What is Business Loan?- Types of Business Loans

The right business loan can help you get the capital you need to start a new venture, expand a current business, gain access to working capital, and cover necessary business expenses. But not all business loans are created equal, and understanding how each type of loan works can give you a better idea of which one is the right fit for you and your business.

What is Business Loan?

A business loan is a loan specifically intended for business purposes. As with all loans, it involves the creation of a debt, which will be repaid with added interest. There are a number of different types of business loans, including bank loans, mezzanine financing, asset-based financing, invoice financing, microloans, business cash advances, and cash flow loans.

How Do Business Loans Work?

Business loans are a form of credit offered by lenders to businesses. In exchange for this money, lenders require repayment of the principal with interest and fees added to it. Usually, working capital loans require the borrower to make regular payments on a set schedule, but repayment terms and interest rates can vary quite a bit depending on the lender and your qualifications.

A business loan is a loan specifically intended for business purposes. As with all loans, it involves the creation of a debt, which will be repaid with added interest.

Business Loan Requirements

Regardless of which type of business loan you apply for; you’ll likely see many of the same requirements to qualify and get approved.

1. Personal and Business Credit Scores

If your business has an established credit history, lenders may run a credit check to see how the company has managed credit in the past. A poor business credit history could make it difficult to get approved for inexpensive business financing.

If your business doesn’t yet have a credit history and sometimes even if it does lenders will also check your personal credit score. This is primarily because many business loans require a personal guarantee that you’ll pay back the debt with your personal assets if your business can’t make payments.

If you have good or excellent personal credit, lenders are likely to assign more value to your personal guarantee. If, however, your personal credit score is considered poor or fair, it could pose more of a risk to the lender, and you may have a hard time getting approved.

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2. Credit Reports

While your credit scores are a good indicator of your overall credit health, they don’t tell the whole story. In addition to checking your credit score, business lenders may also check your credit reports to see if there are any tradelines to be concerned about.

If you have any missed payments, a bankruptcy or foreclosure, or an account in collections, the lender may take that as a sign that you might not repay the debt on time. On the flip side, if your credit report shows a history of responsible credit use, it can help your case, even if your credit score isn’t perfect.

3. Time in Business

Starting a business is a risky venture, so many business leaders don’t provide certain types of loans to newer businesses. On the flip side, some business loans are relatively easy to get, even if your startup is brand new.

To qualify for business term loans, SBA loans, and business lines of credit, you may be required to have been around for two or more years. You can, however, typically get trade credit, merchant cash advances, invoice financing, and collateralized loans like equipment financing from the beginning.

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4. Business Financials

Many business lenders will require detailed information about your financials, including cash flow statements, profit and loss statements, a balance sheet, bank statements, and projections for the future. The stronger your financial situation, the easier it will be to qualify for a good business loan.

Some lenders, such as those offering SBA loans, may also require you to submit your business plan with your loan application so they have a sense of what you plan to do with the funds.

5. Collateral

Not all business loans require collateral, but many of them do, especially ones with lower interest rates. Lenders will typically want a physical asset, such as real estate or equipment. If you don’t have anything of that nature, you may have a hard time getting approved for some loans.

Types of Business Loans

Here are the 10 most popular types of business loans. Loan terms, rates, and qualifications vary by lender.

  • Term loans
  • SBA loans
  • Business lines of credit
  • Equipment loans
  • Invoice factoring
  • Invoice financing
  • Merchant cash advances
  • Personal loans
  • Business credit cards
  • Microloan

1. Term loans

A term loan is a common form of business financing. You get a lump sum of cash upfront, which you then repay with interest over a predetermined period.

Online lenders offer term loans up to $1 million and can provide faster funding than banks that offer small-business loans.

Pros:

  • Get cash upfront to invest in your business.
  • Typically allow you to borrow a higher amount than other types of loans.
  • Funding is fast if you use an online lender rather than a traditional bank; typically, a few days to a week versus up to several months.

Cons:

  • May require a personal guarantee or collateral an asset such as real estate or business equipment that the lender can sell if you default.
  • Costs can vary; term loans from online lenders typically carry higher costs than those from traditional banks.

Best for:

  • Businesses looking to expand.
  • Borrowers who have good credit and a strong business and who don’t want to wait long for funding.

2. SBA loans

The Small Business Administration guarantees these loans, which are offered by banks and other lenders. Repayment periods on SBA loans depend on how you plan to use the money. They range from seven years for working capital to 10 years for buying equipment and 25 years for real estate purchases.

Pros:

  • Some of the lowest rates on the market.
  • You can borrow up to $5 million.
  • Long repayment terms.

Cons:

  • Hard to qualify.
  • Long and rigorous application process.

Best for:

  • Businesses looking to expand or refinance existing debts.
  • Strong-credit borrowers who can wait a long time for funding.

3. Business lines of credit

A business line of credit provides access to funds up to your credit limit, and you pay interest only on the money you’ve drawn. It can provide more flexibility than a term loan.

Pros:

  • Flexible way to borrow.
  • Typically unsecured, so no collateral required.

Cons:

  • May carry additional costs, such as maintenance fees and draw fees.
  • Strong revenue and credit required.

Best for:

  • Short-term financing needs, managing cash flow, or handling unexpected expenses.
  • Seasonal businesses.

4. Equipment loans

Equipment loans help you buy equipment for your business, sometimes including semi-truck financing. (Business auto loans are available for cars, vans, and light trucks.) An equipment loan’s term typically is matched up with the expected life span of the equipment, and the equipment serves as collateral for the loan. Rates will depend on the value of the equipment and the strength of your business.

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Pros:

  • You own the equipment and build equity in it.
  • You can get competitive rates if you have strong credit and business finances.

Cons:

  • You may have to come up with a down payment.
  • Equipment can become outdated more quickly than the length of your financing.

Best for:

  • Businesses that want to own equipment outright.

5. Invoice factoring

Let’s say your business has unpaid customer invoices, which are typically paid in 60 days. If you need cash now, you can get money for those unpaid invoices through invoice factoring.

You’d sell the invoices to a factoring company, which would be responsible for collecting from the customer when the invoice is due.

Pros:

  • Fast cash for your business.
  • Easier approval than traditional funding options.

Cons:

  • Costly compared with other options
  • You lose control over the collection of your invoices.

Best for:

  • Businesses with unpaid invoices that need fast cash.
  • Businesses with reliable customers on long payment terms (30, 60 or 90 days).

6. Invoice financing

Invoice financing is similar to invoice factoring, but instead of selling your unpaid invoices to a factoring company, you use the invoices as collateral to get a cash advance.

Pros:

  • Fast cash.
  • Your customers won’t know their invoice is being financed.

Cons:

  • Costly compared with other options
  • You’re still responsible for collecting the invoice payment.

Best for:

  • Businesses looking to turn unpaid invoices into fast cash
  • Businesses that want to maintain control over their invoices.

7. Merchant cash advances

You get a lump sum of cash up front that you can use to finance your business.

Instead of making one fixed payment each month from a bank account as you would with a term loan, you make payments on a merchant cash advance either by withholding a percentage of your credit and debit card sales daily or by fixed daily or weekly withdrawals from a bank account.

Pros:

  • Fast cash.
  • Unsecured financing.

Cons:

  • Some of the highest borrowing costs up to 350% in some cases.
  • Frequent repayments can create cash flow problems.

Best for:

  • Businesses that have high and consistent credit card sales and can handle frequent repayments.
  • Businesses that can’t get financing anywhere else and can’t wait for capital.

8. Personal loans

It is possible to use a personal loan for business purposes. It’s an option for startups, as banks typically don’t lend to businesses with no operating history.

Approval for these loans is based solely on your personal credit score, but you’ll need good credit to qualify.

Pros:

  • Startups and newer businesses can qualify.
  • Fast funding.

Cons:

  • High borrowing costs.
  • Small borrowing amounts of up to $50,000.
  • Failure to repay can hurt your credit.

Best for:

  • Startups and newer businesses with strong personal credit.
  • Borrowers willing to risk damaging their credit score.

9. Business credit cards

Business credit cards are revolving lines of credit. You can draw from and repay the card as needed, as long as you make minimum monthly payments and don’t exceed the credit limit.

They are typically best used for financing ongoing expenses, such as travel, office supplies, and utilities.

Pros:

  • Earn rewards on your purchases.
  • No collateral required.

Cons:

  • High cost, with a variable rate that may rise.
  • Extra fees may apply.
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Best for:

  • Ongoing business expenses.

10. Microloan

Microloans are small loans $50,000 or less offered by nonprofit organizations and mission-based lenders.

These loans typically are available to startups, newer businesses, and businesses in disadvantaged communities.

Pros:

  • Low cost.
  • Other services may be provided, such as consulting and training.

Cons:

  • Smaller loan amounts.
  • You may have to meet stringent eligibility requirements.

Best for:

  • Startups and businesses in disadvantaged communities.
  • Businesses seeking only a small amount of financing.

How Does Business Loan Repayment Work?

The type of business loan you choose also affects how you’ll end up repaying the debt. There are three main types of business loan repayment options: revolving, installment, and cash flow.

Revolving

Business credit cards and lines of credit are the two primary types of revolving business loans. When you open an account, you’ll get a line of credit that you can access whenever you need it. As you use your card or draw from your line of credit, it reduces your available credit. Once you pay back the amount you’ve borrowed, however, that amount becomes available credit again.

As long as the account is open and during the draw period of a line of credit, you can continue to borrow, repay, and re-borrow up to your credit limit.

Installment

Most business loans are installment loans. Instead of getting a revolving credit line, you receive the full amount of the loan upfront and pay it back in equal installments. This way, there’s a set repayment term, typically with fixed monthly payments.

Cash flow

Cash flow-based business loan functions similarly to an installment loan in that you receive the full amount of the loan upfront. However, repayment is based on your cash flow rather than a set repayment term.

For example, a merchant cash advance offers capital based on your debit and credit card sales. To repay the debt, you may give the lender a cut of your future debit and credit card sales. With invoice financing, you can get financing based on an accounts receivable invoice, which you’ll repay when you get the cash payment from the invoice.

How to Pick the Right Loan for Your Business

There are many different types of small business loans available for small business owners, and each works a little differently. To find out which one is best for you, start by considering where your business stands. If it’s a brand-new startup, you’ll be limited to just a few options, such as business credit cards and invoice financing.

If, however, you’ve been in business for years and have strong financials, you may have your pick of any type of loan.

As you compare different options, think about what you need out of a loan. For example, do you want a revolving line of credit or a lump-sum payment? Would you prefer installment payments or a cash flow-based payment? How sensitive are you to interest rates, and is it worth it to wait to borrow until you’re in a better financial position?

As you consider all of these factors, it’ll be easier to narrow down your choices. Once you decide which type of loan is right for you, take some more time to compare different lenders that offer that loan. Because each lender has different creditworthiness criteria and loan terms, shopping around will improve your chances of getting the lowest interest rate and best terms possible.