7 Types of Loans for Businesses: Which One Should You Choose?
November 15, 2024
Starting and running a business often requires significant investment in time, research, effort, planning, funds, and many more aspects in order to properly grow a successful and sustainable business. Whether you’re looking to expand operations, purchase equipment, or simply maintain cash flow, deciding and implementing the right type or method of financing can make or break your overall business.
With one of the most commonly used types of financing is the use of business loans as it allows entrepreneurs to access the funds needed to execute expansion plans effectively without eroding their operating capital.
However, navigating the landscape of business loans can feel overwhelming and even confusing, especially with the sheer variety of options that are available to choose from. Therefore, understanding the different types of loans, along with their unique benefits and potential drawbacks, is crucial to making an informed decision that aligns with your business’s needs and long-term goals.
In this article, we’ll break down the most common types of business loans, from term loans and SBA loans to flexible solutions like lines of credit and equipment financing. With the right information at hand, your business can better grasp the most suitable business loan for your current and future needs in order to plan accordingly with your business capabilities and its development potential.
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Term Loans are said to be the standard and most common type of loan in businesses whether that be for startups or already established companies. A term loan can be understood as a loan issued by a bank, credit union, or online lender, where the borrower receives a lump sum of money upfront and repays it over a set period with a fixed or variable interest. These loans are often used for major capital investments or business expansion. The amount of funds that can be borrowed can be dependent on your industry, the purpose of the loan, and your business’s financial status.
This type of loan is said to be best suited for funding new equipment or expansions as it is suitable for large investments and significant business growth, has a fixed repayment schedule which makes budgeting predictable, and has lower interest rates for businesses with strong credit. However, it can be seen as less flexible, may require collateral or personal guarantees, and may have a longer approval process, especially with traditional lenders.
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SBA loans are partially guaranteed by the U.S. Small Business Administration, which reduces the risk for lenders and makes it easier for small businesses to qualify. This loan also has different programs which can provide for businesses with different needs (most common type is the SBA 7(a) loan).
Because the federal government guarantees to repay up to 85% of the loan amount if a borrower defaults, it reduces the level of risk involved for the lender. However, it can be difficult to qualify and the application process can be lengthy. This type of loan is said to be best for companies that are not in immediate need of cash and for businesses who wants a competitive interest rate.
Line of Credit Loans works similarly to a credit card, which provides businesses to draw funds up to a certain limit as needed and only pay interest on the money they use. This type of loan is known to be rather flexible through its repayment options as its payments are structured, making these lines of credit ideal for handling ongoing or unexpected expenses and providing some ease in cash flow management.
Although, it is noted that it may have maintenance fees or higher interest rates for smaller amounts, may be difficult to qualify for with limited credit history, and can heighten the risk of overusing credit.
Equipment loan as its name suggest is specifically designed to help businesses purchase equipment. The equipment itself typically acts as collateral, which can make it easier to qualify for this type of loan.
There are a variety of equipments and the rates of these loans vary depending on the type of equipment and the business qualifications. However, this type of loan is strictly used for purchasing necessary equipment.
Invoice financing allows businesses to borrow money against unpaid invoices in which businesses use their outstanding invoices as collateral to obtain a cash advance from a lender. The lender then advances a portion of the outstanding invoice amount and charges a fee for the service.
By converting invoices into immediate cash, businesses can meet their short-term financial obligations, invest in growth opportunities, or handle unexpected expenses without waiting for clients to pay their invoices. That’s why type of loan is usually best towards businesses needing to speed up cash flow from slow paying clients. The downside of this type of loan is that it has higher fees and interest rates which reduces profit margins, and can indicate cash flow issues to potential investors or partners.
Merchant Cash Advances offers borrowers an upfront cash payment and repays it through a percentage of future credit card sales as well as added fees. This type of loan is usually easy and fast to qualify for with loan amounts as it is based on business revenue, and repayments are through automatic withdrawals from your bank account on a daily or weekly basis.
MCA is remarked to be among the most expensive types of business loans therefore best for businesses with high volume of credit card sales who needs immediate funds. Its drawbacks include high fees and interest rates can lead to high repayment costs, and can strain cash flow for consistent earning businesses.
Microloans are typically smaller loans, usually offered by non-profit or community organizations to help startups or small businesses that may not qualify for traditional financing.
These types of loans are varied in their terms as well as their interest rates, their credit requirements tend to be lower than with traditional loans, are more flexible, and may even come with additional services, such as counseling. However, it usually provides small amounts that may not meet larger funding needs, has overall higher interest rates, and potentially may be limited in its availability depending on the location.
In conclusion, understanding the wide range of business loans available is essential for any entrepreneur or business owner seeking financial support. However, the world of business financing is vast, and the types of loans we've explored here are just the beginning. Stay tuned for part 2, where we’ll explore other additional financing opportunities to further equip you with the knowledge needed to make strategic financial decisions for your business.
