10 types of lending to get your business moving.
There’s an old saying,
When you start a business it always takes twice as long as you thought it would, cost twice as much as you thought it would, and you make only half what you thought you would.
Many entrepreneurs underestimate the costs of starting a business and it’s very common for them to need seed capital or other funding to get through the early stages of business growth. According to a survey by Dun & Bradstreet in 2015, 60% of new business owners will approach friends or family for financial assistance at some point to start their new business.
If you don’t like the idea of asking family for money to get things moving then you might want to familiarize yourself with the types of business financing that are out there these days.
Many years ago, small business lending was all about traditional term loans. While these are still a great choice, there are more options than ever before, such as banks, the SBA, commercial lenders, and even your personal credit cards.
Whatever your needs are, you don’t need to pinpoint the exact type of loan you need before you approach a lender; they will help you decide what type of financing is best for your needs. However, you should have some general idea of the different types of loans available so you'll understand what your lender is offering.
Here’s an inside peek at how lender’s typically structure loans with common variations.
1. Line-of-credit loans.
The most useful type of loan for small-business owners is the line-of-credit loan. In fact, it’s probably the one permanent loan arrangement every business owner should have since it protects the business from emergencies and stalled cash flow. Line-of-credit loans are intended for purchases of inventory and payment of operating costs for working capital and business cycle needs. They're not intended for purchases of equipment or real estate.
A line-of-credit loan is a short-term loan that extends the cash available in your business’s checking account to the upper limit of the loan contract. Every bank has its own method of funding but, essentially, an amount is transferred to the business’s checking account to cover checks. The business pays interest on the actual amount advanced from the time it's advanced until it's paid back.
Line-of-credit loans usually carry the lowest interest rate a bank offers since they're seen as fairly low-risk. Some banks even include a clause that gives them the right to cancel the loan if they think your business is in jeopardy. Interest payments are made monthly, and the principal is paid off at your convenience, though it's wise to make payments on the principal often.
Most line-of-credit loans are written for periods of one year and may be renewed almost automatically for an annual fee. Some banks require that your credit line be fully paid off for seven to 30 days each contract year. This period is probably the best time to negotiate. Even if you don’t need a line-of-credit loan now, talk to your banker about how to get one. To negotiate a credit line, your banker will want to see current financial statements, the latest tax returns, and a projected cash-flow statement.
2. Term Loan.
As noted above, this is the most conventional type of loan.
With this, you borrow a lump sum of cash that is paid back, plus interest, over a predetermined period of time (such as five or seven years).
If you like the idea of a conventional loan that is easy to understand, this may be what you are looking for.
3. SBA Loan.
There are many features of an SBA loan that make it more appealing than a term loan. For example, the long term lends well to those who are seeking a lower monthly payment.
Also, SBA loans are known for their low interest rates. On top of this, and perhaps most importantly, these are partially guaranteed by the government.
The downside? Well, the SBA requires every aspect of your personal credit as well as your business to be near perfect, and these loans are notoriously difficult to qualify for. The SBA reports that they only approved 1.8% of the applications they received last year. YIKES!
If you want to learn more about the many types of SBA loans, you can visit the U.S. Small Business Administration website.
4. Small Business Startup Loan.
As the name suggests, this is a startup loan for a company with little to no business or credit history.
Many products fit into this category, such as startup equipment financing. This is used to purchase equipment when starting a business. It is almost always necessary for the business owner to provide a personal guarantee or to provide some type of collateral for this kind of funding.
5. Secured and unsecured loans.
Speaking of personal guarantee, you should know that loans can come in one of two forms: secured or unsecured. When your lender knows you well and is convinced your business is sound and the loan will be repaid on time, they may be willing to write an unsecured loan. Such a loan, in any of the aforementioned forms, has no collateral pledged as a secondary payment source should you default on the loan. The lender provides you with an unsecured loan because it considers you a low risk. As a new business, you're highly unlikely to qualify for an unsecured loan; it generally requires a track record of profitability and success.
A secured loan, on the other hand, requires some kind of collateral but generally has a lower interest rate than an unsecured loan. When a loan is written for more than 12 months, is used to purchase equipment, or does not seem risk-free, the lender will ask that the loan be secured by collateral. The collateral used, whether real estate or inventory, is expected to outlast the loan and is usually related to the purpose of the loan.
Since lenders expect to use the collateral to pay off the loan if the borrower defaults, they'll value it appropriately. A $20,000 piece of new equipment will probably secure a loan of up to $15,000; receivables are valued for loans up to 75 percent of the amount due; and inventory is usually valued at up to 50 percent of its sale price.
6. Personal Loan for Business.
A personal loan for business is one that is made to you, the business owner, based on your personal finances.
If you have strong personal finances, such as a high credit score and net worth, a personal loan for business may be the best way to secure the funds you need to finance your business venture.
But beware, this kind if loan has the most inherent risk to the you as an individual since you will be required to use your personal assets, such as your home, 401k, or savings as collateral. With this option, the lender won't care to see a business plan or financial projections for the business. The loan is made based on your personal ability to pay it back, regardless of the success of the business.
7. Invoice Financing.
This is for established businesses with outstanding invoices.
The primary benefit of invoice financing, also known as accounts receivable financing, is the ability to get paid for outstanding invoices without waiting.
While you can gain quick access to the money that is due to you, this comes with a fee. The typical factor fee is somewhere in the three to five percent range.
8. Letter of credit.
Typically used in international trade, this document allows entrepreneurs to guarantee payment to suppliers in other countries. The document substitutes the bank’s credit for the entrepreneur’s up to a set amount for a specified period of time.
9. Unsecured business credit cards.
With a solid enough business credit score, your business can qualify for credit cards in the name of the business with no SSN required on the application. That means, no personal credit check or guarantee.
Let’s be clear, with this option, you don’t need to speak to a lender, you’ll be working directly with the credit card company.
The upside of this option is that you can expect to get introductory rates on these cards as low as 0%. Sounds good right?
Here’s the catch: You need to have an excellent business credit score to qualify, and most new business owners won’t have this. If you are interested in learning how to quickly do this for your business you can check out this business credit training course.
10. Merchant advance/cash Advance.
A merchant cash advance allows a business owner who accepts credit card payments or has other payment or receivables streams to obtain an advance of the funds regularly flowing through the business’ merchant account.
A merchant cash advance (MCA) is not a loan, but rather an advance based upon the future revenues or credit card sales of a business. A small business can apply for an MCA and have an advance deposited into its account fairly quickly.
These advances are comparatively easy to qualify for… because rates on a merchant cash advance are typically higher than other small business loan options (sometimes higher than triple digit annualized interest rates).
The term “cash advance” has no technical definition but it generally refers to short-term loans with streamlined approval processes, quick funding, and generally high interest.
Which Type of Loan is Best?
In a perfect world, you would always have enough money on hand to fund anything your business requires.
In the real world, you can’t expect this to hold true at all times. There will be situations in which you need to search for outside funding, often in the form of a loan.
Ask these questions when attempting to decide what type of loan is best for your company:
- What do you need the money for?
- How much money are you comfortable paying each month?
- What type of loan will allow you to access the funds you require at the lowest possible interest rate?
- Do you qualify for all types of business loans?
- Is now really the best time to take out a business loan?
When you compare the finer details of each type of loan, while also answering these questions, you will find it much easier to decide what to do next, and as stated above, the best resource to help you through the entire process is a lender that offers all these types of loans.
Emery Advisory Group has built network of over 2,000 lending partners and programs. Virtually every legal type of business lending available today. And since we do so much volume with these partners, our clients enjoy lower rates than are typically offered.
If you are curious to see what your business may qualify for, or just wondering what’s available, you can head over to our direct funding pre-qualification form. It takes about 5 minutes to complete and you’ll have an answer within 24 hours.
It’s good to know that there are many types of business loans. This improves the likelihood of finding one that suits your company and its financial needs.
It may take some time to learn more about each type, but the information you collect will work in your favor.