It takes money to make money, as the saying goes, which means that all business leaders need to know the optimal ways of securing funding to achieve business success. However, too many business leaders know embarrassingly little about business loans, which means they are unable to take full advantage of lending options to help their business survive and thrive.
If you are a business leader wondering how do small business loans work, the answer might be more complex than you expect. There are many different types of small business loans, as explained below, and learning about your options can help you make the right decisions for your business’s future.
SBA Loans
SBA loans are guaranteed by the U.S. Small Business Administration (SBA), which reduces the risk assumed by the lender and therefore allows a larger number of entrepreneurs to acquire funding to launch or grow their small ventures. Interest rates on SBA loans can vary greatly, between 2.8 percent and 13 percent, and repayment terms can extend up to 25 years, depending on the loan program. Generally, SBA loans are some of the most affordable ways for businesses to secure financing, but the requirements to obtain them can be quite strict. You should talk to an expert to learn more about all the different types of SBA loans available to you.
Term Loans
Term loans tend to be what most people imagine when they think of small business loans. Businesses acquire term loans from lenders and repay them over a fixed time period, typically with a fixed interest rate. Interest rates for term loans tend to be around 9 percent and the average repayment term is roughly 10 years. While you can acquire a term loan relatively quickly, especially if you have good credit, you may need to make a personal guarantee, which puts personal assets like your car and home at risk.
Short-term Loans
A short-term loan is like a term loan — but with a drastically shorter repayment period. This loan is useful for businesses that need cash fast; some short-term loans are available in as little as a day. However, businesses also need to repay the loan amount quickly, between six months and three years. Additionally, interest rates can be sky high, and fees tend to add up for short-term loans.
Startup Loans
It can be somewhat difficult for businesses to acquire loans as startup funding because lenders like to see at least one year of a business’s credit history before determining terms. A startup loan is different because they do not demand established credit — and in fact, they can help businesses build good credit to improve their creditworthiness in the future. There is a good amount of variety to the amounts, interest rates and other terms of startup loans, so you may need to speak with different lenders to learn more about these options.
Business Lines of Credit
A business line of credit allows businesses to borrow money as they need it, paying interest only on the amount borrowed. You might imagine a line of credit functioning like a credit card, but with much larger amounts and restrictions on types of purchases. Draw periods for lines of credit typically extend either 12 or 24 months, after which you will begin to repay the balance that you used, plus interest. Flexible and functional for businesses that need open sources of funding, lines of credit can be difficult to qualify for and may demand collateral — perhaps in the form of business equipment — or a personal guarantee.
Working Capital Loan
A working capital loan is specifically used to finance a company’s everyday operations. Typically a variety of short-term loan, working capital loans are often utilized by seasonal businesses that expect to access increased revenues in the near future. These loans are remarkably easy to access, largely because of the intense restrictions on their use, but you should be wary of high interest rates, which might make them a less practical solution for your circumstance.
Merchant Cash Advances
A merchant cash advance (MCA) is typically provided by a merchant services company, which will provide a loan that will be repaid through portions of a business’s daily income. The amount a business can advance, the interest rate and the amount taken out of daily sales depends on a business’s credit card transactions, and there tend to be many fees associated with MCAs. MCAs are notoriously risky, but if your business takes in a high volume of credit sales and you need cash fast, this is a viable solution.
Merchant cash advances are not the only way to access financing based on the promise of future revenue; invoice factoring and financing are two other methods of leveraging your income potential.
Personal Loans for Business Use
If worse comes to worst, you can use personal loans to fund your business. Some entrepreneurs see acquiring personal loans as a form of bootstrapping, but it is worth noting that the risks of acquiring personal debt for business growth are substantial. In fact, many lenders will not provide personal loans to entrepreneurs. What’s more, personal loans tend to be much smaller than business loans, and any credit garnered through them applies only to your personal credit rating, not your business’s.
Different business loans function in different ways. The more you know about your loan options, the sooner you can put your small business on the path to success.
