Types of Business Loans and Lenders

About

A term loan works similarly to a student loan or a mortgage. Essentially, a lender will give you a sum of cash upfront for a specific purpose, which you will pay back over a set period of time with automated, equal payments.

These loans range from around $2,000 to $5 million, with annual percentage rates from 6% to 99%.

Depending on your cost and speed ideals, you can either borrow from a bank or from an online lender. Banks typically offer low rates but have stricter requirements (strong credit score and high annual revenue) and take longer to process. Online lenders are a much quicker option and carry looser requirements than banks, but usually have higher costs as a result.

Repayment for banks can be up to 10 years, while for online lenders, it’s usually between three months and three years.

Pros

• Lower interest rates and large sums of money available to borrow
• Simple application process and fast approval (usually within a few days to a week)
• Flexibility in the sense that the loan’s “duration, amount and interest rate are all negotiated before the loan is granted.” More flexibility is granted to companies with better credit scores
• Good way to build business credit if you can make the payments on time
• Accounting and tax advantages as the interest of a term loan is tax deductible

Cons

• Payments begin immediately after funding, which can be difficult for some businesses to facilitate
• Collateral may be required in the form of an asset that the lender will sell if you fail to make payments
• Loans from the Small Business Association are low-cost but carry “strict requirements and can take a while to fund.”
• With some lenders, shorter-term loans carry high costs and frequent repayments.

Who It's Right For

Term loans are a way to get immediate cash for your business that can be repaid on a schedule that works for you. Hence, they are right for companies looking to upscale through purchasing equipment, renovating office space, or other more contemporaneous investments.

About

There are three key types of Small Business Administration (SBA) loans you should know about. Each is different, with its own unique qualifications and conditions.

The first is the SBA 7(a) loan, which is the most common, flexible, and desirable of all the options. It basically works like a traditional term loan with a maximum loan amount of $5 million with terms of up to seven years, depending on how you use the loan.

The second is the CDC/504 loan, which is meant specifically for real estate and machinery purchases. These have much longer terms, capping at 25 years.

Finally, the SBA offers microloans, which max out at $50,000 and usually have a six-year term.

Pros

• Although the interest rate does vary on the risk of your company and your company’s credit history, the SBA puts borrower-friendly caps on interest rates
• The sheer amount of money you can borrow (up to $5.5 million), which banks would otherwise be very hesitant to lend out
• The longest repayment terms and non-stressful repayment schedules
• Flexibility with how you can spend your SBA loan
• Access to SBA resources, including the network affiliated with the SBA, which can help with training and mentorship

Cons

• The application requires a lot of paperwork (including cash flow projections and personal finance reports) and is somewhat complicated
• Collateral can be required
• Personal liability of the business defaults
• Slow approval process
• Not always accessible for applicants with low credit scores
• Requires a down payment (although it is relatively low)

Who It's Right For

Companies with strong credit scores seeking government support with relatively low interest rates and relatively long-term limits.

About

Business lines of credit, like credit cards, can either be secured or unsecured and have a set term or repayment plan. A business can use its line as needed and return it as cash becomes available, albeit regular minimum payments are usually needed.

Pros

• Flexible because the business owner controls what they are borrowing and when
• Can be one of the easier loans for businesses to get
• No interest is owed until some of the money is borrowed because credit line interest rates are based on the bank’s prime rate (plus a premium). Hence, “a business can set up a credit line just in case without incurring any additional expense.”

Cons

• Not good for companies pursuing longer-term investments that need larger sums of capital because, compared to other financing options, borrowing limits can be low
• Application is somewhat rigorous (requires financial statements, business and personal tax returns, two years of business prior; also requires a yearly review to maintain the credit line)
• Can be easy to misuse and rack up debt

Who It's Right For

This loan is most beneficial for companies looking to manage cash flow or invest through inventory, material, or supply purchases.  Business lines of credit are particularly useful for companies whose profits are affected by the season and have short-term goals in mind.

About

True to the name, microloans are smaller loans offered to businesses that need less than $50,000. They are issued by individuals rather than by banks or credit unions. But other than that, the repayment process works very similarly to traditional loans.

Pros

• Available to businesses without strong credit scores, and can help businesses re-establish their credit
• Can take as little as 14 days to come through
• Includes support from micro lenders who will guide you through the process and increase your likelihood of successfully acquiring a loan

Cons

• Inflated interest rate, which is less than a typical credit card but more than if you loaned money from a traditional bank
• The loan amount is limited, so not ideal if you need more money
• A missed payment on a microloan can still hurt your credit “just as much as defaulting on a conventional loan,” and some lenders require borrowers to pay back via weekly payments

Who it's right for

A microloan is the right option for nonprofits or startups that need a little extra capital to help start their business or take it to the next level. This type of loan is usually most appealing to small business owners who otherwise struggle to access credit.

About

A business credit card works exactly like a personal credit card, except you keep it strictly business. They are available to businesses of all sizes and have numerous benefits for companies in need of funds in the present - especially for companies with higher credit scores.

Pros

• Much more flexible with repayment than traditional loans (monthly payments can be minimum or full balance or something in between)
• Can help businesses build credit which in turn facilitates future borrowing
• Cash back rewards can be beneficial depending on how much you spend

Cons

• Interest rates are usually higher for business credit cards than personal credit cards. Also, the rate is relatively high compared to other types of loans and financing
• There is a big risk of abuse and confusion between personal and professional use
• As the business owner is the sole proprietor, this can impact his/her personal credit history

Who It's Right For

It’s right for companies looking to finance their businesses using revolving credit. Not necessarily the best option if an entrepreneur is looking for larger, long-term investments.

About

Owners of businesses or startups can take out personal loans and use the money for their ventures. Personal loans are offered by major banks, credit unions, and online lenders, who look at a borrower's credit score, credit report, and debt-to-income ratio. The term for repayment is usually two to five years.

Although borrowers with strong credit can benefit from low interest rates and large capital sums, experts generally advise against personal loans for startups/businesses, saying they should be “an option of last resort.”

Pros

• Excellent credit is not required, although it does get you a better deal
• They are versatile and can be used for a number of reasons
• You don’t have to put up collateral, which is useful for consumers who have no assets to put up as collateral
• Good for debt consolidation
• Fixed monthly payments

Cons

• High annual percentage rates, especially for borrowers with bad credit scores (but still relatively decent compared to credit card rates)
• Personal loans have “origination fees” which range from one to six percent depending on the amount borrowed
• You can receive a prepayment penalty for paying off your loan before the term is up

Who It's Right For

Personal loans can be a favorable option for entrepreneurs with strong credit scores and strong incomes. Where they work, writes NerdWallet.com, “is when a business just needs a small amount of money for things like … early-stage production or buying equipment.”

About

Invoice financing is a type of short-term borrowing that allows companies to use unpaid invoices as collateral for financing.

Basically, a company will sell a portion/percentage of its invoices at a discount to a lender for a lump sum of cash. Then, the lender will get paid when it collects from the customers. This is a unique form of lending that benefits companies looking for immediate cash.

Pros

• Provides a company with immediate working capital and remedies the issue of slow-paying customers
• Requires no collateral
• Relatively easy approval process, which means it is an accessible option for companies with poor credit or a limited operating history (may struggle to secure loans otherwise)
• Improved cash flow to help grow business in the long-term

Cons

• Hidden fees (application fees, processing fees, credit check fees, or late fees) can make this process insidiously expensive. Late payments also increase annual percentage rate
• May pose ethical concerns for customers due to lack of direct control
• Your financing could be hindered by a customer’s bad credit or weak finances
• You may be required to buy back an unpaid invoice because there is no guarantee of collection by the lender

Who It's Right For

For businesses that need to “improve cash flow, pay employees and suppliers, and reinvest in operations and growth earlier than they could if they had to wait until their customers paid their balances in full.”

About

This is another quick source of short-term financing for small companies needing immediate cash. In essence, a merchant cash advance provider gives you a sum of money upfront in exchange for part of your future sales.

This can work in two ways. Either you get cash in return for a slice of future credit and debit card sales, or you repay your debt through fixed daily or weekly debits from your bank account.

Pros

• Unique from other loans in that there is no fixed monthly payment, no interest rate, and no payoff date
• No collateral requirement
• Advances are usually made within 24 to 48 hours, which means businesses have near-immediate access to funding
• Easy application process with minimal paperwork
• Repayment is flexible based on the merchant’s credit card transactions

Cons

• Considerably more costly than other financing options because while there is no interest rate, the advance fee you are paying with an MCA is high (can range between 60% and 200%)
• Most cash advance contracts don’t allow you to switch credit card processors, so you have to stay with yours until the advance is repaid
• They are predominantly a short-term solution and can often be used incorrectly.
• Financing future sales is risky

Who It's Right For

Merchant cash advances are a good option for businesses that can’t qualify for traditional bank loans and need quick access to funds. However, if used incorrectly, they can be very damaging for a new business and should be thoroughly researched before committed to.

About

Large banks' small business loan approval rate is 25%. They can be an attractive option for some business owners as a reliable source of capital, with interest rates hovering between 4% and 10%.

The primary loans offered by banks are term loans, SBA loans, business lines of credit, equipment loans, and business credit cards. Based on their applications, interest rates, repayment schedules, and other factors, we recommend Wells Fargo, Bank of America, JPMorgan Chase, Capital One, and U.S. Bank for traditional bank loans.

Other key financial institutions that finance small business loans are credit unions. Credit unions are largely similar to traditional banks but have two key distinctions: they are not-for-profit institutions and usually function as member-focused institutions.

Pros

• Fixed interest rates
• Predictable, fixed monthly payments
• Can help businesses build credit
• Facilitate access to institutional resources, including expert support
• Can be used relatively flexibly

Cons

• Lengthy paperwork
• Longer waiting time
• Require very strong credit scores and demonstrated healthy cash flow
• Banks usually require an established business with minimal risks
• Most require collateral in the form of assets

Who It's Right For

This is right for business owners who have an established company with a strong credit score and a healthy cash flow, looking for a loan to use for a specific purpose.

About

In the online age, crowdfunding has become a relatively popular way for companies to raise money. Business owners simply sign up for an online platform, like Indiegogo or Kickstarter, make their pitch and then wait for the funds to roll in.

It can be challenging if your company doesn’t have a large, preexisting following or base of support but has significantly fewer strings attached than lending from a financial institution.

Pros

• Can be a great way to test the market and see how people feel about your product before you fully commit
• Unlike loans from banks or online lenders, there is very little financial risk
• Your campaign could spread quickly across social media, driving interest and sales

Cons

• Due to oversaturation, it can be difficult to stand out from the crowd
• Can lead to a lot of effort for a little payoff
• If it is unprotected, somebody could steal your idea
• You have to pay fees for some websites. For example, Kickstarter takes 5 percent of every successful campaign
• It is usually only a good option for “consumer-facing” products

Who It's Right For

If you think your product is interesting enough to garner some attention online, this could be a good way to generate buzz and pull in some funds. Maybe you just want to see how your product will be received. Essentially, crowdfunding is good for early-stage entrepreneurs testing a new concept.

About

Another lending option is peer-to-peer (otherwise known as P2P). This form of lending works by connecting lenders and borrowers on online platforms, cutting out traditional banking protocols. “With just a click of the mouse, you can easily find loans online without going to banks in person or waiting for approvals,” writes Investopedia.com.

Pros

• Easy, online process with simple applications
• Low-interest rates make it more accessible than traditional financing (helps both lenders and borrowers save money)
• Accelerated decisions resulting in access to quick funds
• Cuts out the middleman

Cons

• Lender may have to accept the loss if the loan is not repaid unless a loan facilitator is used
• Not insured like many other investments. Hence, there is risk if the borrower defaults on the loan

Who It's Right For

An entrepreneur who would rather not get access to funds through a rigid financial institution. Someone who is looking to minimize interest rates and application stress will find gaining access to funds much faster.

About

If you know someone with the funds, there is always the option of asking a family member or a friend for a loan. You can negotiate the terms of the contract with them to make sure it is favorable for both sides (remember to consider terms and interest rates).

However, remember not to skip out on the contract part because it can get uncomfortable if both people aren’t on the same page.

Pros

• Flexible regarding credit scores, repayment schedules, and terms
• Due to personal relationship, may include the ability to pause payments while getting your business off the ground or while going through tricky periods
• Typically associated with lower interest rates
• Can be a win-win situation providing benefits for the lender as well

Cons

• If there is no firm contract negotiated, there can be a lack of clarity due to no legal documentation
• Tax issues can arise from these types of loans because lenders must still provide sufficient loan documentation to avoid IRS scrutiny
• The potential for social awkwardness due to “mixing business with pleasure”

Who It's Right For

Business owners who need a more lenient lender, possibly due to a low credit score or rocky phases of entrepreneurship.