5 Types of Loans to Consider for Your Small Business

Small businesses are responsible for 44 percent of all economic activity in the United States. The percentage of gross domestic product (GDP) that this accounts for has decreased over the past few years, but it is still sizable.

Small businesses will continue to stimulate the economy if given a chance to expand, but growth can only happen if these companies have access to sufficient capital. Loans are a viable option for small businesses to access finance. Financial solutions like small business loans exist only to serve the needs of small enterprises in the marketplace.

Banks, credit unions, and other financial institutions frequently provide these loans, which can be put toward everything from merchandise and equipment to real estate and even serve as a lifeline for cash flow in times of expansion and contraction.

5 Types of Small Business Loans

Term loans

These entail borrowing and repaying a set amount of money over a set time, plus interest. They're very similar to a car or home loan. Common uses for this type of loan include paying for significant expenses or expenditures like new machinery or building.

Both the borrower and the lender benefit from the steadiness and predictability of a term loan. The borrower can prepare and stick to a budget ahead of time because the loan terms are often designed with a fixed interest rate and payback schedule.

Businesses that need to make long-term investments may benefit from this option since it allows them to stretch the expense of those investments out over a longer time. Commercial credit can be established using a term loan.

Making timely loan payments demonstrates the borrower's fiscal responsibility, which can raise their credit rating and make qualifying for additional loans in the future simpler.

Yet, newer or riskier enterprises may find it more challenging to secure term loans. Some firms might find it difficult to get loans since lenders often demand collateral or a high credit score. Generating sufficient revenue is also essential because the loan comes with fixed payments that businesses must make over a specified time.

When to Consider a Term Loan

Financing a large purchase: Small firms may need to purchase expensive equipment or inventory to expand. A term loan can offer the finances essential to accomplish these acquisitions.
Expansion or renovation: Term loans can be helpful for small businesses in need of capital to finance the expenditures of building or renovations to their physical site.
Consolidating debt: If a small business owes money on several loans or credit cards with high-interest rates, it might want to get a term loan to consolidate debt and make one monthly payment with a lower interest rate.
Building credit: If a small business has no or little credit history, taking out a term loan and paying payments on time can assist in establishing credit.
Startup/ unanticipated costs: Small businesses just starting may need a term loan to cover startup costs such as marketing, legal costs, and hiring staff. Unexpected expenses, such as those incurred by lawsuits, broken machinery, or natural disasters, can devastate a small business's bottom line. A term loan can help firms regain their feet by providing short-term finances to address costs like these.
Seasonal swings: A small retail establishment experiencing slow sales due to seasonal factors can use the money from a term loan to pay for overhead costs like rent, salaries, and utilities.

Lines of Credit

A line of credit (LOC) is a revolving loan from which a company can withdraw funds up to a specific limit as needed. A lender makes money available to a small business on an as-needed basis. Think of it like a credit card account. Only the amount borrowed is subject to interest, and when the loan is repaid, the available credit is increased. Flexibility is a significant benefit of LOCs.

They are often simpler to secure than other forms of credit. A business with fewer conditions may obtain a LOC than a standard term loan, though lenders will still likely need collateral or a high credit score.

LOCs help businesses with limited credit histories or urgent cash flow needs.

However, if the borrower has a low credit score or little collateral, the interest rate on the LOC may be greater than on other loan types. Since the loan line can be quickly depleted, firms must exercise caution to avoid becoming over-indebted.

When to Consider LOC

Managing seasonal fluctuations in cash flow: Companies with seasonal income changes may require extra cash on hand to meet expenses during slower times. Until revenue increases again, a line of credit can help close the difference. Companies can access the credit line as needed, paying interest only on the money they borrow, not the total credit limit.
Covering unexpected expenses: Unexpected costs, such as equipment failures or urgent repairs, can strain a company's budget. Small businesses can use a line of credit to rapidly and conveniently access money to pay for these unforeseen expenses.
Flexibility: A line of credit may be advantageous for small firms that want flexibility when borrowing money for short-term expenses like payroll or inventory.
Taking advantage of growth opportunities: When businesses can expand or take advantage of new business opportunities, they may need additional funding. A line of credit can provide the necessary funds to seize these opportunities.
Building credit: A line of credit can help businesses build their credit score if they make timely payments and use the funds responsibly.

Small Business Administration Loan (SBA)

The government guarantees these loans, allowing lenders to provide more advantageous conditions and interest rates. Which also makes them easier to get. Lenders may be more prepared to risk financing newer or riskier businesses if they know the government supports the loans.

But the downside is the application and approval process for an SBA loan can be longer and more involved than for other lending programs. SBA-approved lenders, including conventional banks and microlending organizations, facilitate loans.

When to Consider SBA Loans

You need a larger loan amount: SBA loans can be used for larger investments, such as purchasing real estate or acquiring another business, and can provide funding up to several million dollars.
You have limited collateral: SBA loans may be a good option for businesses that don't have the collateral required for traditional loans, as lenders are not required to take collateral for loans up to $25,000.
You have a limited credit history: SBA loans may be more accessible to businesses with a limited credit history or who have experienced financial difficulties. Even companies with bad credit may qualify for startup funding.
You need longer repayment terms: The more flexible payback terms of SBA loans mean firms can better manage their cash flow and undertake long-term investments.
You need more favorable terms: The terms of SBA loans are often more advantageous to firms than those of conventional loans, including lower interest rates, more extended payback periods, and smaller initial down payments.

Invoice Financing

A corporation uses invoice or receivable accounts financing to sell its unpaid bills to a third-party lender at a discount. The creditor loans the company a portion of the value of the late invoices in advance and recovers the total amount from the clients when the bills are past due.

Invoice financing is well-known for ensuring that small business owners receive capital within days, being a flexible option to obtain funding at any time, and being more accessible to qualify for than other traditional types of financing.

When to Consider Invoice Financing

You have slow-paying customers: Customers that take too long to pay invoices might strain a company's ability to make ends meet. Invoice financing allows companies quick access to capital by funding some of their unpaid receivables.
You need to cover short-term expenses: Invoice finance might be a viable choice for companies who need to meet short-term obligations like payroll or inventory purchases but don't have the cash on hand.
You don't qualify for traditional loans: If a company cannot obtain conventional loans owing to circumstances such as a lack of credit history or poor credit scores, invoice finance may be a viable solution.
You want to avoid taking on debt: Invoice finance is not a loan but rather an advance on money owed to the company. This means that companies can boost their cash flow without incurring new debt.
You want to focus on their core business: Invoice finance firms receive consumer payments, freeing up a company's time and resources to focus on other elements of its operations.

Equipment Financing

With the help of equipment finance, a company may get the machinery and tools it needs to run without having to come up with the money for the purchase out of pocket. The business will have full ownership of the equipment once the loan has been repaid, which serves as collateral for the loan. If the company defaults on the loan, the lender may take possession of the equipment.

When to Consider Equipment Financing

You need to conserve cash: Equipment financing enables firms to obtain the equipment they require without having to pay the entire cost up front. This can help firms save money for other purposes, such as covering day-to-day expenses or investing in development prospects.
You need to replace outdated equipment: It may be necessary to replace old or broken machinery for a company to continue running. Companies can get the money they need to buy new machinery and tools through equipment financing rather than using their resources.
You want to preserve credit lines: If a company wants to make more purchases or investments in the future, it may not want to use its credit lines to finance equipment acquisitions. Equipment financing can provide firms with a separate line of credit solely for acquiring equipment.
You want to spread out payments: Regular monthly payments over a predetermined time frame are often required for equipment financing. Businesses may find it simpler to plan their budgets and manage their cash flow as a result.
You want to avoid obsolescence: If a business needs to stay up-to-date with the latest technology or equipment to remain competitive, equipment financing can provide a way to acquire new equipment without paying the full cost upfront.

Loans for Your Small Business

Think carefully about whether or not your company can afford the loan's interest and charges before committing to it. Consider the loan's qualifying standards and whether or not your company has good enough credit to qualify.

It would help if you also thought about how taking on debt can affect your company's cash flow and overall financial health. Excessive debt can strain a company's finances and make it challenging to satisfy other financial responsibilities, such as wages or rent.

For more insights and resources regarding loan options, get connected with an Old National Small Business Banker today!

This article was written by Amaka Chukwuma from Wealth of Geeks and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to legal@industrydive.com.