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10 types of small business loans

Higginbotham is not a law firm, and this article is not meant to provide legal advice.

Every small business is unique, as are its capital needs. Navigating the world of small business loans can be confusing. Here are 10 of the most popular types of loans and funding options for small business owners.

What is a Small Business Loan?

A small business loan falls under the category of debt financing, which is what happens when a business borrows money to operate, rather than raising money from investors (equity financing).

Business loans are offered by lenders. In exchange for the money, they charge the business owner interest on top of the loan amount—in the most basic loan structure, interest is charged as a percentage of the loan’s principal.

A small business loan gives business owners access to capital to invest in their business. In the typical small business loan structure, a lender will give a business owner money, which the business owner must pay back, with interest, over a predetermined period of time.

Each type of business loan has its own set of requirements and features. Aspects such as the time you’ve been in business, your business financial health, your credit score, and available collateral all play a role in determining the type of business loan you can get.

Types of Small Business Loans

There are numerous financing options and types of small business loans on the market today, many available through brick and mortar and online lenders.

When you’re trying to find the ideal type of funding, take the following factors into consideration:

  • Interest rate: the amount of the loan that you’ll be charged as part of the agreement
  • Term length: the duration of the payback period
  • Loan amount: the total funds offered
  • How you’ll use the funding: what you’ll do with the money from the loan
  • Your business’s goals: what you’re hoping to accomplish by receiving funding

Here are 10 of the most common types of small business loans.

#1: Term Loans

A term loan is a lump sum of capital borrowed from a lender and paid off at fixed intervals over a set period or term.

Examples of term loans you may be familiar with are student loans, mortgages, or auto loans.

A term loan is often used for investment in long-term business growth, providing time for the investment to contribute back to the business before the loan matures.

Term loans are often used to help with investing in inventory or equipment, adding staff, expanding product lines and services or refinancing debt.

Types of Term Loans

  • Short-Term Loans: short-term loans are unsecured sums that are repaid within a year and are normally used for expenses in which you will immediately receive the cash flow to pay off. They are relatively easy to obtain but can have a much higher interest rate than long-term loans.
  • Intermediate-Term Loans: intermediate-term loans can be repaid directly from the asset they were used to finance on a bi-weekly or monthly basis. These loans are often used to finance hiring new employees to help facilitate company growth and increased revenue.
  • Long-Term Loans: the term of long-term loans is usually three to up to 20 years. These loans may offer lower interest rates, but the qualifications are more stringent. While term loans are versatile, they are most often used for established businesses versus startups, which may not have accurate financial projections, and those with poor credit, who will face much higher interest rates.

How to Apply for a Term Loan

Term loans are traditionally available through banks, though the application process can be long and a little complex. Some of the documents a small business owner will need may include:

  • Driver’s license or other ID
  • Voided business check
  • Bank statements
  • Balance sheet
  • Credit score
  • Tax returns (personal and business)
  • Profit and loss statements

#2: Business Line of Credit

A business line of credit is a lot like a business credit card. It provides the small business owner with access to money that can be used for business expenses. Like a credit card, the lender will set the limit on the amount you can borrow, and interest accumulates once you start drawing on those funds.

Opening a business line of credit is a way to gain access to short-term funding for operational expenses or inventory. Rates for a business line of credit tend to be lower than actual business credit cards.

Another advantage is the opportunity to help your business credit rating by paying off the debt quickly.

How to Apply for a Business Line of Credit

You can get a business line of credit from a traditional bank or online lender. Banks will require your business to have strong revenue and one to three years of positive history to qualify, as well as the following documentation:

  • Tax returns (business and personal)
  • Bank account information
  • Business financial statements

Online lenders generally have fewer restrictions and qualifications than banks, but they tend to charge higher interest rates and have lower credit limits.

#3: SBA Loan

The Small Business Administration (SBA) can help businesses find the funding and resources they need. SBA loans cap at $5 million, and the loan term is usually between 10 and 30 years.

With an SBA loan, the SBA isn’t actually the lender. The agency establishes the guidelines for business loans and then guarantees a portion of the loans. Because lenders have much less risk in the case of a default, they’re more likely to provide funds to small business owners.

Types of SBA Loans

A few of the more popular SBA loans include:

  • SBA 7(a) Loan: this type of loan is the most universal as far as popularity and range of dollars loaned. For most business loans under $350,000, you may not be asked for collateral. Those above that – up to $5 million – will be asked to provide significant collateral to address risk or default.
  • SBA 504 Loan: these business loans are used mainly to fund projects such as building or buying a facility, buying land or long-term machinery. In order to qualify, a business must have a net worth of over $15 million and an average net income of $5 million or less.
  • SBA Express Loan: if you apply for this loan, your application will most likely be reviewed in 36 hours or less; however, the actual funds will take longer to arrive. If you qualify, you can finance up to $350,000.

How to Apply for an SBA Loan

Each program has specific eligibility criteria and an application process. Visit the SBA website for information on how to apply for an SBA loan and for checklists to ensure you have everything you need for a successful loan application.

#4: Equipment Financing Loan

An equipment financing loan is explicitly for the purchase of machinery and equipment essential to running your business – anything from farm machinery to medical equipment to commercial ovens.

Equipment loans come in amounts from $5,000 to $5 million with a loan term of one to five years.

When you obtain business equipment using this type of financing, the equipment itself serves as collateral for the loan. At the end of the term, however, you gain ownership of the equipment and may be eligible for tax savings through depreciation deductions.

How to Apply for an Equipment Financing Loan

For an equipment financing loan, you’ll need to provide your credit score and prove the financial health of your business, most likely with tax returns and bank statements.

Equipment lenders will typically ask for information about the equipment you’re purchasing with the financing. This is why most equipment financing applications will require an equipment quote or equivalent documentation of the equipment cost. You may need the following documents:

  • Driver’s license or other ID
  • Voided business check
  • Bank statements
  • Credit score
  • Business tax returns
  • Equipment quote

#5: Business Credit Cards

A business credit card is created specifically for small business owners and may serve the function of a loan. Business credit cards work similar to consumer credit cards, but often offer specific benefits that align with business needs.

Similar to a business line of credit, a business credit card has fixed limits, and you can charge up to that amount as needed. Only revolved debt will be assessed financing fees. Unlike business lines of credit, you can keep the account active for as long as you like. And business credit cards are more likely to offer a rewards program than business lines of credit.

How to Apply for a Business Credit Card

When you apply for a business credit card, you’ll need to supply all of the information that you’d customarily provide to apply for a personal card. Basic contact information like your name, mailing address, phone number, and email will all be part of the application. You’ll also need to provide several items specific to your business, including your:

  • Business’s name
  • Business’s address
  • Years in business
  • Annual revenue
  • Estimated monthly expenses using the card

In addition, you’ll need to provide your tax identification number (TIN). If your business is incorporated, this may be your business’s employee identification number (EIN). If you’re a sole proprietor or a single-member LLC, this may just be your Social Security number. You’ll also need to state your position at the company, as well as Social Security numbers for any other business partners who own over a certain percentage of the business (usually 20 percent or more).

Depending on the issuer, a card application may also ask what industry the business is in, the nature of business (whether it’s for profit, for example), and the number of employees or additional cardholders.

#6: Personal Loans

If your business is too new to qualify for a traditional business loan, another option is a personal loan. When underwriting small business loans, for example, lenders look at your company’s revenue, time in business, and credit score. Personal loans are underwritten based on your personal credit score and income.

Personal loans can have lower annual percentage rates than other financing options and have fixed payments that ensure your loan is paid back within the time frame. In addition, most personal loans are funded within one week of approval or less, as opposed to an SBA loan, which can take a month or more.

However, personal loans are usually granted in smaller amounts – from $2,000 to $50,000 – and have a shorter repayment term than other financing options. Also, interest paid on a personal loan is typically not tax-deductible like other business loans, unless you can show that the entirety of the personal loan is used to cover business expenses. Talk to your financial and legal advisors for details.

How to Apply for a Personal Loan

Visit lender websites or make phone calls to determine if your financial profile makes you eligible for a loan from that lender. Find out if there is a minimum required credit score and whether there is an income threshold. Determine if there’s a required minimum length of credit history—three years or more is common—and what is considered an acceptable debt-to-income ratio.

Documents you may need include:

  • Loan application
  • Proof of identity, including:
    • Driver’s license
    • Passport
    • State-issued ID
    • Certificate of citizenship
    • Birth certificate
    • Military ID
  • Employer and income verification, including:
    • Paystubs
    • Tax returns
    • W-2s and 1099s
    • Bank statements
    • Employer’s contact information
  • Income verification, if you’re self-employed, including:
    • Bank statements
    • 1099s
    • Income tax returns
  • Proof of address, including:
    • Utility bill
    • Lease or rental agreement
    • Proof of insurance on your home, lease/rental, or vehicle
    • Voter registration card

#7: Invoice Factoring and Invoice Financing

Invoice factoring and invoice financing are two ways your business can acquire on-demand or ongoing sources of funding that in some cases can help you collect payment from customers.

  • Invoice Factoring: invoice factoring, also known as accounts receivable factoring, is a process in which a business owner sells some or all of the company’s outstanding invoices to a third party (the factor) as a way of improving cash flow and revenue stability. Invoice factoring is often used when a business routinely has a lot of outstanding invoices that are affecting its business cash flow. By using invoice factoring, a business can have the bulk of its invoices paid almost immediately versus having to wait for the money to come in, which may help the business to survive. It also may be easier and cheaper than a traditional bank loan and can make chasing down payments from delinquent customers easier.

How to Apply for Invoice Factoring

Most companies that offer accounts receivable financing are commercial lenders, not banks. To apply for accounts receivable financing, you’ll have to fill out an application and share your articles of incorporation, your company’s most recent accounts receivable and payable reports, a master customer list, and an example of your typical invoice.

  • Invoice Financing: invoice financing, also known as invoice discounting, is when a business borrows money against its outstanding accounts receivables. The lender will give you a portion of your unpaid invoices up front – usually 80 to 90 percent – in the form of a loan or line of credit. When your client pays the invoice, you pay the lender back for the amount loaned plus fees and interest. Invoice financing is more confidential than invoice factoring, so your customers will have no idea you’re borrowing against their invoices. It’s also cheaper than invoice factoring. However, you need to have a strong and established credit collection process and a positive net worth on your balance sheet.

The main difference between invoice factoring and invoice financing is in who collects the business’s unpaid invoices. In invoice financing, the customer retains full control of the collections. In invoice factoring, the factoring company purchases the unpaid invoices and takes over collections.

How to Apply for Invoice Financing

One of the advantages of invoice financing is these types of small business loans are not as paperwork intensive. Generally, you can apply to a lender with just the following documentation:

  • Credit score
  • Basic details about your business (such as your industry and time in business)
  • A couple of months of bank statements
  • Information about your outstanding invoices

Some companies offer software that will tie directly into your business bank account and enable lenders to see your financials, which can help with the invoice financing application process.

#8: Merchant Cash Advance (MCA)

A merchant cash advance (MCA) is a cash advance based on the credit card sales deposited into a business’s merchant account. Your business receives a lump sum of cash up front, then you pay back the advance with a percentage of your daily sales.

You can use merchant cash advances on most business expenses: business expansion, equipment repairs, cash flow gaps, etc. Your business can receive cash advances from anywhere from $5,000 to $400,000.

While merchant cash advances are debt, they are a little more predictable. Your payments are dependent on your daily sales volume, so they rise and fall accordingly.

How to Apply for a Merchant Cash Advance

Applying for a merchant cash advance starts by looking at online business lenders and filling out their online applications. Expect to provide three months’ worth of financial statements.

#9: Microloans

Microloans provide small loans to start-up newly established/growing small businesses. They are often used to help disadvantaged or underserved entrepreneurs get business financing to start or expand their businesses.

Businesses can use microloans for a range of purposes, including working capital or buying equipment, machinery or supplies.

A microloan doesn’t come from a financial institution or alternative lender but from individuals or nonprofits. Some focus on certain groups of entrepreneurs, such as immigrant, veteran, woman, or minority-owned small businesses.

Recipients of microloans may be entrepreneurs in developing countries where it can be difficult to access traditional loans or U.S. residents who own or plan to start a business but cannot qualify for a bank loan or need a relatively small amount of money. Loan amounts are typically between $500 and $50,000. For the SBA’s micro-lending program, for example, the average loan is roughly $13,000.

Microloans may charge slightly higher rates than traditional bank loans, but generally have reasonable interest rates from 6 percent to 18 percent and a repayment term of up to seven years. They also provide mentoring or entrepreneurship education to help small business owners build good credit with the goal of being able to qualify for traditional bank funding.

How to Apply for a Microloan Through the SBA

Contact your local economic development office and speak to the person in charge of microloans.

The SBA disburses microloan funds through local, non-profit community organizations that assist borrowers in managing the loan. A complete list of local lenders is available on the SBA website.

You’ll apply directly through the intermediary lender, which will need to know the purpose of the loan. The exact documentation required will vary, but be prepared to supply the following documents:

  • Personal tax returns (at least two years)
  • Recent pay stubs
  • A list of collateral
  • Business plan
  • Cash flow projections
  • Contracts, quotes, or purchase agreements

Existing small businesses will also need to document business financials, which may include:

  • Business tax returns
  • Balance sheet and income statement
  • Business lease and contracts
  • Business licenses and permits
  • List of current business assets

#10: Commercial Real Estate (CRE) Loans

Commercial real estate (CRE) loans are typically used to purchase or renovate commercial property.

Three of the most common types of real estate loans include:

  • Permanent Loans (Traditional Commercial Mortgage Loans): permanent loans, often referred to as traditional commercial mortgage loans, are first mortgages on commercial property. A permanent loan must have some amortization (repayment schedule) and a term of at least five years. Qualifying for this type of loan requires good credit and a high debt service coverage ratio (DSCR), which shows your small business is generating enough revenue to repay the loan. Traditional commercial mortgage loans tend to carry low interest rates.
  • SBA Loans: SBA loans are written by both traditional and non-traditional lenders, but are guaranteed by the Small Business Administration. The most popular SBA loan that caters to different types of borrowers is the 7(a) loan, whose name comes from section 7(a) of the Small Business Act, which authorizes the agency to provide business loans to American small businesses. This loan program is designed to assist for-profit small businesses that are not able to get financing from other resources.
  • Bridge Loans: bridge loans are typically obtained when a borrower is waiting on longer-term small business financing. This type of loan provides a short-term first mortgage loan on a commercial property, typically with a six-month to a three-year term. Down payments on commercial real estate loans range from 20 to 30 percent of the purchase price, and interest rates range from 10 to 20 percent. Most of these loans require the property to be owner-occupied in at least 50 percent of the building.

How to Apply for a Commercial Real Estate Loan

Applying for a commercial real estate loan can be slow and often requires a lot of documentation. In general, banks and lenders will require you to provide this common information:

  • Business tax returns
  • Your books, records, and financial reports
  • Last three months or more of bank statements
  • Details regarding collateral
  • Third-party appraisal of the property
  • Business plan

Finding the right kind of small business loan for you can be daunting. The best place to start is by identifying what your use of the loan will be. Then answer some key questions, like what do you need the extra capital for, what is your desired loan amount, how quickly do you need the funds, and what is your credit score? You should also consult with your financial and legal advisors to understand tax implications, and who is liable for repayment. Then, explore your lending options and find the type of loan that best suits your business needs.

Not sure where to start? Talk to someone who wants to listen.

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