Small businesses account for nearly half of the US private workforce and create two out of three new jobs. If you're a small business owner, getting a business loan can help you start or grow your business, buy the equipment you need, or get the working capital you need. Understanding how business loans work can help you find the right loan for your business that can be a lifeline when used responsibly.
Business Loan is a type of commercial finance that eligible businesses can obtain from traditional banks, online lenders and credit unions.
Businesses can use the funds to cover costs associated with running and developing their business, including everything from purchasing working capital and equipment to large purchases such as real estate.
Business loans provide business owners with financing in the form of a lump sum or line of credit. In return for this funding, your business agrees to pay back the borrowed money plus interest and fees over time. Depending on the type of business loan, the lender may require daily, weekly or monthly payments until fully repaid.
Also, business loans are secured or unsecured. A secured loan requires collateral of value to secure the loan, such as real estate, equipment, cash, or investments, that will be returned if the lender fails to repay. However, unsecured loans do not require collateral. Instead, you are usually required to sign a personal guarantee agreeing to take personal responsibility if the business does not repay the debt as promised.
You can use business loans for many different purposes. When you apply for financing, however, you will usually need to let the lender know how you intend to use the funds. Common uses include:
You may notice a key type of purchase missing from the list above—personal expenses. In general, lenders will not allow you to use business loans to cover personal costs like residential home purchases, personal vehicles or other transactions that aren’t related to a business need.
Below you’ll find seven types of business loans you might want to consider if you need funding for your company.
Using a business loan broker can be a convenient way to find the best deals.
SBA loan is a type of funding funded by the US Small Business Administration (SBA) that guarantees a portion of the cash a business borrows through these loan programs. Therefore, the risk to the lender is low and the lender may be willing to lend money to businesses that would otherwise not approve of financing.
Interest rates on SBA loans can be competitive for qualified borrowers. Additionally, SBA loans are typically between $30,000 and $5 million, with repayment terms extending up to 25 years.
But SBA loans also have notoriously boring eligibility requirements. You are willing to jump through a lot of hoops and wait up to several months to see if you qualify. A personal credit score of 680 or higher is recommended for this type of loan.
Business term loans are another common type of business financing that’s repaid over a set period of time. You may be able to get a business term loan from a traditional bank or an online lender. Newer businesses typically have a better chance of approval through online lenders because they typically offer more flexible qualification requirements.
These loans typically have terms ranging up to 10 years, offer loan amounts up to around $500,000 and annual percentage rates (APRs) that start around 9%. Your business’ history, annual revenue and creditworthiness, including your personal credit, typically determine which loan terms you’ll have access to.
A working capital loan is short-term financing—typically a term loan, line of credit or invoice factoring—that can help businesses that need a cash infusion to cover day-to-day operating expenses such as payroll. Seasonal businesses, in particular, might benefit from a working capital loan during slow seasons when managing cash flow is a challenge.
Working capital loan terms will vary depending on the specific type of financing you apply for and the risk you pose as a borrower. In general, though, working capital loans can range from $2,000 to $5 million. As a rule of thumb, loans that feature easier-to-satisfy qualification criteria tend to come with higher interest rates and fees to offset the lender’s risk.
A business line of credit offers a flexible way to borrow money when you don’t know the exact amount of funding you need upfront. This is because borrowers can access a credit line between $2,000 and $250,000 on an as-needed basis, similar to a credit card. What’s more, you can reuse your credit limit as you repay it throughout the draw period, and you’ll only owe interest on the amount you borrow—not the entire approved limit.
Unlike business credit cards, a business line of credit’s draw period eventually expires, typically within 12 to 24 months. Once the draw period ends, the repayment period begins, and you’ll have to repay any unpaid balances, plus interest.
Repayment terms vary from 6 months to 5 years. During this period, you will no longer be able to access your line of credit for borrowing purposes.
Merchant Cash Advance (MCA) is an easy way to access short-term financing when your business needs money urgently. The business owner gives the lender (usually a merchant services company) a portion of the proceeds from future sales in exchange for a cash lump sum. These amounts and fees are reimbursed either daily or weekly through individual sales of the business or through Automated Exchange Payments (ACH).
However, simplified loan procedures and less stringent eligibility criteria can be costly. MCAs typically charge a rate between 1.2 and 1.5. For example, if the MCA amount is $10,000 and the odds ratio is 1.2, Total return on investment is $12,000. The MCA can be a good option for companies that have a high volume of sales and need quick access to cash without the right to a traditional business loan.
After collection, the factoring company pays your business the balance minus the factoring fee. Factor fees typically range from 0.50% to 5% per month of outstanding bills.
Invoice factoring is a convenient financing method for startups and new businesses that do not yet have a strong credit history.
Equipment Financing helps you finance the equipment you need, including small items such as electronics and large manufacturing equipment.
The loan amount depends on the cost of financing equipment. Lenders typically finance 80% to 100% of the cost of the equipment, but typically also require a down payment of around 15%. The duration varies from 3 to 10 years.
Business Loan Requirements may vary depending on the particular lender and plan to use the funds. The type of loan you are looking for also affects the eligibility criteria that lenders may require before approving new funding applications.
In general, you can expect the following requirements:
Minimum credit rating. Lenders usually check both your business and personal credit scores. The credit type determines the minimum required score. For example, you must have a minimum of 680 points to qualify for an SBA loan or traditional bank loan, and 630 points to qualify for an equipment finance or business line of credit. We also recommend good business loans.
annual income. Some lenders may want to verify a minimum amount of annual business income before qualifying for funding. This will help show that your business can support future debt payments.
operating hours. Businesses that are in operation longer are more likely to be approved for a loan.
Typically, lenders require that the business be in operation for at least one to two years. For some types of financing, businesses that have been in operation for at least six months are eligible.
Debt Ratio. Lenders may also review your debt-to-income ratio (DTI) and debt service ratio (DSCR). DTI compares monthly personal debt to gross income, whereas DSCR measures a business's annual net operating income in relation to total annual debt.
promise. With a secured loan, the lender requires you to provide valuable collateral, such as receivables or real estate, which can be forfeited if you do not repay the loan.
Personal Warranty. Some lenders and types of loans require personal guarantees that protect the lender in case of default. If your business does not comply with the loan agreement, the lender will require you to pay off the debt with personal funds.
.svg_20230202161558723_42.png){kind=icon}
