There are a variety of small businesses in today’s world. Your small business may become the next billion-dollar idea, or maybe it will be just big enough to support the life you live today. There’s no one path toward success.
But all small businesses often need funding, and business loans are one of the most traditional paths. But what’s right for your business and goals? Here are some of the most common types of business loans and how they may benefit your small business.
What are business loans?
Business loans are a form of commercial financing. Like the personal loan process, a lender approves you for a predetermined amount. They then require you to pay back this money in a set amount of time according to a particular interest rate.
Businesses can use loans for startup costs, expansions, to pay off business expenses and to purchase larger assets like real estate. But all loans are different, so finding the right loan for your business’s circumstances is critical.
How much down payment do you need for a business loan?
Every type of business loan is different, and your lender may have different requirements. Depending on your financial situation, you can expect to pay 0%-30% down.
Typically the more you can use as a down payment, the less you pay. You will see savings in two ways: 1) you pay interest on a lower principal, and 2) many banks will lower interest rates when you put down more for a down payment.
Types of business loans – Which loan is right for my small business?
There are a variety of business loans to use. They all have pros and cons and vary regarding interest rates, qualifications terms and how to use the money.
|
Business loan type |
Typical terms (amount, rates, repayment time averages) |
Benefits for small businesses |
|
Term loan: A traditional loan that comes with terms that you need lender approval. |
Up to $500,000, 9% APR, 10 years |
Those with good credit that can take the time to go through a more formal approval process. |
|
SBA loan: A loan backed by the SBA. |
There are SBA 7(a), SBA 505 and SBA microloans that have different terms. See more below. |
SBA loans tend to have lower interest rates and longer terms. But the approval process is longer because you have to satisfy lender and SBA requirements. |
|
Microloan: Small loans that you can access quickly with an easier qualification process. |
Up to $50,000, 9%-16% APR, 3-6 years. |
Microloans are a fast way to access business financing, and many microloans focus on minority groups. |
|
Invoice factoring: Sell you outstanding invoices and receive the partial value of future invoices. |
70%-95% of the value of the invoices, 1%-6%, 30-90 days. |
This is a fast loan option that a small business can use if you have longer invoice terms to access money faster. |
|
Invoice financing: You maintain control over invoicing but use your outstanding invoices as collateral for a loan. |
Up to 80% of the outstanding invoice value, 0.5%-5% per week, 30-90 days. |
This is a quick loan that still gives you control over your invoicing (unlike invoice factoring). |
|
Merchant cash advance: Similar to a payday cash advance, a merchant services company looks at what you earned in the past and loans you an amount based on this. |
High rates up to 350%, loan amount based on your credit card transactions, daily payments via auto draft. |
A quick and easy-to-qualify- for loan, but with high-interest rates. It should only be considered if you have limited funding options. |
|
Lines of business credit: Like a credit card, you can access a set of money and repay to reaccess the money. |
4%-60%, up to $250,000, five years. |
A business line of credit gives you the flexibility to spend the money however you need, and it’s also a faster loan application process. |
|
Equipment loan: Use this loan for startup costs like equipment, tools, or vehicles. |
Value of equipment, 8%-30% APR, term usually matches up with lifespan of equipment. |
It is usually easy for small businesses to gain approval because equipment is used as collateral. |
|
Commercial real estate loan: You can use this loan to buy storefronts, warehouses and offices. |
Price of real estate minus required down payment, as low as 3%, 5-20 years. |
Perfect to use for expansions costs. |
|
Personal loans for business: Personal loans you can transfer over to your business. |
Up to $35,000, around 10%, 1-5 years. |
If your business doesn’t have a credit history yet, you can leverage your personal credit score to fund your business. |
|
Friends and family loan: You can reach out to friends and family about loaning money to your small business. |
You should establish clear terms for your loan to protect your relationships. |
It can feel natural to ask loved ones for a loan, and the people closest to you are often the most invested. |
Term loan
A term loan is a traditional loan that comes with terms. This means you apply for a set amount, and the bank will approve it with an interest rate, and you must pay the loan back in a set amount of time.
Term loans often come with a fixed interest rate. Traditional banks will lend up to $500,000 with 9% APR and 10-year repayment terms. But you should always shop around for bank loans. You will see different rates from online lenders. Usually, they loan out more money with higher interest rates.
How a small business or solopreneur can use this loan:
Term loans are great for businesses that want to grow, and you can use them for various purposes. Some examples include real estate, buying other companies and business expansion.
Business term loans favor those with good credit scores — personal or business — otherwise, you may have to put up collateral. Many solopreneurs will use personal assets as collateral as they establish business credit. This is inherently risky. You should consult your accountant or financial advisor before doing this.
SBA loan
The application process for an SBA loan is similar to a term loan so it may feel similar. But the critical difference is that the U.S. Small Business Administration (SBA) guarantees these loans.
If you default on an SBA loan, the federal government agrees to pay the lender 85% of the loan. This makes an SBA loan less risky for the lender, and you will have to qualify through the lender and the SBA’s requirements. SBA loans have a longer application process.
But the time-consuming application may be worth it. SBA loans have comparably lower interest rates (2.8%-13%) and longer terms (10-25 years). Here are the specifics of the different SBA loans:
- SBA 7(a) loans: You can borrow up to $5 million for expanding your business, working capital or acquisitions.
- SBA 504 loans: Borrow up to $5 million for fixed-cost assets like equipment, real estate or upgrades to these assets.
- SBA microloans: Smaller loans (up to $500,000) for working capital like equipment or inventory.
How a small business or solopreneur can use this loan:
A small business can use an SBA loan to make meaningful purchases for their business with a loan that has comparatively low-interest rates and long repayment terms. But this is not the type of business loan program for someone that needs money fast for their business. The loan process is time-consuming, and you need good business credit even to qualify.
Microloan
Microloans are small loans (up to $50,000) that you can access quickly because the qualification process is less arduous. Lenders expect you to repay these loans faster. Interest rates range from 9%-16%, and lenders may ask for collateral.
Non-profits, foundations and mission-focused lenders have microloan programs. Their push is to serve underserved groups like women and minorities. Lenders often have training, consultants and support for borrowers as well.
How a small business or solopreneur can use this loan:
Small businesses can use microloans for startup costs. They benefit businesses needing cash quickly because the loan application process is faster. You can also tap into resources that are specific to your unique situation. For example, if you find a microloan lender catering to minority-owned restaurant owners, you can use their resources to help your business.
Invoice factoring
You can fund your business by selling your unpaid invoices. This process is called invoice factoring.
The typical process starts with a factoring company buying your invoices. You receive 70-95% of the value of the invoices upfront. The factoring company collects on the invoice themselves. They deduct their fee from the collections (usually 1%-6%), and then they give you any remainder.
How a small business or solopreneur can use this loan:
This is another fast loan option because the invoice factoring company gives you a lot of the money upfront. If your business has long payment terms (30, 60 or 90 days), then your business can struggle to come up with liquid cash. Invoice factoring can help with that.
But it does have some downsides. When you hand over invoicing operations to a different company, you lose control over customer service and relationships. This can harm your business in the long run if done poorly. You also may encounter high fees if your customers have bad credit or pay late.
Invoicing financing
You may not want to hand over complete control of your invoices or accounts receivable to another company. But you can still use your outstanding invoices as collateral. This way, you can still control the invoicing process.
Many invoice financing companies will loan you up to 80% of your outstanding invoice value. The downside is that the fees can be high at about 0.5%-5% per week.
How a small business or solopreneur can use this loan:
Invoicing financing is another example of a quick type of business loan. If you’re interested in using your invoicing as collateral but still want to be hands-on with collections, then this is a financing option for you. It is comparable to a cash advance loan, but you will pay high fees.
Merchant cash advance
Merchant cash advance (MCA) is similar to a personal payday cash advance. A merchant services company will examine what your company earned from credit card sales in the past and then approve you for a cash advance.
MCA agreements usually require that you make payments each day via auto-draft. This includes a percentage of daily sales plus interest. Interest can be as high as 350%, so read the fine print before taking on a merchant cash advance.
How a small business or solopreneur can use this loan:
Anyone can qualify for this small business loan, but you will also see some of the highest rates on an MCA. If you have a lot of transactions, your business can qualify with bad credit. You also repay less when transactions are low because you pay back a percentage of weekly or monthly transactions.
Small business owners should be wary of merchant cash advances because they can create future cash flow problems and have high-interest rates.
Lines of business credit
Think of a line of business credit like a business credit card. A lender approves you for a credit limit, and you can access this amount.
You can reaccess the credit limit again as you pay off this amount. The lender will also charge interest on the money you use in the line of credit.
The big difference is that a line of credit does not last indefinitely, and you have a period to utilize the credit. This period is usually 12-24 months, and the repayment period is around five years.
How a small business or solopreneur can use this loan:
A business line of credit is best for small businesses that need quick cash access and flexibility. This may be because you need something to cover startup costs and are unsure of the exact amount of money you need.
A business line of credit is meant to be temporary and may be a short-term solution. A business line of credit requires good credit and collateral.
Equipment loan
If purchasing all the necessary equipment is a huge hurdle to starting your business, then an equipment loan (or equipment financing) may be right for you. With this financing, you can buy or lease equipment, tools, and vehicles.
Rates for equipment are competitive at 8%-30% APR, and your credit score doesn’t have to be perfect to qualify. This type of business loan term usually matches up with the lifespan of the equipment. Lenders can do this because they use the equipment as collateral.
How a small business or solopreneur can use this loan:
Equipment loans are great for small business owners to cover startup costs or buy extra equipment to expand their business. If you own the equipment, it’s also a great way to increase the value of your business by building up equity.
Commercial real estate loan
You can use commercial real estate loans to buy storefronts, warehouses and offices. There are SBA-backed loans that you can use to purchase commercial real estate, and there are separate commercial real estate loans. Lenders will use the property as collateral and offer rates as low as 3%. (Rates depend on factors like loan-to-value ratio, company revenue, debt, credit score, cash flow and down payment.)
Be sure to get a realtor or financial expert to review the fine print for commercial real estate loans. Some of these loans function like traditional loans, and others are more complicated. Hard money lenders often include stipulations like balloon loans with complex payment terms.
How a small business or solopreneur can use this loan:
Small businesses often need to expand their spaces but often lack the capital. Commercial real estate loans are a great business funding option.
Personal loans for business
You can use personal loans for business. Many business owners will do this to cover startup costs while building their company’s financial and credit history. Personal loans tend to be lower at around $35,000. The interest rates will vary based on your personal financial situation but are a little over 10%.
One word of caution: you can lose personal assets (like your house and car) if your business defaults on a personal loan.
How a small business or solopreneur can use this loan:
Many small business and entrepreneurs use their businesses as pass-through entities. This means they pass the money they make into their business and personal assets. It makes sense to pass money the other way via financing. Personal loans are a great way to access cash when your business can’t qualify for a loan.
But consider why you established your business separate from your personal finances. You were fearful of exposing your personal assets to risk. When you use a personal loan for business, it does open your personal finances up to more risk.
Loan from your friends or family
You can also receive a loan from your friends and family. This is one of the most flexible options but doesn’t come without strings. Your loved ones want you to succeed and may not know how to ask for payment terms or interest.
Avoid future difficult conversations by having discussions about this type of business loan upfront. Present them with a plan on how you will use the loan, terms for paying it back and keep the communication open for future discussion.
How a small business or solopreneur can use this loan:
Many small businesses lean on friends and family for support. It can feel natural to ask loved ones for a loan, and the people closest to you are often the most invested. But be careful about business relationships that can ruin personal relationships.
NEXT helps small businesses and solopreneurs stay protected
We know the assets in your small business are vital, and we want to help keep your business protected. NEXT specializes in customized business insurance.
NEXT is dedicated to insuring small business, so as you work to secure business financing consider protecting your assets through insurance. It’s easy to get a quote that is tailored to your business.
