the one needed for your specific job. To increase your odds of success, you would have to identify the paint’s color, sheen, and whether it’s indoor or outdoor.

“Getting a business loan sounds simple — until you realize how many types of loans exist and how many lenders offer those loans,” says business.org. “Suddenly, you find yourself overwhelmed by choices that you didn’t even know existed.”

The best place to start is by identifying what your specific use will be for the loan. If your objective for the money isn’t clear, it’s safe to say you have work to do before knocking on a lender’s door. Create a solid plan, and then determine the specific amount of money needed to make it happen. Also consider how long you would like to have to pay the money back.

The 11 most popular types of small business loans

The following information covers the common routes entrepreneurs take to get the capital they need. Pay attention to the dollar amounts, rates, terms, and other elements, as they’re like the product details in the paint store that will help you choose the small business loan type that’s perfectly suited for your business needs.

1. Business line of credit

When flexibility is a priority, consider a business line of credit. You can get anywhere from $1,000-$500,000, and the money is typically available in a week or two. The rates vary from 8-24%, and the financing usually comes with a 1-2 year maturity.

A business line of credit is revolving, so rather than receiving a lump sum, you can access the money as many times as required. There’s no pressure to dip into the money, but it’s always there. Whether you’re using it to purchase equipment, add inventory, hiring staff, expand to a new location, pay invoices, or add a vehicle to your fleet, you’ll only pay interest on the exact amount of money you use.

Qualifying for a business line of credit isn’t difficult. If you’ve been in business for more than half a year, are bringing in $50,000 or more in annual revenue, and have a credit score of 560 or higher, consider yourself a prime candidate.

As part of the application process, a lender may require you to make a personal guarantee. This agreement allows the lender to levy your personal assets if you default. Of course, if you consistently make your payments, this element of the financing becomes a moot point.

2. SBA loan

Think of the Small Business Administration (SBA) as your personal government friend. The main purpose of this federal agency is helping small businesses find the funding and resources they need. In particular, the SBA assists small businesses that are disadvantaged and might not be able to get help otherwise.

With an SBA loan, you can expect amounts from $50,000 all the way up to $5,000,000. Terms also a cover a broad range, typically from 10-25 years. One downside to SBA loans is they’re famous for being slow and paperwork-intensive. For example, if you submit an application in early July, you often won’t see the funds until August or September. In some cases, it might even stretch into October.

SBA loans are unique because the aforementioned agency isn’t actually the lender. Rather, it guarantees a substantial portion of each loan, which reduces other lenders’ risk and makes them more willing to approve your request.

The SBA offers an array of loans to small business owners. Here are a few of the most popular options:

  • SBA 7(a) Loan: This loan is the most sought after and can be used for all kinds of purposes. If you’re seeking less than $25,000, the lender might not ask for collateral. When you start approaching the neighborhood of $350,000 or higher, plan on providing significant collateral to address the risk of default. In case you’re wondering, 7(a) loans can be awarded for as much as $5 million to those who meet all the qualifications.
  • SBA 504 Loan: These loans are mainly used to fund projects, so they require more research and examination for approval. To even be considered, your business must have a net worth above $15 million and an average net income of $5 million or less. Qualifying projects include buying an existing building, building a new facility, buying land, and buying long-term machinery. The benefits to these loans include fixed interest rates, 90% financing, longer amortizations, and no balloon payments.
  • SBA Express Loan: As the name implies, this type of small business loan is extra fast. As long as you meet the requirements, you can finance up to $350,000 with an SBA Express. Expect to have your application reviewed in 36 hours or less. Of course, this is still an SBA loan, so your funds will probably take a month to arrive.

Before you apply for an SBA loan, you’ll need to gather all the necessary documentation. You’ll need to include your business license, 2 years of business tax returns, 2 years of personal tax returns, YTD Profit and Loss statement, YTD balance sheet, and a debt schedule.

3. Short term loan

Short term loans are like an SBA Express Loan on steroids. Click submit on your application and, if approved, you can have the money in as little as 24 hours. That’s right — you can obtain a loan in roughly the same amount of time it takes to binge-watch a season of your favorite TV show. Because they’re built for speed, the amounts for these loans only go up to about $500,000. You’ll also need to pay that amount off quickly, generally within 1-3 years. The interest rates can be quite favorable, starting as low as 8%.

Many entrepreneurs use short term loans for times when they need quick solutions to pressing circumstances. So whether you need to pay for unexpected expenses, hire new staff, endure a sales slump, replace a broken piece of equipment, or take action on an exciting business opportunity, a short term loan can be a solid option.

The qualification requirements aren’t too stringent for these types of small business loans. As long as you’ve got healthy credit and have been in business for at least a couple of years, you’ll be in good shape. In some cases, the lender may require you to secure the loan with some personal collateral. Common examples of collateral include a house, truck, or real estate property.

4. Business term loan

A business term loan is a great way to acquire working capital, expand your business operations, purchase equipment, hire additional staff, or whatever else it is that you need.

This type of financing product has been popular among entrepreneurs for decades. If loans were cars, these would be the Toyota Corolla. No, they’re not the flashiest loan on the block. But they’ve been a top-seller for decades and are known for their reliability. The loan amounts range from $5,000 all the way up to $2,000,000, and you can often see that money in your account in just a couple of days.

Plan on your business term loan repayment terms to be somewhere between 1-5 years. Better yet, the interest rates start as low as 6%. These loans have a fixed interest rate or flat fee, so the payments will never go up during the lifetime of the loan. A major benefit of this loan is it’s easier for you to identify how much you can afford to borrow, while also making it less stressful to pay off.

5. Merchant cash advance

With a merchant cash advance, you borrow against your future earnings to secure the financing you need. Once you’ve been approved and the funds are advanced to your account, you’ll begin repaying the loan by having an agreed upon percentage of your daily credit card deposits withheld for the lender. Your advance can be used for myriad purposes, so this type of financing has earned a reputation among entrepreneurs for being very flexible.

Like short term loans, merchant cash advances are known for speedy delivery. You can apply for anywhere from $5,000 to $200,000, and time to funds can be as short as 24 hours. This type of convenience comes at a premium rate, and you can expect the interest rates to start around 18%.

Qualifying for a merchant cash advance is surprisingly simple because the nature and terms of the loan make the risk lower for a lender. So you probably won’t need to submit piles of paperwork in the application process and the lender won’t ask for collateral. In fact, you might not even have your credit pulled. A lender will usually just want to check out your past 4-6 months of bank statements or receivables.

6. Business credit card

Of all the types of small business financing out there, the business credit card is the most user-friendly. If you’ve had a personal credit card, you basically know how it works. You can access amounts up to $500,000 with a business credit card, with interest rates from 8-24%. It’s not unusual to get a 0% introductory rate. There’s very little paperwork required compared to many loans, and the time to funds rarely exceeds 2 weeks.

This option is excellent for those who don’t feel ready to pursue a business loan or have been repeatedly turned down for them in the past. You’ll boost your working capital with fast access to cash, plus get the added benefits of leveraging a card rewards program and building your credit.

Business credit cards can be used for just about anything related to your operations. Whether you need to buy a new dump truck, add inventory, expand your office, take a client out to lunch, or hold an off-site staff event, this financing can be just the ticket.

Qualifying for a card isn’t difficult, which makes it a good match for those who are new to business. As long as you’ve got a credit score above 680 and have a decent business history, you should be in good shape.

7. Equipment financing

Some business loans are like Swiss Army Knives. They don’t provide a specialized tool, but when you open them up, you’ll find they have dozens of tools that can be used for multiple purposes. Startup loans and merchant cash advances are good examples of this all-purpose financing.

But there are times when precision has its value. Equipment loans fall into this camp. With amounts available up to $5,000,000, you can use them to purchase any kind of equipment your business might need. And that’s where the name is a little deceiving. When most people hear the word “equipment,” they think of things like backhoes, trucks, forklifts, tractors, cubicles, refrigerators, trailers, conveyor belts, and trash compactors.

This type of financing can also be used for less obvious equipment, such as payment processing programs, solar panels, or accounting software for your office. The point is, if the purchase will help to equip your business for its needs, it probably meets the criteria.

One great thing about this type of small business loan is that you can access the money quickly. After submitting your application, you may see funds in as little as 24 hours.

Another strong point is the interest rate, which can start as low as 7.5%. Qualifying for equipment financing is less difficult than many other types of loans. If your business has been running for a year or more, brings in $50,000 or more in annual revenue, and has a credit score of 650 or above, you should be sitting pretty. However, if your credit score is below 650, don’t despair. As long as you can prove you’ve got steady cash flow and provide revenues for the prior 3-6 months, you could still get the green light.

With equipment financing, you usually don’t need to worry about a down payment or collateral because the equipment you’re buying will serve as the collateral, allowing you to move forward with a purchase without draining your liquid cash or putting your personal assets in jeopardy. The loan amount your lender approves will depend on the type of equipment you plan to purchase. If the equipment is in excellent condition and has a strong lifetime value, you’ll obviously be approved for more than if it’s currently rusting in a salvage yard somewhere.

8. Commercial mortgage

A commercial mortgage can be used for just about any property need, whether that’s retail space, an office, a warehouse, or a restaurant. If you’ve been around for decades and want to expand, that’s no problem. New to the business and want to purchase your first location? Perfect.

You can use a commercial mortgage to get out of a lease and begin the next stage of property ownership. You can leverage the financing to purchase a business location you’ve always wanted. If you’d prefer to build, you can use a commercial mortgage to pay for the construction costs. For those looking to expand their existing property, you can use it to add square footage. And if you’re working with an older location that needs some updating, such a restaurant or retail store, this financing can be just the ticket. Finally, you can use a commercial mortgage to refinance to extend your payment term or secure a better interest rate.

This financing option is an asset-based loan, so the amount and rate of your commercial mortgage will be based on your credit and the value of the property you’ll be using as collateral. You can expect amounts ranging from $250,000 to $5,000,000. The interest rates are usually on the lower end, starting around 4.25%, with terms in the neighborhood of 20-25 years. These terms make it an affordable type of financing that will save you a hefty sum over the lifetime of the loan.

Qualifying for a commercial mortgage loan requires a clear plan for how you’ll put the cash to use. For example, if you’ll be making renovations to a property, your lender will want to know how you intend to do it and will also assess the after-repair value (or ARV) of the property. Having a plan in place before approaching a lender ensures you’ll always be able to answer their questions without breaking a sweat.

You can plan on a lender requesting several property-related documents, including the purchase contract, property blueprints, a market analysis for the property, project budget, scope of work, and assessment of the property’s existing condition.

9. Accounts receivable financing

If you’re like most businesses, you frequently deal with unpaid invoices. The situation is so prevalent that experts estimate our nation’s businesses have a total of about $825 billion in unpaid invoices. Having people owe you money is part of business, but when those people never pay you, it can be a business killer.

Accounts receivable financing (sometimes referred to as factoring) is tailor-made for the times you need money but have money held up by unpaid invoices. With this type of financing, you’ll receive the money you need by selling your purchase orders or receivables. The amounts vary, but you can often get up to 80% of your receivables. The money arrives in as little as 3 days, and the loan term can last up to a year. As for the factor rate, it’s as low as 5%.

One of the main benefits of accounts receivable financing is it relieves you of the burden of tracking down those who owe you money to collect on the outstanding debts. Instead, the lender will do the dirty work for you.

Another key advantage is you can qualify even if your credit is less-than-great. The factoring company is most interested in the credit of the company owing you money because that’s where they’re going to get their money. So if your debtors have good credit, the factoring company will consider it likely that they’ll pay up, meaning they’ll be more willing to have you transfer the invoice to them. Your credit, in the meantime, stays mostly out of the picture.

Also, accounts receivable financing doesn’t require you to put forth any collateral. Again, this is because the lender doesn’t consider you a risk. It’s the companies that owe you money that are evaluated. So you can hold on to all your personal belongings and not need to worry about putting them in jeopardy at any time.

10. Startup loan

As a wise person once said, you have to start somewhere. The issue that entrepreneurs run into is that some types of small business loans require a substantial business history to qualify. If you’re just trying to get your business up and running, you lack the tenure and revenue a lender may require.

Some business owners get around this by seeking loans from their family and friends. This approach can be solid, but it’s fraught with challenges. And seeking investors outside of your inner circle can potentially require you to surrender too much equity.

This stage is where a startup loan saves the day. This type of financing is meant for new businesses and can provide funds as low as $500 on up to $750,000. You’ll receive the money in only a few weeks. The interest rate varies wildly based on the details of the loan, so you can expect anything from 0-17%. The loan terms can last as long as 25 years.

It will always be tough to build a business, but you don’t have to bootstrap things to the extreme. A startup loan gives you the capital necessary to lease office space, build inventory, purchase equipment, hire and train staff, and cover your other regular expenses.

You’ll have multiple options when looking at startup loans, including SBA loans, equipment financing, lines of credit, short term loans, and business credit cards. The payments will be based on the amount of the loan, as well as the interest rate, term, and collateral.

To qualify, it’s usually necessary to have a credit score of 680 or higher. A lender will also want proof that you have experience in the industry related to your small business. Some lenders will also request collateral to secure your loan. This assurance might include personal assets like a house, car, or boat.

11. Business acquisition loan

A business acquisition loan is one of those small business loans engineered for a specific purpose: buying an existing business or franchise. Because when great business opportunities arise, it’s not likely you’ll have a pile of money sitting around for the purchase. Instead, your objective will be to find the best financing option to make it happen.

With a business acquisition loan, you’ll get anywhere from $5,000 to $5,000,000. The terms can be revolving or for 10-25 years. The funds won’t arrive particularly fast, usually taking about a month to hit your account. One of the best aspects of these loans is that interest rates begin as low as 5.5%. These favorable rates mean you’ll save a substantial amount of money over the lifetime of the loan.

Getting a business acquisition loan can provide a jumpstart to your business, as buying a franchise or existing business is a great way to step right into a functional business without the backbreaking work of building it from the ground up. So instead of pouring your money into figuring out how to keep a fledgling business afloat, you can put your resources toward helping your business soar.

While the application varies depending on whether you’re buying a franchise or existing business, you can plan on lenders evaluating factors such as your credit history, business tenure, and revenue. You’ll need to provide records of the business’s performance and valuation, in addition to your own business plan and financial projections. Lastly, lenders will want to know about any relevant experience you have that will enable you to run the business successfully.

How can you get approved?

Once you click submit on a loan application, the lender will use multiple factors to determine their response. These same factors also play a role in determining the loan’s terms and rates if you’re approved.

So how are approval decisions made? Here are 6 essential factors lenders use to evaluate your business credit and decide whether or not to open their wallet to you.

  1. Personal credit – You can almost always expect lenders to be keenly interested in your business credit. But your business credit is inextricably linked to your personal credit, so it’s safe to assume they’ll also want to take a look at your personal financial health. This information typically includes your credit in use, credit history, payment history, and amounts owed.
  2. Personal debt coverage – Again, your personal and business finances are related, so a lender will be interested in your personal debt coverage. If you’ve got a healthy state of affairs, expect lenders will consider you less of a risk and will be more keen to work with you.
  3. Business debt coverage – There’s no problem with your business carrying debt. The question is whether your business can handle its debt obligations. To get a bead on your business debt coverage, a lender evaluate your cash flow and debt payments.
  4. Personal debt utilization – If you’re carrying personal debt, you’re in good company. About 80% of Americans have some form of debt. What can set you apart from the masses is if you have credit available that you’re not currently using. To get this metric, a lender will divide your outstanding debt by the cumulative amount of your available revolving credit.
  5. Business debt utilization – Lenders also care about the state of your business debt. Having debt isn’t a big deal. What matters is whether the amount of debt you’re carrying is appropriate compared to the size of your business and the industry you’re working in. This assessment comes from comparing your outstanding business debt to your assets and revenue.
  6. Business revenue trend – Lenders are more motivated to work with you if your business is trending in the right direction, so they’ll want to ascertain what your average revenue growth will be over time. If yours lands at or above the average for your industry, you’re in great shape. If you fall below the average, plan on there being some possible challenges in your pursuit of financing.

A note about business loan applications

While lenders use a variety of tools to determine your qualifications for a loan, none of these metrics are indicative of your worthiness or strength of your character. So as you begin the process, it’s important to remember that you will likely face rejection at some point. After all, the majority of small business loan requests are unsuccessful.

If you get turned down for a particular loan, don’t take it personally. Simply learn from the experience and try to use it to make your next application even better.

The good news is that there are nearly as many loan products out there as there are stars in the sky (at least the stars that are visible from your house on any given night). If your initial application is rejected, try again. By keeping an open mind throughout the process, you’ll be able to adapt to the situation and identify new options.

It’s often beneficial to speak with an expert who can evaluate your financing needs and guide you toward the best financing solutions. By doing your research, asking the right questions, and keeping your mind open, you’ll be setting yourself up for success.

About the Author

Grant Olsen

Grant Olsen

Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.

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