Running a small business is a major investment of your time and energy. To some extent, being your own boss will always be a gamble. However, there are ways to protect your financial security, and taking advantage of small business loans is one.
Take the time to investigate and prepare for financing before you need it.”
It’s important to think carefully about what kind of financing you’ll need and when you’ll need it. “Take the time to investigate and prepare for financing before you need it,” says Gerri Detweiler, head of market education for Nav. Detweiler states, “If you wait until you need money fast, you’re more likely to get stuck with high-cost financing.”
Here’s a comprehensive guide to the many types of small business loans you should consider.
You can, in fact, fund your business with a personal loan, but this is a risky option. First and foremost, if you default on a personal loan, you are personally liable. Additionally, “Loans that show up on your personal credit may impact your personal credit scores,” says Detweiler. She states, “Building strong business credit scores will help you obtain loans in the name of your business.”
When to finance with a personal loan
Many banks and other lending institutions will not lend to brand new businesses. If you’ve already tapped resources like your savings and investments from friends and family, but still don’t have enough to cover your startup costs, a personal loan may be your only option.
Business credit card
Many entrepreneurs don’t realize their business credit card can be a great form of short-term financing, says Detweiler. She states, “While your credit card interest rate may not be as low as other options such as bank loans or SBA loans, it often beats other options such as merchant cash advances.”
When to finance with your business credit card
Financing with a business card you already hold is the fastest way to get money when you’re in a pinch. It’s also a great choice if your other financing options have higher interest rates or lower limits. You may even be able to take advantage of an introductory 0% Annual Percentage Rate (APR) promotion when you apply for a new card.
Term loans are one of the most common forms of business loan. They’re usually used for major investments in capital or new growth, and can last anywhere from three to 20 years, usually with a set repayment schedule and fixed interest rate.
When to finance with a term loan
Term loans are one of the most difficult business loans to get, and the application process can be rigorous and lengthy. Do not rely on a term loan when you need cash quickly. You’ll also need a large down payment and a proven track record. If you can handle all of the above, these loans often offer some of the best rates.
Of the loans offered by the Small Business Administration (SBA), 7(a) loans are the most popular, says Detweiler. While the SBA does not finance these loans directly, it does guarantee them, helping more businesses gain access to financing through traditional financial institutions, like banks. These loans take into account both the credit score of the business and the business owner.
When to finance with an SBA loan
“These are popular loans for a reason: Interest rates and repayment terms are usually very attractive,” says Detweiler. However, according to the SBA, “SBA-guaranteed loans may not be made to a small business if the borrower has access to other financing options on reasonable terms.” So, while these loans can have very appealing terms, you may not necessarily qualify.
Business line of credit
“A business line of credit gives you the flexibility to borrow when you need to,” says Detweiler. To open and maintain a business line of credit, you will be required to provide a good deal of documentation on an annual basis. The benefits are clear though: Access to funds whenever you need them without having to apply for a new loan or scrape together cash in a hurry.
When to finance with a business line of credit
If you can get a business line of credit, the terms are usually very advantageous. With access to traditional financing on the decline, according to the National Small Business Association, you may need to rely on nontraditional lines of credit, like a business credit card.
One of the greatest advantages of microloans is that they typically come with the added benefit of technical assistance. “The lender may offer help with business development, networking or other services to help the small business be successful,” says Detweiler. These microloans are usually distributed by community-based non-profit organizations, which also set many of the terms of the loan and eligibility requirements.
When to finance with a microloan
Microloans are specifically for smaller loans of an average of $13,000 and can be repaid over a maximum of six years. So, if you don’t need a large amount of money, but need a while to pay it back, these can be the right option. The technical assistance could also prove to be invaluable for your business.
Invoice factoring is a method of getting cash sooner for outstanding balances — think of it as a payday loan for your business. After sending an invoice to a customer, a business can sell that invoice to a factor. The factor advances the money to the business and takes control of receiving payment from the customer.
“Typically with invoice factoring the company that offers the service is more interested in the credit of the company that will pay the invoice than the credit of the business requesting the advance,” says Detweiler.
Invoice financing is a similar, though not exactly identical, process. When you opt for invoice financing rather than factoring, the financing company no longer acts as a middleman taking payment from your clients.
When to use invoice factoring
Businesses who are in a cash crunch and without strong credit who need money for inventory or employee salary can use invoice factoring to get cash on hand. However, it’s typical to only expect 70-90% of the invoice value from the invoice factoring company.
Merchant cash advance
Merchant cash advances are usually agreements between payment processors (i.e. credit card companies). The credit card company will advance a business money and then take a percentage of debit and credit card sales each day until the advance is paid back
“This is often one of the most expensive types of financing,” says Detweiler. She states, “Some entrepreneurs don’t realize they will repay the advance through automatic withdrawals from their merchant account, usually on a daily basis. This may create a cash flow crunch that forces them to go back for another advance, and so on.”
When to finance with a merchant cash advance
Businesses who don’t typically qualify for bank loans — usually because of poor credit — can benefit from merchant cash advances through an easier approval process. The interest and fees are usually higher than bank loans, so businesses with a high volume of credit and debit card sales can pay them off sooner.
“Small business lenders are not required to disclose an Annual Percentage Rate (APR), and sometimes costs are confusing,”
Whatever type of financing you choose for your small business, always do your research. “Small business lenders are not required to disclose an Annual Percentage Rate (APR), and sometimes costs are confusing,” says Detweiler. She says, “Make sure you understand what you are getting into.”
To explore various types of business loans, head to our business loans reviews and find a company that works for your needs.