6 Types of Financing For Small Businesses
Small business financing is notoriously difficult to procure. Most bank loans require that the applicant have stellar credit and 2+ years in business—and even then, there’s no guarantee you’ll get a loan, especially if you’re applying with a large bank.
According to Biz2Credit, big banks approved just 27.3% of all small business loan requests in March 2019, while small banks approved 49.3% of applicants, and alternative lenders approved the largest share, 57.3%, of SMB loan applications received.
Covering the Basics of Small Business Financing
Whether you call it business financing, business funding, or whatever other jargon the industry has come up with, small business financing is the money you need to help start, run, and grow your company—and, of course, the act of coming up with that money.
While you could technically pay the upfront costs and cover any cash flow gaps with your own money, out of pocket, it generally doesn’t make much sense to do so.
Instead, most successful business owners turn to outside small business financing—whether that means debt, equity, or something even more creative. We’ll explain what each of those paths might hold for you, and what to know about them, in just a minute.
Types of Loans
#1. Short-Term Loans
When you think of debt financing, you probably already imagine a term loan. You get a lump sum of cash and you use it to grow your business, making daily, weekly, or monthly payments back to your lender until the loan is all paid off. It’s a pretty straightforward arrangement—and one that’s easy to plan your business’s financials around.
Businesses big and small can qualify for short-term loans: They have some of the laxest requirements in small business financing, or at least of the term loans. In fact, short term loans are expensive in part because of their accessibility—lenders need to protect themselves against the losses of investing in borrowers with less time in business, lower credit scores, and smaller annual revenues by hiking up their rates. Short-term loans for bad credit exist, but they will be expensive.
#2. Term Loans
Term Loans are large lump sums of cash that are best for large purchases where it’d be advantageous to spread the large payment over a period of time. They’re the catch-all small business financing debt product for business owners with some experience, annual revenue, and good credit scores.
Only about 20% of small business owners can qualify for a bank loan, which tends to be the longest and most affordable small business financing option out there.
But not to worry. Medium-term loans are still available through online alternative lenders if that’s the product you’re interested in.
#3. SBA Loans
There are a variety of loans offered by different lenders that are guaranteed by the SBA, which reduces rates and fees but make the loans harder to qualify for than loans from online lenders. The SBA encourages actual lenders to loan away money to small businesses by guaranteeing large portions of those loans. If your business takes out an SBA loan but defaults, your lender doesn’t lose all that much of their money. Essentially, they’re incentivized to take more risks by financing a small business, because there’s less danger in doing so. You can also expect some pretty extensive documentation requirements and a heavy reliance on your personal credit.
#4. Equipment Financing
Equipment financing is different from term loans and lines of credit in one very important way:
It’s an asset-based loan. This type of loan is best for purchasing large machinery or vehicles. Equipment financing is a good option if you can’t afford the price tag of a piece of equipment upfront, but you’re confident that the revenue you’ll get from the use of the equipment outweighs those interest payments. Asset-based loans rely on the value of the asset, which acts as collateral.
#5. Merchant Cash Advances
Businesses with frequent and large volumes of transactions like retail stores will benefit from the lowest rates. Merchant cash advances help alleviate issues that stem from long sales cycles. While merchant cash advance lenders use “factor rates” instead of interest rates, you can convert their fees. Merchant cash advance APRs range from 15 – 80% APR, which can really affect your business’s financials.
#6. Invoice Factoring
Invoice Factoring is beneficial for businesses that can’t qualify for competitive term loans or lines of credit from traditional or online lenders and have invoices that aren’t being paid on time. This type of loan can help alleviate issues that stem from long sales cycles. There are a few different variations of invoice financing, but in most cases you’ll receive around 85% of the cash for those invoices you want to finance upfront—then you’ll receive the remaining 15%, minus fees when your customer pays.
Here are some questions to ask yourself when you’re trying to figure out the right way for financing a small business:
- How much money do you need?
- Do you need that business financing now, soon, or just in the near future?
- Are you alright with sharing your business equity?
- How will your business fare with daily, weekly, or monthly loan repayments?
- Does your product have that crowd-pleasing pizzaz?
- Who are your customers?
- Where do you see your business going and growing?
- What’s your competition like?
- Do you prefer the expertise of an investor or the freedom of a loan?
- What’s your credit history like?
- Can you successfully navigate the venture capital world?
- Finally, what kind of business do you want to own?
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