6 Loan Types Every Small Business Needs to Know

6 Loan Types Every Small Business Needs to Know
Ronis Gracie
on March 20, 2020
Read in 3 min

There are so many options when searching for money to grow a business that the sorting process can itself be a daunting task.

Be it the capital source debt, equity, or an intermediate mezzanine type of financing, it’s clear that today’s business owners have multiple options available.

In this article, we discuss 6 loan types every small business owner needs to know about in order to grow their business.

1. SBA Guaranteed Loans

The Small Business Association (“SBA”) guarantees loans made by its lending partners which must adhere to SBA guidelines.

Since a portion of the loan is guaranteed by the SBA, loan applications which may not have been otherwise approved become more attractive to the SBA’s private lenders.

The SBA has several types of loan programs depending upon the business’ requirement(s).

The most popular loan type is the 7(a) general business purpose loan. Small business loans, also called microloans, in amounts below $50,000 are offered to small businesses which need working capital, inventory, equipment, supplies, and furniture.

If the loan is used to purchase fixed assets, such as commercial real estate or equipment, a CDC/504 loan may be the right choice.

2. Term Loans

A term loan is a fairly straightforward traditional lending concept.

These loans set terms which the lender and the borrower agree to that include the duration of the loan, the number of loan payments and the interest rate, which may be fixed or variable.

This type of loan depends on the borrower’s credit rating and other borrower financial data.

The typical duration of term loans is between 1 and 5 years. Term loans are offered by both banks and alternative lenders.

Businesses use these types of loans for various activities including equipment and inventory purchases, providing working capital, debt repayment, taxes and other types of business uses.

3. Short-Term Loans

Short-term loans are of fixed duration, a smaller amount than standard term loans and, as its name implies, for significantly shorter periods.

Businesses typically use short term business loan lenders to infuse cash into business operations, for example, to take advantage of immediate unforeseeable opportunities such as large order fulfillment.

One such lender offering short-term loans starting at 12% APR is Lendistry.

Other purposes include providing capital for payroll, paying taxes or refinancing other short term debts at lower rates.

Seasonal small businesses usually use these loans to upgrade operations and inventory during the holiday season.

4. Invoice Financing

Invoice financing, also known as accounts receivable financing or invoice factoring, allows businesses to immediately access funds tied up in accounts receivable invoices.

The finance company that provides this type of loan typically advances 85 percent of the invoice amount(s) to the business, holding the 15 percent balance in a reserve account.

An upfront fee for the loan is typically collected by the finance company from this reserve amount.

Afterward, the finance company assesses a “factor fee” which varies with the time frame of invoice repayment.

An example might be a factor fee in the amount of 1 percent, charged each week while the invoice is held as collateral.

The business motivation behind invoice financing is to smooth out the peaks and troughs of cash flows that are driven by customer receivable accounts with lengthy terms.

Because of its cost, which is typically higher than the other loan types, businesses use invoice financing for critical operations such as payroll, taxes and other urgent cash flow necessities.

5. Merchant Cash Advance

A merchant cash advance is similar in concept to invoice financing. However, the cash advance is provided against future credit card receipt balances due.

Technically, the arrangement does not qualify as a loan because its terms differ significantly from loan terms.

Common merchant cash advance terms include the collection of an agreed upon percentage of upcoming credit card and debit card receipts.

This option is attractive to businesses that do not have a strong credit rating, but which do generate a significant amount of credit card receipts.

It allows businesses to receive cash advances against future credit card purchases by its customers for immediate business use.

The most common type of merchant cash advance relationship is between a merchant and a credit card processing company, with the terms being such that the credit card processor deducts amounts due to it by the merchant upfront before paying the merchant’s transactions.

6. Business Line of Credit

Line of credit loans make cash available up to certain preset, though not hard-set, amounts frequently used to increase a business’ working capital. The loans can be either secured or unsecured.

While the loan amount is available, in a manner similar to a home equity loan, there are no fees or other charges until the line of credit is actually accessed.

Certain types of lines of credit, referred to as revolving lines of credit, can be accessed repeatedly without the business’ having to go through the loan application process again.

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Ronis Gracie Finance Journalist

A serial entrepreneur experienced with building several small companies from the ground up and consulting for many others, Ronis understands the finer points of small business financing. He’s passionate about small business & is committed to simplifying small business lending for others.