The type of small business loan you acquire can make or break your success. According to statistics, 20% of small businesses fail within the first year of operation. Within five years, the percentage of failed businesses rises to 50%. Not surprisingly, most failed businesses cite lack of funding as the primary cause for failure. This may prove that in the small business world, access to capital can determine your rate of success.
Most small business owners require at least one loan to fund operations until the business becomes profitable. And the type of small business loan you take out matters. While some small businesses fail because of underestimated expenses, many business owners fail because of taking out the wrong loan.
Which Type of Small Business Loan Should you Choose?
With multiple types of small business loans to choose from, it is important to make the right choice. Some loans provide more capital but charge high interest rates. Other loans provide less capital but offer lower interest rates.
Is it worth paying more interest to get more funds? The answer depends on a variety of factors. If you need capital for your small business, this article may help you choose the right type of small business loan that meets your specific needs.
How to Choose The Right Type of Small Business Loan
Choosing the right loan depends on:
- What loan you can qualify for
- The payments you can make
- What you plan on financing with your loan
For instance, if your business is already thriving and you need capital for a new marketing campaign, a merchant cash advance could serve you well. However, if you need capital for startup costs, you’re likely better off taking out an ACH loan or a business term loan.
A good way to get started is by eliminating financing options you do not qualify for.
While you can’t know for sure if you’ll be approved before you apply, you can eliminate some loans from your list of possibilities based on qualifications you don’t meet. For example, if you don’t have a sufficient number of unpaid invoices, you won’t qualify for an accounts receivable loan. Likewise, if you’re just launching your business, you won’t have the business income required to qualify for a merchant cash advance.
Types of Small Business Loans
If you are not sure what is required for each type of loan, the following list will help you determine financing options for your small business.
1. Business Term Loan
A business term loan gives you access to all the capital you’ve been approved for up front. To repay the loan, you’ll make payments in a set amount over a specified period of time based on your loan’s terms.
A business term loan is perfect for:
- Successful businesses that need extra capital
- Any business that can make regular payments
The drawbacks are less flexibility, higher costs for short-term loans, and you might need to offer up collateral.
2. Small Business Administration (SBA) Loan
SBA loans are long-term loans partially secured by the U.S. Small Business Administration (SBA). These loans tend to have low interest rates, and the funds can be used for just about anything.
Qualifications can be tough to meet. To qualify for an SBA loan, a business should generally have been in business for at least two years, generate at least $100,000 in annual revenue, and have strong credit (620+).
When applying for an SBA loan, be prepared to fill out a mountain of paperwork and go through a strenuous application process.
An SBA loan is perfect for:
- Businesses that need large amounts of capital
- Businesses in industries like food service, medical, beauty, convenience stores, contractors, landscaping, and trucking
3. Merchant Cash Advance
With a merchant cash advance, your business’ future revenue is used as collateral to get you fast cash. It’s easy to qualify, but fees can be high, and these loans usually come with strict contingencies. For instance, some lenders won’t allow you to give discounts for cash payments, changing locations, or closing your store for a certain period of time.
A merchant cash advance is perfect for:
- Businesses generating consistent revenue
- Businesses with a strong track record of success
4. Accounts Receivable Financing
An accounts receivable loan gives you access to capital based on your outstanding invoices. If you default on the loan, your lender has the right to take ownership of your unpaid invoices.
An accounts receivable loan is perfect for:
- Businesses that work with vendors that accumulate debt before paying their invoices
5. Equipment Loan
Equipment loans are loans that must be used to buy equipment. The funds cannot be used for other purposes.
An equipment loan is perfect for:
- Food establishments that need to purchase kitchen appliances
- Construction businesses that need to buy machinery and equipment
- Tech startups that need to buy web servers, hosting, networking equipment, and other related tools
- Entrepreneurs that need to furnish an office
- Companies that need to buy computers for their remote employees
6. Business Line of Credit
A business line of credit works similarly to a credit card where you’re given a maximum line of credit that you can borrow from, repay, and then borrow again. You’ll earn business credit using this type of loan. However, it’s difficult to qualify for a business line of credit and the fees can be sky high.
A business line of credit is perfect for:
- Small businesses with reliable revenue
- Startups and entrepreneurs who can’t qualify for other loans
7. ACH Loan
To qualify for an ACH loan, your business must maintain a certain daily bank balance regardless of business revenue.
An ACH loan is perfect for:
- Startups that generate revenue and don’t have many expenses
- Businesses with significant cash flow
8. Commercial Mortgage
A commercial mortgage is a loan designed to help small businesses obtain a physical location. However, you’re agreeing to a long-term commitment that could last up to 30 years.
A commercial mortgage is perfect for:
- Businesses looking for a physical location
- Businesses looking to move to a new location
- Businesses that need to perform remodels, renovations, or repairs
9. Short Term Loan
A short-term loan is a loan that has a short repayment period. You can get cash fast when you need it – even with less than perfect credit – but be prepared to make more frequent payments and pay a higher annual cost.
A short-term loan is perfect for:
- Businesses that need fast capital and can pay back the loan in a short amount of time
10. Startup Loan
Startup loans are specifically designed to help new businesses get off the ground.
A startup loan is perfect for:
- New businesses
- Less established businesses
- Entrepreneurs just getting started
Paying Back Your Small Business Loan
Make sure you can pay back the loan(s) you pursue. Although the type of loan right for your business depends on a variety of factors, one thing is true across the board: you should only apply for a loan you can pay back.
You might reason to yourself that once you become profitable, you will have no problem paying back a huge loan. However, things may not work out that way.
If you take out a large loan at a high interest rate, your business might not become profitable in time to pay back the loan. The last thing you want is to become delinquent and rack up excessive fees for missed payments.
No matter what type of loan you pursue, make sure you have a solid (and realistic) business plan before signing on the dotted line.
Apply for a Small Business Loan Online
Whether you’re launching your first business or you need capital for an existing venture, we can help you apply for a small business loan online. The online loan application process provides access to funding options from more than 300 lenders. Lenders offer every type of small business loan from lines of credit and short-term loans to ACH and equipment loans.