As a small business owner, it’s common to find yourself in situations that require urgent cash. This cash emergency has led to the rise of companies, institutions and governments offering business loans and financing options.
Although small business goals share a common goal, these loans have different factors that set them apart. It is necessary to ensure that you have knowledge about these loans and how they work.
Knowing about these different loan types will ensure that you don’t make the big mistake of choosing the wrong loan. Business loans should be chosen based on urgency of money, affordability of interest rates and convenience of repayment period.
An example of a bad business loan is when a business owner wants a quick loan to help them buy new stock, then chooses a personal loan.
In this article, we’ll look at the different types of small business loans and which ones are best for you.
a. Term loans
Term loans are the most common and widely adopted business financing option. In the case of term loans, the business owner asks for a specific amount of money up front. When negotiating the term loan, the company is given a predetermined period in which the loan must be repaid.
Term loans also embed interest rates. You should check the interest rate and repayment period of term loans. You need to make sure that your company will manage the interest rate and payment term specified.
The interest paid at the end of the term loan often depends on the payment period. In term loans, failure to pay results in a fine, as stated in the loan agreement.
Term loans are granted by banks or online lenders. Online lenders offer faster loan processing and often provide better support for small business loans. In Canada, for example, online lenders can offer loans up to CAD 1 million. Securing such an amount from a bank is highly unlikely since their lending limits are usually extremely low, even for stable businesses.
b. Business line of credit
Commercial line of credit is almost similar to term loans in that you only pay interest on the amount drawn. For term loans, a business owner may take out a loan and end up using a small portion of the money. In such a situation, the lending institution will always charge interest on the full principal amount.
The business line of credit allows the business owner to take out loans from a checking account with a revolving credit limit. It works the same way as a credit card. In the business line of credit, the business owner can take out a loan that reaches the maximum loan limit, pay it off, and take out another loan.
An advantage of this type of loan is that they are unsecured loans that do not require collateral.
vs. SBA Loans
Banks and other lending institutions provide loans to the Small Business Administration (SBA). They are classified as long term loans as they offer long repayment terms. Businesses frequently use SBA loans to finance real estate purchases, commercial equipment purchases, and working capital.
The repayment period granted depends mainly on the purpose of the loan. Repayment terms can range from 7 years to 25 years. SBA loans offer high loan limits of up to $5 million. The problem with SBA loans is that the application process is quite long and tiring. Loans also take a long time to process and approve.
SBA loans are therefore not recommended for business owners looking for quick cash.
D. Equipment loans
For business owners specifically looking to purchase equipment, it is more advisable to take out equipment loans rather than SBA loans. Equipment loans provide the amount of money needed to purchase equipment, and the equipment purchased serves as collateral.
Repayment terms for equipment loans depend on the expected life of the purchased equipment. Equipment loan interest rates vary depending on the financial worth and stability of the business and the value of the equipment.
The advantage of equipment loans is that businesses with good credit can get low interest rates.
Commercial auto loans are also classified as equipment loans. Equipment loans are the best option for a business looking to own equipment and slowly build equity on purchased equipment.
e. Invoice financing
Invoice financing is the use of unpaid commercial invoices to obtain cash advances or loans from lending institutions. Invoice financing provides quick access to cash for businesses. However, the disadvantage of using invoice financing is that its rates are very high.
Although you used unpaid invoices as collateral to obtain the loan, you still own the invoices. This means that the business is required to collect the payments and transfer the money to the lending institution.
Invoice financing should only be considered as a financing option if there is no other viable financing method.
f. Factoring of invoices
Similar to invoice financing, invoice factoring uses unpaid invoices to secure business loans. The difference, however, is that invoice factoring involves waiving all rights of a factoring company to obtain advance payments.
In invoice factoring, the factoring company is the one who is responsible for collecting payments for unpaid invoices. A thorough analysis of factoring and invoice financing as a method of financing businesses reveals that they are technically not loans.
Both sell unpaid invoices at a discount to factoring companies for cash advances. These methods significantly reduce a company’s revenue and should only be taken as a last resort for financing.
While accepting any finance option that uses unpaid bills as collateral, you also need to be alert and watch out for hidden charges. These charges may include processing fees, service charges, late payment penalties, etc.
Based on the loan options available to businesses outlined above, the best option when in need of quick cash is term loans. However, if you are unsure of the exact amount you need, choose a business line of credit.
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For businesses looking for high loan amounts without the hassle of long repayment periods, SBA loans are a good option. However, small business loans should not be taken out to purchase equipment. This is because the SBA loan will require collateral. For acquiring business equipment, equipment loans are the best.