e you considering taking on a
small business loan to help grow your business? The small business lending landscape is rapidly changing, especially over the past few years.
For small businesses, this is great news. Traditional bank loans are no longer the only option, which is a good thing, as
82% of small businesses get their loan applications denied by the banks. And even those who do qualify for bank loans often use more than one type of business financing, for their different business needs. In fact, a recent study by the SBA on the sources of small business financing, showed that 40% of the firms used multiple sources of credit (bank loans and trade credit).
To help introduce you to this new world of small business lending, I want to walk through the 5 most popular loan products, and the pros and cons of each.
- Bank Loans
Bank loans, hands down, are going to be the cheapest source of external financing for your business. If both you and your business are financially strong, you should absolutely consider going to a bank for a loan. They mostly offer long-term loans, and sometimes lines of credit.
The biggest pro of a bank loan is the low interest. However, their loan applications can often be very time-intensive, and it could take months to secure the loan. If you need cash fast, they may not be the best option.
Generally speaking, banks are only going to want to do larger loan sizes (at least six figures), so if you just need a small amount of cash, it may not be the best fit. Since small business loan application denials are so high, it could be very discouraging to spend the time applying with a bank and then be declined. If you’re considering going this route, mentally prepare yourself for a potential “no.”
- SBA Loans
SBA loans are the most affordable “non-traditional” loan product available to small businesses, as they offer single-digit interest rates. At their core, they are essentially a traditional, long-term bank loan. What makes them different? Since the government guarantees a portion of the loan, it makes the approval process easier. As well, you can often get SBA loans for smaller sums, making them an excellent fit for smaller businesses.
The cons to an SBA loan are very similar to a bank loan: the applications are lengthy and sometimes it can take a while to hear back from lenders. However, there are now some online options for
SBA loans, which can make the application faster and more seamless.
- Medium-Term Loans
Medium-term loans are some of the most affordable products coming from the alternative, “online,” lending industry. Their terms are often shorter than SBA or bank loans, around 1- 5 years in length. They operate as a traditional term loan, with monthly payments.
The biggest pro of a medium-term loan is that its application process is much faster than bank or SBA loans. You can get funded in as little as two days. So if you need cash fast, it is one of the most affordable options to do so.
The con? The interest rates will be higher on these loans than an SBA loan or bank loan. They range from 7 to 30%.
- Short-Term Loans
Short-term loans are a great way to get cash quickly and paid off quickly. The terms for a short-term loan are usually 3 to 18 months, meaning the debt isn’t on your books very long.
Short-term loans are most unique in that you pay back the loan daily vs. monthly. Lenders will automatically debit money from your bank account each business day. Short-term loans require little paperwork to apply (most often just 3 months of bank statements), and you can get the funds in days.
The downside? These are one of the more expensive products on the market. Interest rates start at 14%, but can get much higher. In some cases, APRs have been known to hit three-digit percentages. If you are considering a short-term loan, make sure to have someone walk you through the costs.
- Invoice Financing
Invoice financing isn’t really so much a product as it is an industry. You have invoice factoring, specialized invoice financing companies, or lines of credit secured by accounts receivable.
What all of these types of financing have in common is that your accounts receivable help you secure the funds, as they are seen as collateral by these lenders. Factoring companies buy the invoice from you, taking on the debt and controlling the collection of the invoice. Invoice financing companies will advance you a sum around 80% of your total invoice amount, and when the customer pays you back, you can pay back the sum plus fees. Asset-based lines of credit are usually a credit line that is around 80 to 85% of your total invoices that you can borrow against, paying back what you borrowed as your customers pay you.
Although there are different ways to utilize your receivables to find funding, this is a great option if you’ve had trouble securing traditional financing. You can get your funding in days. The downside is that this can often be as expensive as a short-term loan, and every financing company has a different fee structure. Be sure you understand the cost structure before committing to this type of financing.
- Purchase Order Financing
Purchase order financing solves the cash flow gaps of small businesses by giving you funding for specific single (or multiple) orders from your vendors. The way it works is that a financing company pays your vendor for your order, you get the goods, and then you pay the financing company back at a later date. Depending on the specific purchase order financing company and your business’s qualifications, they may pay for a portion or all of the order.
This type of financing works particularly well for businesses with specific purchases in mind. The orders can range from repeat transactions (like monthly B2B service fees), to seasonal cash flow gaps, or new projects to accelerate business growth. As this capital is used directly for a purchase,
you’re only paying interest on money you’re using, versus with some business loans, where you could be paying interest on a working capital loan that is just sitting in your bank account.
This is a great option for new businesses who haven’t had a chance yet to build up their credit. The rates are often higher than traditional bank loans, but more affordable than short-term loans.
Finding the right financing mix for your business
If you’re about to start your small business loan search, good luck!
Keep in mind you have many options, and try to consider things like your financial strength, how fast you need the funding, and the loan amount you need before you get started. Answering these questions will help you decide the best place to start.
Meredith Wood is the Editor-in-Chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. Prior to Fundera, Meredith was the CCO at Funding Gates. Meredith is a resident Finance Advisor on American Express OPEN Forum and an avid business writer. Her advice consistently appears on such sites as Yahoo!, Fox Business, Amex OPEN, AllBusiness, and many more.
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