As a small business, you have a lot on your plate. From juggling administrative responsibilities and payroll to navigating the hyper-competitive marketplace, running a successful small business is challenging. Unfortunately, over 20% of businesses fail within their first few years. For 29% of those small businesses, “lack of capital” is why they shut their doors. Finding capital is a critical component of running a small business. You need liquid cash to help you compete, from working capital and emergencies to real estate and new business ventures.
But what types of loans are out there? How do you secure a loan? And what types of terms can you expect? Here’s a list of small business loan types and how you can utilize them to dodge crisis or grow your business.
Types of Small Business Loans
1. Term Loans
Term loans are great for:
- Small businesses with excellent credit history looking for upfront capital to fund expansion, equipment, or new technology
Term loans are not-so-great for:
- Startups, small businesses with a poor credit history, or small businesses looking for flexible capital for emergencies
If you’ve ever purchased a vehicle or financed a mortgage, you’re likely familiar with this type of business loan. When you take out a term loan, you borrow a lump sum of money and repay that money (with interest) on a repayment schedule over a specific period of time (or “term”). These repayment schedules can vary from short-term (12 months) to long-term (4+ years), and term loans are offered with both fixed and variable interest. Like traditional car loans or mortgages, small business term loans follow an amortization schedule. Most payments at the beginning of the loan period will go towards paying off interest, while the latter half of the loan will tackle the upfront capital. You may be able to reduce your interest payments by paying off the loan early but pay attention to possible early payment penalties.
Individual banks typically offer term loans. Since these banks take the bulk of the risk when issuing term loans, each bank will have unique requirements, terms, and conditions. One of the most significant advantages of term loans is their low rates and variability. Term loans are typically reserved for companies with excellent credit history and high annual revenue. Therefore, they offer some of the lowest rates among small business loans. Additionally, term loans don’t have specific spending requirements, so you are free to utilize the upfront capital however you see fit.
Depending on the issuing party, you may be required to make a personal guarantee on your term loan — effectively making you financially liable for the loan. However, this depends on the lending institution, your business’s credit history, and the amount of capital issued.
Note: Short-term lenders offer term loans to small businesses with poor credit history. However, these types of term loans carry more aggressive rates, and they often have strict requirements and lack the flexibility of traditional bank term loans.
2. SBA Loans
SBA loans are great for:
- Small businesses with good credit looking to secure upfront capital for a variety of reasons.
SBA loans are not-so-great for:
- Small businesses with poor credit looking for quick capital to fund an emergency.
The U.S. Small Business Administration partially guarantees a type of business loan known as an SBA loan. While the SBA does not issue these loans directly, it does guarantee a significant portion of the loan’s total amount, which reduces the risk for lenders. Unlike term loans, which are uniquely structured by the lending unit issuing the loan, SBA loans follow criteria set in place by the Small Business Administration. Interest rates are capped, and specific terms are set-in-stone by SBA guidelines.
Note: SBA loans still require a decent credit history. The SBA only guarantees up to 75% of the loan (85% for loans under $150,000). So, the bank still takes a risk when issuing these types of loans.
Typically, term loans provide slightly better terms than SBA loans. However, SBA loans are available for a wider variety of small businesses, including startups. There are three primary “types” of SBA loans:
- 7(a) loans: This is the primary SBA loan, and this type of loan operates nearly identically to term loans.
- 504 loans: If you need capital to repair equipment or real estate, 504 loans may be the right choice. These loans have interest rates based on 5-year and 10-year U.S. Treasury issues, and they come with 10 or 20-year repayment schedules.
- Microloans: These are small loans (up to $50,000) for startups.
You can use SBA loans for various functions, including purchasing equipment or materials, real estate, construction, new businesses or ventures, refinancing existing debts (under certain conditions), or to use as working capital. Various factors go into determining the maximum amount of capital you’re eligible to receive with an SBA loan (e.g., business location, income, credit history, industry, etc.). Still, the maximum loan is $5 million.
3. Merchant Cash Advances
Merchant cash advances are great for:
- Small businesses with poor credit need immediate capital that requires no physical, upfront collateral.
- Small businesses need immediate financial assistance and do slower business.
Merchant cash advances are not-so-great for:
- Small businesses looking to avoid a potential debt cycle.
- Small businesses looking for capital to fund long-term operations.
One alternative to traditional small business loans is merchant cash advances. With a merchant cash advance, you get upfront capital in exchange for a percentage of future credit card and debit card sales (i.e., “holdback”) or via automatic payments, plus fees, through an Automated Clearing House that takes sums directly from your bank account. Merchant cash advances can be tricky. You will be assigned a factor rate (based on a risk assessment) to determine your payment amount and schedule. It’s not uncommon for merchant cash advances to have APR terms that hover above 150%, so it’s important to choose a reliable and trustworthy lender.
As an example, let’s say that your business takes out a $20,000 merchant cash advance to renovate your retail space. Since your credit score is low and your annual revenue isn’t spectacularly high, you get a factor rate of 1.5. In other words, you will end up repaying $30,000, plus fees, to cover the loan. Most merchant cash advances have short-term repayment cycles. In the scenario above, the merchant cash advance lender may put a 15% lien on all of your credit and debit card transactions until the loan is paid off. Every transaction in your store will automatically send 15% to the lender until the loan is paid off. Your APR is partially based on how long this process takes.
Merchant cash advances are not federally regulated since they are structured as commercial transactions. Due to this, many merchant cash advances may use confusing terms and conditions that are not standardized across typical business loans. It’s important to read the terms carefully. In short, these types of loans are useful for small businesses that are still struggling to do consistent business or those that need quick money. You can get a merchant cash advance in under 24 hours. However, they aren’t a sustainable source of long-term capital.
4. Business Credit Lines
Business credit cards are great for:
- Small businesses with excellent credit looking to finance short-term purchases, emergencies, or seasonal flux.
Business credit cards are not-so-great for:
- Small businesses looking to secure capital for property, expansion, or expensive equipment.
Operating a business credit line allows you to borrow capital up to your credit limit. Technically, this isn’t even a type of business loan; it’s a credit-driven capital solution. You will pay interest on the capital your borrow. Typically, lines of credit have slightly higher interest rates than term loans or SBA loans. However, business credit lines rarely have early payment penalties, and you can overpay on your monthly statement to eliminate some of the interest.
The main benefit of a credit line is flexibility and ease of use. You can access your credit nearly instantly. Additionally, lines of credit are fantastic for financing unexpected issues or seasonal cash flow problems. Depending on the issuer, your credit line may be fixed or variable. Variable credit lines essentially “reset” after you pay off your balance.
While credit lines probably won’t offer enough capital to finance expansion or new property, you don’t need physical collateral to open a new line. Your collateral is your credit score. However, credit lines often carry additional fees, so pay attention to your terms.
5. Commercial Mortgage
Commercial mortgages are great for:
- Small businesses looking to purchase property or upgrade/expand existing properties.
Commercial mortgages are not-so-great for:
- Small businesses that need non-property-related loans.
If you need to purchase a new property, commercial mortgages are the go-to option. Similar to traditional mortgages, the underlying property acts as a form of collateral for the loan. There are a variety of terms, interest rates, and conditions available for commercial mortgages. You also may want to provide a down payment to negotiate lower interest rates.
It’s not uncommon for bank-issued commercial mortgages to have sub-5% interest rates and 25 – 30 year repayment periods. Hard money lenders also offer commercial mortgages, including balloon loans. Depending on your lender, you may not receive the full amount needed to finance the property. Small businesses often combine commercial mortgages with other loan options to secure total funding, especially if they lack capital for a down payment.
What is a “balloon loan”? Lenders that offer balloon loans allow you to make smaller down payments over the period of the loan, followed by a large balloon payment at the end of the loan.
The structure of your mortgage will dictate your interest rates. Hard money loans — which solely use the property as collateral — often require higher interest rates than commercial loans, which consider credit scores, income, and other factors.
6. Equipment Financing
Equipment financing is great for:
- Small businesses looking to purchase expensive equipment.
Equipment financing is not-so-great for:
- Small businesses looking for capital outside of equipment purchases.
Every small business needs new equipment at some point. Fortunately, securing financing for equipment is an incredibly common and simple process. Equipment financing — which is often offered by equipment vendors and backed by a bank — is available to nearly every small business, even those with less credit history.
Equipment financing uses the equipment itself as collateral, so there’s rarely any down payment required. While this type of vendor-fueled funding comes in a variety of shapes and sizes, equipment financing typically has competitive interest rates. You can secure equipment financing for all sorts of business equipment, including cars, industrial machines, and computers.
Microloans are great for:
- Startups looking to secure critical capital.
Microloans are not-so-great for:
- Existing businesses looking for short, medium, or long-term capital.
What if you’re a small business with little-to-no cash flow and nonexistent credit history? We can’t all secure Series A, B, or C venture funding, so most startups need a small loan to secure critical operational investments. This is where microloans come in. Microloans are small (usually sub-$50,000) loans given to small businesses by alternative lenders and non-profit organizations.
Like traditional loans, microloans come with terms, interest, and a repayment schedule. Typically, microloans have higher interest rates than term loans, simply due to their lessened credit expectations. The SBA partially guarantees some microloans through community-based non-profit partners, but many microloans are also available from private lenders. Companies like Kiva, Accion, and First Down Funding are privately-owned businesses that issue these loans without SBA intervention.
8. Accounts Receivable Loan
Accounts receivable loans are great for:
- Small B2C companies that need quick capital and have outstanding debts.
Accounts receivable loans are not-so-great for:
- Small B2C companies or B2B companies with little-to-no outstanding invoices.
So far, we’ve covered a variety of asset-based loans. Commercial mortgages use property, equipment loans use the equipment, and hard loans often use existing assets to cover debts. But what about incoming payments? Accounts receivable loans are an incredibly popular option for B2B businesses with a network of outstanding debt obligations from clients. Any invoices that have been billed, but aren’t yet paid, can be used as capital to secure accounts receivable loans.
One of the primary benefits of these types of loans is the terms. Accounts receivable assets are incredibly liquid. So, they’re immediately valuable and highly regarded by lending institutions. Some accounts receivable loans don’t even operate on interest. Instead, they charge you a weekly or monthly fee until the loan is repaid. Usually, lenders will provide you with an advance on your accounts receivable (usually 90%). They will then charge you a fee until your clients pay their dues. Afterward, they will give you back the extra 10% and pocket the monthly fees.
The drawback of accounts receivable loans is that you can only secure as much as you have in outstanding debt. Plus, accounts receivable cycles are generally short (1 – 2 months), so this is an incredibly short-term loan for most borrowers. However, AR loans can help you navigate emergency cash flow issues, especially those related to late payments.
9. Business Acquisition Loan
Business acquisition loans are great for:
- Existing businesses that are looking to acquire a new business.
Business acquisition loans are not-so-great for:
- Small businesses that are not looking to acquire a new business.
Whether you’re looking to expand your existing company by purchasing new assets or you want to enter into new territories, business acquisition loans are a great way to secure the capital necessary to purchase a new business. Chances are, you won’t have the liquid capital to finance an acquisition when the opportunity presents itself. Business acquisition loans exist to help you secure that acquisition by leveraging your existing business as capital.
Like term loans or mortgages, business acquisition loans come in a variety of terms and agreements. The lender you choose will influence your APR, but it’s not uncommon to secure sub-6% interest rates. The primary difference between business acquisition loans and term loans is the use case. If you are using the funds to acquire a new business, you may get more favorable interest rates than if you were to take out a traditional term loan.
Where Do You Apply For Small Business Loans?
There are a variety of lenders on the market. And you can find a lender that will cater to your unique financial situation. Alternative private lenders provide a variety of financing options for small businesses that have been abandoned by traditional lenders and offer non-traditional loan structures to businesses that need immediate capital. At the same time, private banks are always available for commercial mortgages and long-term loans. Your loan type will often dictate the type of entity you borrow money from, as well as any terms and conditions on the loan.
You can find small business loans from sources like:
- Private banks
- Private companies
- Hard money lenders
- Equipment vendors
- The SBA
- Short-term lenders
Remember, the lender you choose directly influences your loan structure, so choose wisely.
How Do You Choose the Right Type of Business Loan?
Why do you need your loan? Often, loan choices come down to two factors:
- Reason for the loan (e.g., acquisition, working capital, real estate, etc.)
- Credit history
Ideally, you want to choose the loan type appropriate for your use. If you need real estate, you should look into a mortgage or a 504 loan. If you need working capital, a term loan or business credit line may be your best bet. For those with a poor or non-existing credit history, merchant cash advances, equipment loans, and microloans are all options.
What Small Business Loans Do You Qualify For?
Chances are, you qualify for a small business loan. But you certainly don’t qualify for all small business loans. The reason you’re taking out the loan, your credit history, your working capital, and your existing business structure all play a role in the qualification process. Luckily, the business landscape is drenched in lenders. You can shop around and find a vendor that’s perfect for your needs.
Small Business Loan FAQs
It depends on what type of business loan you want. If you use an alternative lender like First Down Funding for non-traditional loans (e.g., microloans, startup loans, merchant cash advances, etc.), you simply apply with that lender. If you’re looking for a traditional loan, you would need to apply with a private bank. We highly recommend using your existing bank, since you may secure better terms. You can apply for SBA loans on the SBA portal. And equipment financing is often offered by your equipment vendor.
While most small business loans are under $100,000, you can secure multi-million-dollar loans. The SBA puts a $5 million cap on SBA loans, and most lenders are hesitant to go above that limit. Of course, you have the option to secure multiple loans, but be careful of overreaching and getting into a debt cycle.
Not having a down payment doesn’t automatically disqualify you from a small business loan. In fact, many small businesses take out loans without any upfront capital; it’s a regular fare in the lending industry. However, you will almost certainly have to put down collateral or make a personal guarantee (or both).
It depends. Some small business loans, like low-interest term loans, may require excellent credit and a down payment. However, other types of business loans like equipment financing and merchant cash advances may not require a credit history or any upfront capital. In general, it’s not difficult to obtain a small business loan. While the type of loan you choose will dictate how long it takes you to secure the loan (as well as the terms of the loan), there are so many loan options on the market that nearly every business can secure some type of business loan.
Things have been made even easier by the internet. You can apply for online loans in minutes. In other words, even small businesses with a poor credit history and minimal incoming business have options.
Due to the sheer number of loan types and lending bodies, it’s difficult to pinpoint an average rate for a small business loan.
In addition to merchant cash advance loans, other similar types of business loans are available to businesses that need to secure immediate capital. Bank-only ACH loans, bridge funding, next-day funding, and short-term financing are all viable options.