Guide To Business Loans

4. 11 Types of Small Business Loans and How They Work

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Business Loans

11 Types of Small Business Loans and How They Work

May 23, 2024 • 10+ min read
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Table of Contents

      There are many different kinds of small business loans, making it essential to do your research before beginning any application process.

      The best place to start is by identifying how you will use 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 quickly you need the funds and how long you would like to have to pay the money back.

      The following information covers the common types of business loans. Pay attention to the dollar amounts, rates, terms, and qualification criteria to help you choose the small business loan type perfectly suited for your business needs.

      1. Term loans

      A term loan provides a lump sum of money repaid in monthly installments with interest over a set term. 

      Term loans
Lump sum disbursement
Fixed repayment schedule
Annual interest rate
How to use a term loan
Expand operations
Purchase equipment
Working capital
Debt refinancing

      Common use cases: A business term loan is a great way to acquire working capital, expand business operations, purchase equipment, or hire additional staff.

      Typical terms: Term loan amounts range from $5K to $500K with a repayment period between six months and 10 years. You can often see that money in as little as 1-3 days. These loans generally have a fixed interest rate, but some lenders may offer a variable rate that fluctuates with the market.

      Minimum eligibility requirements: Each lender will have its eligibility criteria. In general, minimum requirements for a term loan include a 600 credit score, $8K in monthly revenue, and one year in business.

      Pros:

      • Fixed repayment schedule – A term loan offers a clear repayment timeline, which can help businesses plan and manage their budget.
      • Lower interest rates – Compared to other types of loans, term loans usually come with lower interest rates.
      • Access to larger amounts – Term loans typically allow businesses to borrow larger amounts, which can be beneficial for significant investments or expenditures.
      • Building credit – Regular and timely repayments can increase a business’ credit score.

      Cons:

      • Collateral required – A term loan often requires collateral, which could be a risk if the business fails to repay the loan.
      • Strict requirements – The eligibility criteria for term loans tend to be stricter, which might not suit businesses with lower credit scores.
      • Long-term commitment – The repayment of term loans spans over a long period which might not suit businesses wanting short-term solutions.
      • Early repayment penalties – Some lenders might charge a penalty for paying off the loan earlier than the agreed term.

      2. Business lines of credit

      Unlike a traditional loan, where you receive a lump sum all at once, a line of credit allows you to borrow only what you need and pay interest on the amount you use. Think of it as a credit card for your business, but typically with lower interest rates and higher borrowing limits. 

      Line of credit
Withdraw funds as needed.
Repay the borrowed amount.
Borrow again once previous amounts are repaid.
How to use a line of credit
Manage cash flow
Seasonal financing
Emergency expenses
Purchase inventory

      Common use cases: This flexibility makes it an excellent tool for managing cash flow, handling unexpected expenses, or addressing short-term funding needs.

      Typical terms: You can get anywhere from $1,000 to $250,000, and the money is typically available in one to two days with a 6- to 18-month maturity. Most lenders charge a simple interest rate on the amount you draw with no prepayment penalty.

      Minimum eligibility requirements: 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 600 or higher, consider yourself a prime candidate.

      Pros:

      • FlexibilityYou can withdraw funds up to your limit anytime, only paying interest on what you’ve borrowed.
      • Access to emergency funds – A business line of credit serves as a financial safety net, allowing you to handle unexpected expenses swiftly.
      • Cash flow management – A business line of credit can help manage cash flow, particularly for businesses with seasonal revenue.
      • Funding small projects – A business line of credit can be used to fund small projects or short-term business needs.

      Cons:

      • Potential fees – Some lenders may charge establishment or maintenance fees for a business line of credit.
      • Higher interest rates – Interest rates for business lines of credit are generally higher than traditional term loans because you have ongoing access to the credit line instead of needing to reapply like you would for a term loan.

      3. SBA loans

      The Small Business Administration (SBA) was created to assist small businesses through various educational and funding programs. SBA loans are unique because the SBA isn’t 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.

      SBA loan
Government-backed loan
Longer repayment terms
Lower interest rates
How to use an SBA loan.
Expand existing business
Purchase real estate
Buy equipment
Working capital

      Common use cases: SBA loans are typically used for working capital or to purchase fixed assets such as equipment or real estate.

      Typical terms: With an SBA loan, you can expect amounts from less than $50K up to $5M. Terms also cover a broad range, typically from 10-25 years. Expect the entire process to take 1-2 months.

      Types of SBA loans: 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 most business purposes. You’ll be required to provide collateral for any loan $50K or more.
      • SBA 504 loan: These loans are used to finance fixed assets. Qualifying projects include buying an existing building, building a new facility, buying land, and buying long-term machinery. The benefits of 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 $500,000 with an SBA Express loan. Expect to have your application reviewed by the SBA in 36 hours or less. Time to fund will depend on the lender but will likely range from 30 to 60 days.

      Minimum eligibility requirements: SBA loans have stringent credit requirements. You’ll need a minimum credit score of 650, at least two years in business, and a minimum of $8,000 in monthly revenue to be considered by an SBA lender.

      Pros:

      • Lower interest rates – SBA loans typically offer lower interest rates than other types of loans, making them more affordable.
      • Longer repayment terms – SBA loans come with longer repayment periods, which can help ease the burden of monthly payments.
      • Access to larger capital amounts – SBA loans can offer access to larger amounts of capital than may be available through a traditional bank loan.
      • Credit building – Timely repayment of an SBA loan can contribute positively to a business’ credit history.

      Cons:

      • Lengthy application process – The process of applying for an SBA loan can be long and tedious, which might delay access to needed funds.
      • Strict eligibility criteria – SBA loans have strict eligibility criteria that some businesses might not meet.
      • Limited use of funds – There may be restrictions on how the loan funds can be used.
      • Rates based on Prime – Because SBA loan rates are based on the WSJ Prime rate, interest rates will vary based on market conditions. If you opt for a variable rate, your rate could go up or down.

      4. Business cash advances

      A business cash advance borrows 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 repay the funder a fixed daily amount via a withdrawal from your bank account.  Some funders offer a merchant cash advance where you’ll have an agreed-upon percentage of your daily credit card deposits withheld for the lender. 

      Business cash advances: Receive a lump sum based on future sales. Repay with a percentage of revenue. Daily or weekly repayment schedule. How it's used: working capital, unplanned expenses, seasonal business needs, business growth.

      Common use cases: A cash advance can be used for any business expense. Common use cases include working capital, covering seasonal business needs, and expansion costs.

      Typical terms: Business cash advances are known for speedy delivery. You can apply for anywhere from $5,000 to $500,000, and time to funds can be as short as 24 hours. A cash advance comes with a factor rate instead of an interest rate. Factor rates are expressed as a decimal number, such as 1.5. To calculate payback, multiply the total borrowed by the factor rate. For example, $10,000 borrowed x 1.5-factor rate = $15,000 total payback.

      Minimum eligibility requirements: Qualifying for a business cash advance is surprisingly simple because the nature and terms of the loan make the risk lower for a lender. Minimum credit score requirements start at 500. You’ll need a minimum monthly revenue of $10,000 and a minimum time in business of three months to qualify for a cash advance.

      Pros:

      • Fast funding – Business cash advances often provide quick access to capital, usually within a few days.
      • No collateral required – Business cash advances are unsecured, meaning you don’t have to put up any assets as collateral.
      • Easy approval – Approval is based on business performance, not personal credit, making it easier for businesses with poor credit to qualify.

      Cons:

      • Costly – Business cash advances often come with high factor rates, making it one of the more expensive financing options.
      • Daily or weekly repayments – Daily or weekly withdrawals from your business bank account can impact cash flow.
      • Not regulated like loans – Business cash advances are not considered loans or regulated by lending laws, leading to potentially aggressive collection practices.

      5. Equipment financing

      Equipment financing is a specialized form of financing used to purchase equipment. With amounts available up to $5 million, you can use them to buy any kind of equipment your business might need. 

      Common use cases: When most people hear the word “equipment,” they think of heavy equipment like backhoes, trucks, tractors, refrigerators, and trash compactors. But 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 equip your business for its needs, it probably meets the criteria.

      Typical terms: Equipment financing is available from $5K-$5M with terms from one to 10 years. After submitting your application, you may see funds in as little as 24 hours. Interest rates start as low as 7.5%. The equipment you purchase will serve, at least in part, as collateral for the loan, so you may need less additional collateral than you would for other loan types. Some funders may require a down payment. 

      Minimum eligibility requirements: Qualifying for equipment financing is easier 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 520 or above, you should be sitting pretty. Some equipment financing companies will work with day-one startups. The lender will also evaluate the value and condition of the equipment as part of the approval process.

      Pros:

      • Less need for collateral – The equipment often serves as collateral, so you don’t need to risk other assets.
      • Preserves cash flow – Equipment financing allows businesses to preserve their working capital for other operational expenses.
      • Tax advantages – Interest and depreciation on financed equipment can often be deducted as a business expense.
      • Access to latest technology – It provides an opportunity to afford the latest technology or higher-quality equipment that might be too expensive to buy outright.

      Cons:

      • Risk of obsolescence – The financed equipment might become obsolete before it’s fully paid off, leaving you paying for outdated equipment.
      • Total cost – The total cost over the term of the finance agreement will be higher than the equipment’s actual purchase price.
      • Ownership uncertainty – Depending on the agreement, the financier may hold the title to the equipment until you’ve completed your monthly payments.

      6. Commercial mortgages

      A commercial mortgage or commercial real estate loan is used to purchase or renovate commercial property such as an office building or warehouse.

      Commercial mortgages. Long-term loan for commercial property. Fixed or variable interest rates. Down payment required. How it's used: purchase commercial real estate, refinance existing property loans, expand or repair existing property.

      Common use cases: 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. Ready to purchase your first location? Perfect.

      Typical terms: A commercial mortgage is similar to a home mortgage but with a few key differences. One, you’ll need to provide a down payment. There are typically no options for 100% financing. Two, the terms will be shorter, typically 10-25 years. Three, some commercial real estate loans come with a balloon payment at the end of the term, which is one large payment that pays off the remaining balance of the loan.

      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 at around 6.25%.

      Minimum eligibility requirements: 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.

      Lenders will also look for:

      • Minimum credit score: 650
      • Down payment: Starting at 10-25%
      • Time in business: 2 years or more

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

      Pros:

      • Asset ownership A commercial mortgage allows your business to own an asset that can appreciate over time.
      • Stability – It provides a stable location for businesses which could be a significant advantage for customer retention.
      • Renting potential – The extra space could be rented out to generate additional income.
      • Tax benefits – Interests on commercial mortgages are tax-deductible.

      Cons:

      • Down payment – Commercial mortgages typically require a substantial down payment, often more than what’s required for a residential mortgage.
      • Maintenance costs – Owning a commercial property can bring additional costs like maintenance, repairs, and insurance.
      • Lengthy process –The time to fund a commercial mortgage can take anywhere from 4-8 weeks.

      7. Accounts receivable financing

      Accounts receivable financing (sometimes called invoice factoring) is tailor-made for when you need money but cashflow is tied up in outstanding invoices. With this type of financing, you’ll sell your outstanding invoices to a factoring company that will pay you a percentage of the invoice’s value upfront. The factoring company will collect the money from your customer when the invoice comes due and pay you back any remaining balance minus the factoring fee.

      Common use cases: Invoice factoring is frequently used to boost cash flow, cover short-term expenses, and manage business seasonality.

      Typical terms: The amounts vary, but you can often get up to 80% of your receivables. The money arrives in as little as 24 hours, and the loan term can last up to a year. As for the factoring fee, it starts as low as 3%.

      Minimum eligibility requirements: To qualify for invoice factoring, your business must be B2B or B2G, have a minimum monthly revenue of $10K, and operate in the funder’s preferred industry.

      Pros:

      • Immediate cash flow – Accounts receivable financing provides immediate cash, improving business liquidity and enabling timely handling of operational expenses.
      • Reduce time spent on collections – 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 outstanding debts. Instead, the lender will do the work for you.
      • Credit score irrelevant – This type of financing generally depends on the creditworthiness of your customers, not your business. Therefore, businesses with lower credit scores can still qualify.
      • Flexible terms – The financing volume can grow with your sales, providing flexibility for businesses with seasonal demand fluctuations.

      Cons:

      • Factoring minimums – Some factoring companies may require you to factor a minimum amount with them over a set period. 
      • Loss of control – You may lose some control over customer relationships, as the financing company may interact directly with your customers during the collection process.

      See if your business is eligible for financing.

      How much money are you looking for?

      8. Startup loans

      The term “startup loan” can be a bit of a misnomer. While there are a handful of lenders who will work with day-one startups, it’s rare to find financing to start a brand-new business. However, there are still business loan options available for young startups with only a year or two in business. Common loan types for startups include business cash advances, invoice factoring, and equipment financing. The SBA also offers two programs for startups: SBA microloans and the Community Advantage program. These programs are meant to support underserved communities and will typically have less stringent qualifying criteria.

      Pros:

      • Access to capital – A startup loan can provide the necessary capital to get your business off the ground, covering expenses such as equipment, inventory, and marketing.
      • Building credit – Regular and timely repayments of a startup loan can help build a positive credit history, which can be beneficial for securing future financing.
      • Retain ownership – Unlike equity financing where you might have to share ownership, a startup loan lets you retain complete control over your business.
      • Lower interest rates – SBA microloans and Community Advantage loans can sometimes offer lower interest rates than other types of financing.

      Cons:

      • Repayment risk – As a startup, you may not have a steady cash flow yet, making loan repayments a potential challenge.
      • Collateral – Startup loans often require collateral, which means your personal or business assets could be at risk if you default on the loan.

      9. Business acquisition loans

      A business acquisition loan is used to buy an existing business or franchise.

      Typically these loans will be structured as a term loan or line of credit used to purchase equipment, real estate, and intangible assets. SBA loans can also be used to acquire an existing business.

      The loan terms will be specific to the loan type, lender, and specific acquisition costs. In general, expect lenders to look for a minimum credit score of 650, steady revenue, post-acquisition business plans and financial projections, and in many cases a significant cash contribution to the overall purchase. Lastly, lenders will want to know about any relevant experience to help you run the business successfully.

      Pros:

      • Immediate operational benefits – Securing a business acquisition loan allows quick entry into a market with an already operational business, eliminating the time and effort to build a business from scratch.
      • Established track record – An acquired business usually comes with an established customer base, existing cash flow, and a market presence, reducing the uncertainties associated with startups.
      • Expansion opportunities – For an existing business, an acquisition loan could enable the acquisition of a competitor or expansion into new markets.

      Cons:

      • Debt burden – An acquisition loan adds to the financial obligations of a business, which could strain the business’ cash flow, especially if the acquired business does not perform as expected.
      • Risk of overvaluation – There’s a risk of overpaying for the business being acquired if its assets or earning potential are overvalued.
      • Integration issues – Merging two different business cultures, systems, and processes can be a complex and challenging process.
      • Collateral requirement – Business acquisition loans often require collateral, which could be at risk if the business fails to make repayments

      10. Short-term loans

      Short-term loans are repaid in a term of six months to three years. They can be structured as a term loan, a cash advance, a line of credit, or invoice factoring. Be aware that many term loans with short term lengths will require a daily or weekly payment similar to a business cash advance.

      Many entrepreneurs use short-term loans 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.

      Pros:

      • Quick access to funds – Short-term loans are usually processed quickly, giving immediate access to the funds needed.
      • Easier approval – The approval process is often less rigorous compared to those for long-term loans, allowing businesses with less-than-perfect credit scores to get approved.
      • Short repayment period – As the name suggests, short-term loans are repaid quickly, which can be an advantage for businesses not wanting long-term debt.
      • Less interest over time – Since the loan term is shorter, the total interest paid over the lifespan of the loan might be less than a long-term loan (despite higher interest rates).

      Cons:

      • Higher interest rates – Short-term business loans usually have higher interest rates compared to long-term loans.
      • Frequent payments – These loans often require daily or weekly payments, which could be a strain on your business’s cash flow.
      • Less money – Generally, short-term business loans offer less money than long-term loans, which might not be sufficient to cover larger financial needs.

      11. Business credit cards

      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 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.

      Pros:

      • Reward points – Many business credit cards offer reward points or cash back on purchases, which can be reinvested into the business.
      • Building credit – Regular and responsible use of a business credit card can help build your business’s credit rating.
      • Separate business and personal expenses – Business credit cards make it easier to keep business and personal expenses separate, simplifying accounting and tax filing.
      • Emergency funds – Business credit cards can be used to manage cash flow during lean periods or to cover unexpected expenses.

      Cons:

      • High interest rates – If the balance is not paid off each month, the interest rates on business credit cards can be high, increasing the cost of borrowing.
      • Dependence on credit – Over-reliance on business credit cards can lead to excessive debt and negatively impact the business’ credit score.
      • Personal liability – In many cases, business credit card debt is personally guaranteed by the business owner, putting personal assets at risk.

      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 evaluates 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.

      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.

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      About the author
      Tanner Cupello

      Tanner Cupello has worked in the small business lending industry for eight years assisting thousands of small business owners to get financing to sustain and grow their businesses. At Lendio he oversees and trains the full team of funding managers on business loan products and a network of over 75 lenders.

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