Written by guest author Meredith Wood.
As a business owner, when you are cash-strapped due to business seasonality, slow-paying clients, or managing operations for a large order, you need resources—and fast. But how should you go about getting that financing, and what will the long-term repercussions be?
Popular business loan types
Let’s take a look at the most popular business loan types, and which one might be best for you.
1. Bank loans
Since the beginning of the 2008 recession, banks have made fewer and fewer loans to small businesses. Whether you think this is a wise practice or not, the fact remains that banks see small business lending as a big risk, and have become increasingly cautious about lending funds.
But, you should still consider them, as bank loans enable you to borrow locally at the lowest rates in the industry.
On the negative side, however, the application process is lengthy and cumbersome. On top of that, banks often have steep credit and collateral requirements, which is not always feasible for startups. Finally, banks today are lending at a low rate to small businesses, therefore, it’s possible you could go through a long and involved application process only to be rejected.
That said, for small businesses that have the bandwidth to make it through the paperwork and qualification process, the upside of potentially lower interest rates may be worth the time and effort. Research some tips for obtaining a business loan to learn more.
2. SBA loans
The Small Business Administration (SBA) is a federal agency that can help small business owners secure financing, especially when they might have trouble meeting the traditional small business loan requirements.
If a business owner has direct access to a traditional bank loan, they are typically not eligible for an SBA Loan.
There are several types of SBA loans out there, but the two most common are the 7(a) Loan Program, which entrepreneurs can use to start or expand their businesses; and the Certified Development Company (CDC) 504 Loan, which allows already established, growing businesses to cover major fixed assets like land and buildings.
The pros of both SBA loans are the very reasonable interest rates and generous repayment terms. On the other hand, though, like bank loans, SBA loans require extensive paperwork, strict approval conditions, and a long time to approve.
3. Line of credit
A line of credit works well as a safety net and can be used for a variety of purposes. It works similar to that of a credit card, and is best for short term needs like paying off more costly debts or dealing with seasonal changes in a business’s cash flow.
Another bonus for small business owners is the continuous access to the funds you need without having to reapply for a new loan every time you borrow. Lines of credit offer lower interest rates and closing fees than traditional loans, making them attractive for small business needs.
On the other hand, new businesses may find it more difficult to qualify. And, if you exceed your limit or make late payments, higher interest rates will kick in. Your borrowing limits and repayment terms are based on your business revenues, your credit rating, and several other factors, which may mean smaller loans or higher rates for new businesses.
The best bet is to apply for a line of credit before you actually need to use it. It’s well-suited for short-term needs, so don’t tie up these funds with long-term financing projects. If you do, you won’t have quick access to these funds when you need them.
4. Short-term loans
Short term loans, which typically have a duration between three and 18 months, are easier to qualify for, more widely available, and get you cash faster than their longer term counterparts.
But with that convenience comes a significant cost. Short-term loans are some of the most expensive loans on the market—so you always want to pay attention to the terms before signing on the dotted line.
If you’re in a position where failing to secure new capital will cost your company guaranteed revenue, a short-term loan is almost always a good choice. The money can be paid back quickly, with little-to-no risk. Using a short-term business refinance loan other short-term debt at a better rate can also be a smart move.
In general, short-term loans are best suited for situations where they can be directly tied to revenue. But if you’re not sure exactly how or when you’ll be able to pay the loan back, take a look at a longer-term solution.
Keep in mind that there are more than four loan types – these are just the most common. Do your homework to find the best possible solution for your unique situation, and shop around with multiple lenders to make sure you’re getting the best possible terms.