Small Business Loans

There are many different types of business loans. To understand which is the best one for you, first choose the amount and purpose of the loan, how soon you need it, how long it will take to repay, length of time you’ve been in business, its current financial shape, and the amount of collateral you have available.

The answer to these will give you a better idea of the loan type that’s best for you, and whether you should pursue a government-backed loan, a bank loan or line of credit, or seek out an alternative lender for a line of credit, loan, or cash advance. Loans can be used for obtaining working capital, equipment or building purchases, remodels or construction, and in some cases, to refinance business debt. Other types of loans are merchant cash advances (loans based on on the volume of your business’ credit card transactions), professional practice loans (designed specifically for providers of professional services like healthcare, accounting, or engineering), and franchise startup loans.

Government-backed Small Business Administration (SBA) loans provide a guaranty that enables a bank or alternative lender to extend credit it might otherwise have declined. They can be used for a wide variety of purposes, but have generally strict qualifying requirements, additional paperwork, extra fees, and take longer for approval.

Bank loans or lines of credit are the traditional way to fund businesses, but since the Great Recession of the late aughts, getting approval has become more difficult. They tend to carry low interest rates, and approval is slightly faster than SBA loans. However, repayment terms are generally shorter, and often include balloon payments of the outstanding principal sum, interest-only having been paid until then.

Alternative lenders have gradually become pervasive in the lending marketplace, offering loans to startups and small businesses with less than stellar credit history. Their approval requirements are considerably less stringent than for the two previous types of loans, applications are typically fully completed online, approval decisions are quick, and funding can arrive in less than five business days. Interest rates and associated fees can be substantially higher than with traditional lenders, however, as these loans generally carry higher risks.

You must have both good personal and business credit scores in order to qualify for an SBA-backed or traditional bank loan. Alternative lenders, while they do take credit history into account, generally have more lenient requirements, and place more emphasis on the business’ cash flow and track record.

Business loans can be used for a number of different operational needs. Some traditional bank loans may have specific conditions or limits on usage, but loans and financing designed specifically for small businesses can be used for nearly everything, including equipment purchases, inventory, daily expenses, and payroll.

Other uses can encompass the purchase of new technology, hiring, marketing or advertising, education and training, and finally, expansion. In the case of loans guaranteed by the Small Business Administration (SBA), there are generally specifically permitted usages.

SBA 7(a) loan proceeds can be used to pay long and short-term operational expenses, to purchase real estate, as revolving funds, to renovate or construct a new building, to establish a new business, and under some circumstances, to refinance existing business debt. These funds cannot be used to refinance existing debt where the lender would receive a loss, to repay delinquent taxes, to affect a partial change of business ownership, to reimburse funds to any owner, or for any purpose that the SBA doesn’t consider sound.

SBA 504 loans, or Community Development Corporation (CDC) loans, are strictly for real estate and equipment purchases. This program is unique in that it pairs a CDC with a lender, and they finance the loan jointly. Finally, the SBA also features microloans, in which they provide funds to nonprofit organizations, who in turn, lend the money to the business.

A business line of credit is an arrangement between a financial institution and a business that establishes a maximum loan balance that the lender permits the borrower to access or maintain. Borrowers can access funds at any time, as long as they don’t exceed the agreed-upon maximum amount or any other requirements set by the financial institution.

Lines of credit are revolving accounts generally unsecured by collateral. This means that borrowers can spend the money, repay, and then spend it again, in a virtually never-ending cycle. Repayment can be adjusted as needed, opting for minimal monthly payments or settling the entire outstanding balance at once. This differs from installment loans, in which borrowers receive a lump sum, and repay it in equal monthly installments.

Invoice factoring is a type of accounts receivable financing that converts outstanding invoices due within 90 days into immediate cash. Businesses pay a percentage of the invoice amount to the lender as a fee for borrowing the money, while the lender limits its risk by not advancing the full invoice amount.

Invoice factoring can work in various different ways, but the most common is known as factoring. In this case, the company sells its outstanding invoices to a lender, who then pays them between 70% and 85% of what the invoices are worth. When the lender receives the remaining balance, it then remits the remaining 15% to 30% to the business, which in turn, pays interest and/or fees for the service.

Another alternative is invoice discounting. This is structured similarly to factoring, but the business itself collects the invoice payment, not the lender. The lender can advance up to 95% of the total amount, and upon customer payment, the business then repays the lender, minus a fee.

A merchant cash advance is a lump sum of capital that is repaid automatically using a fixed percent of your daily credit card transactions. They are not loans, but rather an advance based on a business’ future revenues.

Merchant cash advances view risk differently than lenders of traditional loans do, focusing daily receivables or credit card receipts rather than on credit criteria. Rates are typically higher than for other small business financing options, such as loans, but qualifying is substantially easier.

Online lenders are great options over banks, when businesses are younger, or can’t meet a bank’s requirements for borrowing. To qualify for SBA-backed and traditional bank loans, businesses need excellent credit, strong business revenue, and zero defaults on taxes or government loans.

Online and alternative lenders analyze both traditional credit standards, (such as personal credit score, revenue records, and cash flow), as well as nontraditional metrics like social media and vendor payments. This emphasis on alternative qualifiers enables non-traditional lenders to fund so-called higher-risk businesses, such as startups or clients with poor credit scores. These loans are also easier to apply for, as the whole process can be completed from the comfort of your home or office computer. Approval or denial also tends to process much quicker than with traditional lenders.

Business loans costs are different for each borrower, as rates depend on a number of factors, unique to each business. However, borrowers should always keep in mind all the associated costs of the loan, including interest rates, APR, factor rate as applies, and any fees for costs such as origination, application, guarantee, late payment or prepayment penalty, check processing, and underwriting.

SBA 7(a) loans also require a guaranty fee of between .25% to 3.75% for the part of the loan that is guaranteed by the agency, depending on the size and maturity date of the loan. Since SBA loans are government regulated, interest rates are set. For June 2017, maximum interest rates on SBA 7A Loans range from 6.25 % to 8.75 %, and currently range from 3.84% to 4.39 % including fees for the CDC portion of CDC / 504 loans.

As a general rule of thumb, the company’s expected profits from the use of the business loan should be greater than the loan’s total cost, and the business should generate enough cashflow to be able to easily cover the monthly payments. Repayment terms also vary depending on the lender and the loan purpose, which affects the total sum the borrower must repay.