Small business loans are a type of debt financing where a borrower receives a lump sum of money, typically under $500,000, from alternative and traditional lenders, then makes payments on a predetermined schedule with interest. The financing is a way for the company to:
- Bridge gaps in cash flow
- Purchase or lease equipment, vehicles, inventory, or machinery
- Recover from disasters
- Keep operations running
- Acquire a competitor or expand their own footprint
- Invest in growth
- Or any other business purpose approved in the loan agreement
There are three main resources a company can go to for a small business loan including alternative or online lenders, traditional banks and credit unions, and the SBA. The terms, approval times, amounts, and interest rates change based on where you get the loan from and the type of small business loan.
You could be applying for the same SBA 7(a) loan from two different lenders and one will offer $100,000 in financing while the other offers $250,000 depending on how well they know your space and how creditworthy they determine you are. This is due to the SBA not being the actual lender. Inventory financing will have a shorter payback period because the company recovers the revenue faster. Equipment financing involves a larger amount of money and takes longer to get profitable as the equipment won’t be sold for quick profit like inventory.
While the SBA is a provider, it only backs the loan through a traditional or alternative lender, but the SBA adds additional terms making them a unique third party. Here’s how they compare as a general rule of thumb so you’ll know what to expect as you apply.
|
|
Alternative lenders |
Traditional lenders |
Small Business Administration (SBA) |
|
Average amount to be borrowed |
$5,000 – $500,000 |
$10,000 – $1,000,000 |
N/A – $5,000,000 |
|
Interest rates |
Higher |
Lower |
Capped by the SBA |
|
Ease of approval (1 easiest – 10 most difficult) |
3 |
7 |
8 |
|
Speed of approval |
Fast as quickly as 24 hours |
Slow between 1 and 2 weeks |
Slow between 30 and 90 days |
|
Payback periods |
3 months – 5 years |
3 years – 10 years |
10 years – 25 years |
|
Term flexibility |
Very |
Very |
Very |
|
Applications |
Normally online |
Normally in person visits are required |
Both online and in person |
There are multiple types of small business loans and each serves a different purpose for how the financing can be used, has different payback periods, what can be placed as collateral, and interest rates. Here’s some more information on each so you can decide which is the right one for your company.
The Types of Small Business Loans and Their Purpose
The types of small business loans start with being secured meaning the borrower puts collateral down, or unsecured business loans where the lender does not require collateral, but may require a personal guarantee. From there they get divided into the length of time for repayment and the way the borrower will use the financing.
Each can be modified for specific industries, with the exception of the SBA loans as they have restrictions on the types of businesses that can borrow, and the terms will change based on the standards from the industry.
A real estate investor may carry more debt during projects than a consulting practice, but the risk levels are even as the assets used for collateral from the real estate investor like the property that is being renovated offset the risk for the lender, and the consultant may not have as many assets to provide as the investor.
Here are some of the most common types of small business loans in alphabetical order and what they’re used for.
Bridge
Business bridge loans are for companies that need immediate access to larger sums of money than a line of credit or a business credit card can provide to secure immediate opportunities like making a deposit on a real estate deal, bidding on a competitor that is for sale, or securing a large stock of raw materials when supplies are limited. The payback period is normally quick as the bridge loan is meant to bridge a temporary gap in financing while waiting for a larger amount to come through.
Commercial and corporate
Commercial business loans, also known as corporate loans, are for larger purchases and are approved for a small business when they’re crossing into medium-size territory or have a strong and low-risk opportunity to scale and expand.
The financing here may start over $1,000,000 and extend well upwards into the SBA maximum of $5,000,000 with the SBA 7(a) loan. In order for a small business to get approved they will need to have a strong business plan that clearly outlines how the money will be made back, and one that secures the confidence of the lender that they are a wise investment. In the case of an SBA loan, they’ll need to meet the requirements for being a small business.
This is why they are one of the hardest small business loans to get approved for. The applicant needs a strong financial history, enough time in business (at least three years), and demonstrate strong credibility to the lender.
Disaster recovery
Alternative lenders can provide access to enough financing in as quickly as 24 to 72 hours making disaster recovery and emergency business loans a good way for small businesses to stay afloat. Emergencies that may qualify can be power outages, fires, floods, infestations, and earthquakes. The SBA also offers a disaster relief product, but it takes longer to get approved for than a regular emergency business loan.
Equipment financing
For buying or leasing new and used equipment, equipment financing loans are a good option for a small business. Unlike a working capital loan where you need collateral not being purchased with the loan, you can likely use the equipment, machinery, or vehicles as collateral. This makes it easier to get approved for as the lender will know the value of the collateral and have an idea of how easy it can be liquidated in case the borrower defaults.
Inventory financing
Inventory financing can be used to stock up before a busy season, chase inventory as the season rush is happening or demand surges, and to purchase supplies in bulk. It is for larger amounts of stock where the price does not make sense for a credit card or line of credit to cover, or when you need a bit more time to pay the amount back.
The inventory can include consumer products, materials like blank t-shirts if you run a printing company or seasonal gift shop that presses patterns, and perishables for restaurants and food processing companies.
SBA
SBA loans are the most sought after type of small business financing because the interest rates are capped and the amount of financing goes up to $5,000,000. The SBAs restrictions on them make them more friendly for small businesses as interest rates are capped, and lenders like them because the SBA takes on part of the risk.
The longer payback periods make them ideal for new companies that need more time to get profitable, and the financing is flexible so it can be used to hire staff, advertise your business, and build a new location.
There are multiple options for SBA loans including the most popular 7(a), 504, express, and microloans. Each one has unique qualifications, purposes, and amounts you can borrow.
The approval time is longer and can take up to three months or longer, so they’re not a good idea for immediate needs or time sensitive opportunities.
Short-term
Short-term business loans can have a payback period of three months to two years helping to clear the debt from your business credit score and free up cash flow sooner. A general short-term business loan is flexible and can have mixed uses for the financing, while niche types of short-term business loans like inventory financing and business bridge loans will have specific uses and terms that match the purpose.
Working capital
Working capital loans are designed to cover any day-to-day operational costs to keep your business running including repairing damaged equipment, hiring part time staff, paying rent and utilities, even covering payroll. It’s the right option for anything operational that is too expensive for a business line of credit or business credit card to cover, and where your business needs financing to continue operating without delay.
The Times to Take a Small Business Loan
The times to take a small business loan include:
- The expense being larger than the credit available on a business credit card or business line of credit.
- Needing to spread the expense out over a long period of time to ease the burden on cash flow.
- Waiting for accounts receivable to come in and you don’t want to use your available revolving credit or cash flow.
- Purchasing large equipment, machinery, and vehicles as the loan covers the cost while not depleting your cash on hand.
- Situations where merchant cash advances, invoice factoring, and other types of debt financing do not make sense, and you can qualify for the loan.
- Time-sensitive opportunities that require financing like buying a building or a competitor.
Small business loans are a type of debt financing to help a business cover any operating, growth, or recovery expense where a lender offers a set amount of money that is repaid with interest on a fixed schedule. Unlike revolving credit where the amount that can be borrowed refills, the borrower will need to apply for another small business loan if they need more financing. If you’re looking to see how much you can qualify for, click here to contact us for a risk-free quote.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
