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One of the hardest things about starting a business is dealing with cash flow issues. And given the ongoing economic uncertainty due to COVID-19, this is an issue that many business owners are all too familiar with right now.
Fortunately, there are many financing options available to cash-strapped entrepreneurs. But with so many options to choose from, how do you know the type of loan that’s best for your situation?
9 Types of Small Business Loans
The first place to start is by identifying the purpose of the loan and what you intend to use the funds for. If you’re considering applying for a business loan, here are nine types of business funding you should know about.
1. SBA Loans
The Small Business Administration backs loans from $5,000 up to $5 million. You can apply for the loan through a bank or credit union, and the SBA guarantees the loan.
Since the loans are backed by the government, SBA loans come with low interest rates and flexible repayment terms. These loans can be used for almost any business purpose.
If your business has been negatively impacted by the coronavirus, then you might consider applying for an EIDL Advance. You could receive an advance of up to $10,000, and then the SBA will let you know if you qualify for further funding.
- Larger loan amounts are available
- Loans come with low interest rates
- SBA loans come with flexible repayment terms
- The application process is notoriously difficult
- You’ll need strong credit history to qualify
2. Business Line of Credit
If you’re trying to alleviate occasional cash flow issues, then you might consider taking out a business line of credit. The application process tends to be faster than other types of business loans, and it’s usually available for businesses with lower credit scores.
A line of credit is revolving, so you can borrow the money as needed. You don’t have to spend it, but it can provide a little financial security just knowing that it’s there in case of an emergency.
The average APR for a business line of credit ranges between 7% and 25%, so you will pay more in interest. But you’ll only pay interest on the amount that you actually spend.
- More flexible than other types of business credit
- Available to individuals with lower credit scores
- You only pay interest on the amount you actually spend
- Interest rates tend to be higher
- You may need to provide collateral
- You’ll pay hefty fees for missed payments
3. Merchant Cash Advance
With a merchant cash advance, you’re allowed to borrow a lump sum against your future earnings. Once you’re approved and receive the funding, you’ll start repaying the loan with a daily percentage of your total credit card transactions.
The benefit of taking out a merchant cash advance is that funding tends to be fairly quick. There is no fixed repayment schedule; you’ll just keep paying on the loan until the full amount is paid off.
However, merchant cash advances come with very high interest rates. The rates typically start at around 18%.
- Good option for businesses with poor credit
- Approval is fast and you can receive the funds within 24 hours
- Receive one large lump sum
- Interest rates tend to be very high
- There is no predetermined repayment schedule
4. Equipment Loans
You can use a small business loan to purchase equipment, or you can apply for a designated equipment loan. These loans can be used to finance any type of equipment purchase, and this includes a lot more than you may think.
You can use an equipment loan to purchase upgraded equipment, accounting software, or solar panels for your office. And since anything you purchase can be used as collateral for the loan, equipment loans tend to come with lower interest rates.
- Available to businesses with less-than-ideal credit
- Equipment purchased is used as collateral for the loan
- Tends to come with lower interest rates
- Most equipment depreciates in value so you may lose money on the initial purchase
5. Invoice Factoring
If there is one pain point I can identify with, it’s waiting for clients to pay overdue invoices. That’s where invoice factoring can be helpful.
Invoice factoring allows you to sell your unpaid invoices and receive an advance between 60-90% of the full amount. The lender then collects the full payments from the customers. Once the full payment has been collected, your lender will pay you the remaining balance, not including any fees or interest for the services rendered.
Invoice factoring tends to be easy to qualify for, and you don’t need a strong credit score to apply. However, the fees can be quite hefty so you should only go this route if you’re really in a financial bind.
- Approval is fast and relatively easy
- You don’t need great credit to qualify
- Can help resolve cash flow issues
- The fees tend to be fairly high
6. Peer-to-Peer Lending
Not everyone wants to apply for a loan through a bank, which is why peer-to-peer (P2P) lending has become a popular alternative. Using a P2P network, you’ll connect with private investors that are interested in financing your loan.
You’ll start by filling out a form indicating how much money you’re looking to borrow and how you plan to use it. From there, you’ll be matched with potential lenders. Once you’ve agreed to the rates and terms, you’ll complete the paperwork and receive funding for the loan.
- Less time-consuming than applying through a bank
- Good options for new business owners
- Usually comes with lower interest rates
- Borrowers with poor credit may not qualify
7. Business Credit Card
Applying for a business credit card is probably the most straightforward option out there. I’m going to assume that you’ve already applied for a consumer credit card at some point, so you know how the process works.
The benefit of a business credit card is that it can be used for any type of business expense. Business credit cards also tend to come with higher credit limits than consumer cards. Plus, you’ll have the opportunities to earn cashback rewards for your business expenses.
However, you may be held personally liable for the debt. And borrowers with poor credit may not qualify.
- Can be used for any business expense
- You can earn rewards for business expenses
- Tend to have higher credit limits than consumer cards
- Borrowers may be held personally liable
- You’ll need excellent credit to qualify
8. Commercial Real Estate Loan
If you’re looking to purchase any type of property then you’ll want to look into taking out a commercial real estate loan. This loan can be used to finance a restaurant, office space, or a storage warehouse. You can also use it to buy land or add on to an existing property.
You’ll apply for a commercial real estate loan through a bank or credit union, and the application process can be lengthy. These loans tend to come with lower interest rates and longer repayment terms.
- Can help businesses finance real estate purchases
- The loans come with low interest rates
- There are a wide variety of commercial real estate loans available
- You’ll need excellent credit to qualify
- The application process is longer and more challenging
- The requirements are higher for businesses than on standard commercial mortgages
If you need $50,000 or less in business financing, then you may be a good candidate for a microloan. Microloans are a great option for small businesses and sole proprietors that have limited working capital needs.
Many people use a microloan to fund a business expansion or startup costs. You can apply for a microloan through nonprofit organizations or you can apply through the SBA’s microloan program. The SBA loan comes with interest rates between 8% and 13% and a maximum repayment term of six years.
- A good option for small businesses and sole proprietors
- Can be used to fund startup costs or a business expansion
- Available through the SBA or nonprofit organizations
- Not ideal for businesses that need larger loan amounts
- Microloans tend to come with more restrictions than other types of loans
- If you apply through the SBA, the approval process tends to be longer
Things to Consider Before Applying
As you can see, there are many different types of business loans available. You’ll want to consider several different factors when you're evaluating which type of loan is best for your situation.
Your personal and business credit history, business finances, and time spent in business will all play a role in determining whether or not you get approved for a loan. If you get turned down the first time you apply, don’t take it personally. Many entrepreneurs are unsuccessful the first time they apply for a business loan.
It can help to speak with a qualified loan officer before you get started. That person can answer any questions you have and help you identify your next steps.
Contributor’s opinions are their own. Always do your own due diligence before investing.
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